Adv Audit Module
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This Study Material has been prepared by the faculty of the Board of Studies (Academic). 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 clarification or have any suggestion for
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All care has been taken to provide interpretations and discussions in a manner useful for the
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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.
© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
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.
Basic draft of this publication was prepared by CA. Vandana D Nagpal.
Edition : April, 2023
Committee/Department : Board of Studies (Academic)
E-mail : bosnoida@icai.in
Website : www.icai.org
Price : ` /- (For All Modules)
ISBN No. : 978-81-19472-09-3
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The Institute of Chartered Accountants of India,
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© The Institute of Chartered Accountants of India
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BEFORE WE BEGIN…..
Evolving Role of a CA. - Shift Towards Strategic Decision Making
The role of a chartered accountant is evolving continually to assume newer responsibilities in a
dynamic environment. There has been a notable shift towards strategic decision making and
entrepreneurial roles that add value beyond traditional accounting and auditing. The causative
factors for the change include globalisation leading to increase in cross border transactions and
consequent business complexities, significant developments in information and technology and
financial scams underlining the need for a stringent regulatory set up. These factors necessitate
an increase in the competence level of chartered accountants to bridge the gap in competence
acquired and competence expected from stakeholders. 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 stepped up
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
apply the professional knowledge acquired through academic education and the practical
exposure gained during articleship training in addressing issues and solving practical problems.
The integrated process of learning through academic education and practical training should also
help you inculcate the requisite technical competence, professional skills and professional
values, ethics and attitudes necessary for achieving the desired level of 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
© The Institute of Chartered Accountants of India
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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.
Know your syllabus and Study Material
The Study Material of Advanced Auditing, Assurance 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 nineteen 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 webhosted on the BOS Knowledge Portal 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. Components of Each About the Component
No. Chapter
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.
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3. Beginning with a After Chapter Overview in flowchart, importance of the Chapter
Story and key points to make the Chapter interesting are explained
in the form of Story.
4 Introduction A brief introduction is given at the beginning of each
chapter/unit which would help you get a feel of the topic.
5. 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 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.
6. Test Your Test your Understanding feature is also newly added feature.
Understanding With the help of this feature student can test their
understanding and refer the answer given after the end of the
Chapter.
7. Key Takeaways This feature summarise the Key Takeaways for revision
purpose.
8. Exercise Questions Exercising questions and answers alongwith Integrated Case
with Case Study/ Scenario based MCQs would help you to apply what you have
Case Scenario / Test learnt in problem solving. In effect, it would sharpen your
Your Knowledge application skills and test your understanding as well as your
application of concepts/provisions.
Though all efforts have been taken in developing this Study Material, the possibilities of errors /
omissions cannot be ruled out. You may bring such errors / omissions, if any, to our notice so
that the necessary corrective action can be taken.
We hope that the 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!
© The Institute of Chartered Accountants of India
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SYLLABUS
PAPER 3: ADVANCED AUDITING, ASSURANCE AND
PROFESSIONAL ETHICS
(One Paper – Three hours 100 Marks)
Objective:
(a) To gain the ability to analyse current auditing practices and procedures and apply them in
auditing engagements.
(b) To develop the ability to solve cases relating to audit engagements.
Contents:
1. Quality Control
SQC 1 Quality Control for Firms that Perform Audits and Reviews of Historical Financial
Information and Other Assurance and Related Services Engagements
SA 220 Quality Control for an Audit of Financial Statements
2. General Auditing Principles and Auditors Responsibilities
SA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
SA 250 Consideration of Laws and Regulations in an Audit of Financial Statements
SA 260 Communication with Those Charged with Governance
SA 299 Joint Audit of Financial Statements
SA 402 Audit Considerations Relating to an Entity Using a Service Organisation.
(Note: Content of SA 200 Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Standards on Auditing; SA 210 Agreeing the Terms of Audit
Engagements and SA 230 Audit Documentation is covered in depth at Intermediate level.
Thus, application part of above SAs may be discussed in the form of Case Study at Final
level.)
3. Audit Planning, Strategy, and Execution
SA 300 Planning an Audit of Financial Statements; (Content is covered in depth at
Intermediate level, therefore, application part of SA 300 may be discussed in the form of
Case Study at Final level.)
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SA 450 Evaluation of Misstatements identified During the Audit
SA 520 Analytical Procedures
SA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates and
Related Disclosures
SA 610 Using the Work of Internal Auditors
SA 620 Using the Work of an Auditor’s Expert
4. Materiality, Risk Assessment and Internal Control
Evaluation of Internal Control Procedures; Components of Internal Controls; Internal Control and
Risk Assessment; auditor’s response to assessed risks; Risk-Based Audit- Audit Risk Analysis;
Reporting on Internal Control Weaknesses, Framework on Reporting of Internal Controls.
SA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance
and Management.
SA 330 The Auditor’s Responses to Assessed Risks
(Note : Content of SA 315 Identifying and Assessing the Risk of Material Misstatement
through Understanding the Entity and its Environment and SA 320 Materiality in Planning
and Performing an Audit is covered in depth at Intermediate level. Thus, application part of
above SAs may be discussed in the form of Case Study at Final level.)
5. Audit Evidence
(Note : Content of SA 500 Audit Evidence; SA 501 Audit Evidence - Specific Considerations
for Selected Items; SA 505 External Confirmations; SA 510 Initial Audit Engagements –
Opening Balances; SA 530 Audit Sampling & SA 550 Related Parties is covered in depth at
Intermediate level. Thus, application part of above SAs may be discussed in the form of
Case Study at Final level.)
6. Completion and Review
(Note: Content of SA 560 Subsequent Event; SA 570 Going Concern and SA 580 Written
Representation is covered in depth at Intermediate level. Thus, application part of above
SAs may be discussed in the form of Case Study at Final level.)
7. Reporting
SA 700 Forming an Opinion and Reporting on Financial Statements
SA 701 Communicating Key Audit Matters in the Independent Auditor’s Report
SA 705 Modifications to the Opinion in the Independent Auditor’s Report
SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent
Auditor’s Report
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SA 710 Comparative Information – Corresponding Figures and Comparative Financial
Statements
SA 720 The Auditor’s Responsibility in Relation to Other Information
8. Specialised Areas
Basic and Overview of SA 800 Special Considerations-Audits of Financial Statements
Prepared in Accordance with Special Purpose Frameworks
Basic and Overview of SA 805 Special Considerations-Audits of Single Financial Statements
and Specific Elements, Accounts or Items of a Financial Statement
Basic and Overview of SA 810 Engagements to Report on Summary Financial Statements
9. Related Services : Basic and Overview of SRS 4400 Engagements to Perform
Agreed-upon Procedures Regarding Financial Information
Basic and Overview of SRS 4410 Compilation Engagements
10. Review of Financial Information
Basic and Overview of SRE 2400 Engagements to Review Historical Financial Statements
Basic and Overview of SRE 2410 Review of Interim Financial Information Performed by the
Independent Auditor of the Entity
11. Prospective Financial Information and Other Assurance Services
Basic and Overview of SAE 3400 The Examination of Prospective Financial Information
Basic and Overview of SAE 3402 Assurance Reports on Controls at a Service Organisation
Basic and Overview of SAE 3420 Assurance Engagements to Report on the Compilation of
Pro Forma Financial Information Included in a Prospectus
12. Digital Auditing and Assurance
Auditing digitally and Digital auditing, Usage of Automated Tools such as CAAT, Data
Analytics, Artificial Intelligence, etc., Remote Auditing.
13. Group Audits
Audit of Consolidated Financial Statements - Responsibility of Parent Company, Auditor of
the Consolidated Financial Statements; Audit Considerations - Permanent Consolidation,
Current Period Consolidation; Reporting.
Audit of Group Financial Statements including the work of Component Auditors,
SA 600 Using the Work of Another Auditor
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14. Special Features of Audit of Banks & Non-Banking Financial Companies
15. Overview of Audit of Public Sector Undertakings: Concept of Propriety Audit;
Performance Audit; Comprehensive Audit.
16. Internal 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; Audit Trail, Internal Audit
as a Management Function.
17. Due Diligence, Investigation and Forensic Accounting: 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 Accounting-
meaning, difference between Statutory Audit and Forensic Accounting, Forensic Accounting
and Investigation Report, Introduction of Forensic Accounting and Investigation Standards
18. Emerging Areas: Sustainable Development Goals (SDG) & Environment, Social and
Governance (ESG) Assurance etc.
19. Professional Ethics and Liabilities of Auditors: Introduction of Code of Ethics as per
IESBA and Code of Ethics with special reference to the relevant provisions of the Chartered
Accountants Act, 1949 and the Regulations thereunder; Application of Fundamental
Principles; Application of Threats, Evaluation of Threats; Addressing Threats and
Safeguards; Conceptual Framework; Important Provisions of Chartered Accountants
Act,1949 and Chartered Accountants Regulations 1988.
Note: If any new legislations / Engagement and Quality Control Standards/ Guidance Notes/
Statements are enacted in place of the existing legislations / Engagement and Quality Control
Standards / Guidance Notes / Statements, the syllabus will accordingly include the corresponding
provisions of such new legislations / Engagement and Quality Control Standards / Guidance Notes
/Statements, with effect from the date to be notified by the Institute.
Similarly, if any existing legislations / Engagement and Quality Control Standards/ Guidance Notes
/Statements ceases to be in force, the syllabus will accordingly exclude such legislations/
Engagement and Quality Control Standards/ Guidance Notes / Statements with effect from the date
to be notified by the Institute.
Further, the specific inclusions/exclusions in any topic covered in the syllabus will be effected by
way of Study Guidelines every year, if required.
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CONTENTS
MODULE – 1
Chapter 1: Quality Control
Chapter 2: General Auditing Principles and Auditors Responsibilities
Chapter 3: Audit Planning, Strategy and Execution
Chapter 4: Materiality, Risk Assessment and Internal Control
Chapter 5: Audit Evidence
Chapter 6: Completion and Review
Chapter 7: Reporting
MODULE – 2
Chapter 8: Specialised Areas
Chapter 9: Related Services
Chapter 10: Review of Financial Information
Chapter 11: Prospective Financial Information and Other Assurance Services
Chapter 12: Digital Auditing & Assurance
Chapter 13: Group Audits
Chapter 14: Special Features of Audit of Banks & Non-Banking Financial Companies
MODULE – 3
Chapter 15: Overview of Audit of Public Sector Undertakings
Chapter 16: Internal Audit
Chapter 17: Due Diligence, Investigation & Forensic Accounting
Chapter 18 : Emerging Areas: Sustainable Development Goals (SDG) & Environment, Social
And Governance (ESG) Assurance
Chapter 19: Professional Ethics & Liabilities of Auditors
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DETAILED CONTENTS MODULE - 1
CHAPTER 1: QUALITY CONTROL
LEARNING OUTCOMES .......................................................................................................... 1.1
CHAPTER OVERVIEW ............................................................................................................. 1.2
Contents:
1. Audit Quality................................................................................................................... 1.3
2. SQC 1 Quality Control for Firms that perform Audits and Reviews of historical
Financial Information, and other Assurance and related Services Engagements .............. 1.3
2.1 Elements System of Quality Control...................................................................... 1.3
3. SA 220 Quality Control for an Audit of Financial Statements: ......................................... 1.14
3.1 Leadership Responsibility for Quality of Audits ................................................... 1.14
3.2 Relevant Ethical Requirements........................................................................... 1.15
3.3 Acceptance and Continuance of Client Relationships and Audit Engagements .... 1.16
3.4 Assignment of Engagement Teams .................................................................... 1.16
3.5 Engagement Performance .................................................................................. 1.16
3.6 Engagement Quality Control Review................................................................... 1.16
3.7 Monitoring.......................................................................................................... 1.18
3.8 Documentation ................................................................................................... 1.18
4. SQC 1 Vs. SA 220 Key Differences in Nature, Scope and Applicability .......................... 1.19
5. Mechanisms for Review of Quality Control .................................................................... 1.20
5.1 Peer Review Board ............................................................................................ 1.20
5.2 Quality Review Board ......................................................................................... 1.20
5.3 National Financial Reporting Authority (NFRA) ................................................... 1.21
KEY TAKEAWAYS ................................................................................................................. 1.24
TEST YOUR KNOWLEDGE .................................................................................................... 1.26
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CHAPTER 2: GENERAL AUDITING PRINCIPLES & AND AUDITORS RESPONSIBILITIES
LEARNING OUTCOMES .......................................................................................................... 2.1
CHAPTER OVERVIEW ............................................................................................................. 2.2
Contents:
1. General Auditing Principles and Auditor’s Responsibilities ............................................... 2.3
2. SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements” ..................................................................................................... 2.4
2.1 The objectives of the auditor in accordance with SA 240 ....................................... 2.4
2.2 How Fraudulent Financial Reporting may be caused by Entities? .......................... 2.6
2.3 How Misappropriation of Assets may be Accomplished by Entities? ...................... 2.7
2.4 Whose Primary Responsibility is to Prevent and Detect Fraud? ............................. 2.7
2.5 Responsibilities of the Auditor .............................................................................. 2.8
2.6 Maintaining Professional Skepticism ................................................................... 2.14
2.7 Discussion among the Engagement Team .......................................................... 2.15
2.8 Risk Assessment Procedures and related activities be geared towards
obtaining information for use in identifying risk of Material Misstatement
due to Fraud ...................................................................................................... 2.15
2.9 Responses to the Assessed Risks of Material misstatement due to Fraud
at the Financial Statement Level......................................................................... 2.15
2.10 Audit Procedures Responsive to Assessed risks of Material Misstatement
due to Fraud at the Assertion Level .................................................................... 2.16
2.11 Audit Procedures Responsive to Risks related to Management override of
Controls ............................................................................................................. 2.16
2.12 Evaluation of Audit Evidence .............................................................................. 2.17
2.13 Circumstances in which auditor is unable to continue the engagement ................ 2.17
2.14 Management Representations ............................................................................ 2.18
2.15 Communications to Management and with those charged with Governance ......... 2.19
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2.16 Communications to Regulatory and Enforcement Authorities ............................... 2.19
2.17 Documentation ................................................................................................... 2.19
3. SA 250 Consideration of Laws and Regulations in an Audit of Financial Statements ...... 2.21
3.1 Effect of Laws and Regulations of Financial Statements of an Entity ................... 2.21
3.2 Objectives of auditor in accordance with SA 250 ................................................. 2.22
3.3 Responsibility of Management for Compliance with Laws and Regulations .......... 2.22
3.4 Responsibility of the Auditor ............................................................................... 2.23
3.5 Audit Procedures when Non-Compliance is Identified or Suspected .................... 2.26
3.6 Reporting of Identified or Suspected Non-Compliance ........................................ 2.27
3.7 Documentation.................................................................................................... 2.28
4. SA 260 Communication with Those Charged with Governance ...................................... 2.28
4.1 Objectives of Auditor in Accordance with SA 260 ................................................ 2.30
4.2 Matters to be Communicated by the Auditor........................................................ 2.30
4.3 Communication of Auditor’s Independence in Case of Listed Entities .................. 2.34
4.4 Documentation ................................................................................................... 2.35
5. SA 299 Joint Audit of Financial Statements ................................................................... 2.35
5.1 Objectives in accordance with SA 299 ................................................................ 2.36
5.2 Audit planning, Risk Assessment and Allocation of Work .................................... 2.36
5.3 Responsibility and Co-ordination among Joint Auditors ....................................... 2.37
5.4 Audit Conclusion and Reporting ......................................................................... 2.39
5.5 Communication with Those Charged with Governance ........................................ 2.39
6. SA 402 Audit Considerations Relating to an Entity Using a Service Organisation ........... 2.40
6.1 Objectives of user auditor in accordance with SA 402 ......................................... 2.42
6.2 Type 1 report and Type 2 report ......................................................................... 2.42
6.3 Obtaining an Understanding of the Services ....................................................... 2.43
6.4 Using Type 1 or Type 2 Report ........................................................................... 2.45
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6.5 Responding to the Assessed Risks of Material Misstatement .............................. 2.45
6.6 Tests of Controls ................................................................................................ 2.46
6.7 Fraud, Non-compliance with laws and Regulations and uncorrected misstatements in
relation to activities at the service organisation ....................................................... 2.47
6.8 Reporting by the user auditor ............................................................................... 2.47
KEY TAKEAWAYS ................................................................................................................. 2.49
TEST YOUR KNOWLEDGE .................................................................................................... 2.51
CHAPTER 3: AUDIT PLANING, STRATEGY & EXECUTION
LEARNING OUTCOMES .......................................................................................................... 3.1
CHAPTER OVERVIEW ............................................................................................................. 3.2
Contents:
1. Commencing An Audit .................................................................................................... 3.3
1.1 Benefits/Advantages of Planning in an Audit of Financial Statements .................... 3.4
1.2 Nature and Extent of Planning .............................................................................. 3.4
1.3 Planning - A Continuous Process ......................................................................... 3.4
1.4 Overall Audit Strategy and Audit Plan - Responsibility of the Auditor ..................... 3.5
1.5 Acceptance and Continuance of Client Relationships and Audit Engagements ...... 3.5
1.6 Contents of an Audit Plan ..................................................................................... 3.6
1.7 Changes to Planning Decisions ............................................................................ 3.7
2. Overall Audit Strategy ..................................................................................................... 3.8
2.1 Factors while establishing Overall Audit Strategy .................................................. 3.8
2.2 Benefits of Overall Audit Strategy ......................................................................... 3.8
2.3 Considerations in Establishing the Overall Audit Strategy ..................................... 3.9
2.4 Documenting the Audit Plan ............................................................................... 3.11
2.5 Relationship between the Overall Audit Strategy and the Audit Plan .................... 3.12
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3. Audit Programme ......................................................................................................... 3.13
3.1 Formulating an Audit Programme ....................................................................... 3.13
3.2 Drawing up the audit programme ........................................................................ 3.14
4. Audit Execution ............................................................................................................ 3.16
4.1 Execution Planning ............................................................................................ 3.17
4.2 Risk and Control Evaluation ............................................................................... 3.17
4.3 Testing .............................................................................................................. 3.17
4.4 Reporting ........................................................................................................... 3.17
4.5 Other Important Considerations .......................................................................... 3.18
KEY TAKEAWAYS ................................................................................................................. 3.56
TEST YOUR KNOWLEDGE .................................................................................................... 3.58
CHAPTER 4: MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL
LEARNING OUTCOMES .......................................................................................................... 4.1
CHAPTER OVERVIEW ............................................................................................................. 4.2
Contents:
1. Materiality & Risk Assessment ....................................................................................... 4.3
1.1 Identification of Risks ........................................................................................... 4.4
1.2 Audit Risk Components ........................................................................................ 4.4
1.3 Steps for Risk Identification ................................................................................ 4.10
2. Risk-Based Audit Approach .......................................................................................... 4.12
2.1 Audit Risk Analysis ........................................................................................... 4.13
2.2 General Steps in the Conduct of Risk Based Audit .............................................. 4.13
3. Internal Control System - Nature, Scope, Objectives and Structure ................................ 4.18
3.1 Nature of Internal Control ................................................................................... 4.20
3.2 Scope of Internal Controls .................................................................................. 4.20
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3.3 Objectives of Internal Control System ................................................................. 4.21
3.4 Structure of Internal Control ............................................................................... 4.22
4. Components of Internal Controls ................................................................................... 4.24
4.1 Control Environment .......................................................................................... 4.25
4.2 Entity’s Risk Assessment Process ...................................................................... 4.26
4.3 Control Activities ................................................................................................ 4.28
4.4 Information System, Including the Related Business Processes, Relevant to Financial
Reporting, and Communication .......................................................................... 4.29
4.5 Monitoring of Controls ........................................................................................ 4.30
5. Review of the System of Internal Controls ..................................................................... 4.33
6. Internal Control Assessment & Evaluation ..................................................................... 4.36
6.1 Techniques of Evaluation of Internal Control ....................................................... 4.37
7. Reporting To Clients on Internal Control Weaknesses ................................................... 4.48
8. Frameworks of Internal Control ..................................................................................... 4.52
8.1 International Internal Control Frameworks .......................................................... 4.53
KEY TAKEAWAYS ................................................................................................................. 4.60
TEST YOUR KNOWLEDGE .................................................................................................... 4.62
CHAPTER 5: AUDIT EVIDENCE
LEARNING OUTCOMES .......................................................................................................... 5.1
CHAPTER OVERVIEW ............................................................................................................. 5.2
Contents:
1. SA 500 Audit Evidence ................................................................................................... 5.3
2. SA 501 Audit Evidence- Specific Considerations for Selected Items ................................ 5.5
3. SA 505 External Confirmations ....................................................................................... 5.7
4. SA 510 Initial Audit Engagements-Opening Balances ...................................................... 5.8
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5. SA 530 Audit Sampling ................................................................................................... 5.9
6. SA 550 Related Parties ................................................................................................ 5.11
KEY TAKEAWAYS ................................................................................................................. 5.26
TEST YOUR KNOWLEDGE .................................................................................................... 5.29
CHAPTER 6: COMPLETION & REVIEW
LEARNING OUTCOMES .......................................................................................................... 6.1
CHAPTER OVERVIEW ............................................................................................................. 6.2
Contents:
1. SA 560 Subsequent events ............................................................................................. 6.4
2. SA 570 Going Concern ................................................................................................... 6.6
3. SA 580 Written representations ...................................................................................... 6.8
KEY TAKEAWAYS ................................................................................................................. 6.22
TEST YOUR KNOWLEDGE .................................................................................................... 6.23
CHAPTER 7: REPORTING
LEARNING OUTCOMES .......................................................................................................... 7.1
CHAPTER OVERVIEW ............................................................................................................. 7.2
Contents:
1. Introduction .................................................................................................................... 7.3
2. The Auditor’s Report on Financial Statements ................................................................. 7.4
3. SA 700 Forming an Opinion and Reporting on the Financial Statements .......................... 7.4
3.1 Purpose ............................................................................................................... 7.5
3.2 Basic Elements of the Auditor’s Report ................................................................. 7.6
3.3 Auditor’s Report Prescribed by Law or Regulation .............................................. 7.18
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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 .................................................................... 7.20
3.5 Supplementary Information Presented with the Financial Statements .................. 7.20
4. SA 701 Communicating Key Audit Matters in the Independent Auditor’s Report ............. 7.21
4.1 Purpose ............................................................................................................. 7.22
4.2 Scope ................................................................................................................ 7.22
4.3 Determining Key Audit Matters ........................................................................... 7.23
4.4 Communicating Key Audit Matters ...................................................................... 7.24
5. SA 705 Modifications to the Opinion in the Independent Auditor’s Report....................... 7.25
5.1 Types of Modified Opinions ................................................................................ 7.25
5.2 Objective ........................................................................................................... 7.26
5.3 Circumstances When a Modification to the Auditor’s Opinion is Required ............ 7.26
5.4 Determining the Type of Modification to the Auditor’s Opinion ............................. 7.26
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 ................................................................................. 7.31
5.6 If the auditor decides to withdraw ....................................................................... 7.31
5.7 Other Considerations Relating to an Adverse Opinion or Disclaimer of Opinion ... 7.32
5.8 Form and Content of the Auditor’s Report When the Opinion is Modified ............. 7.32
5.9 Communication with Those Charged with Governance ........................................ 7.39
6. SA 706 Emphasis of Matter Paragraphs and other Matter Paragraphs in the
Independent Auditor’s Report ....................................................................................... 7.39
6.1 Objective ........................................................................................................... 7.39
6.2 When to give emphasis of Matter Paragraphs in the Auditor’s Report? ................ 7.40
6.3 When the auditor includes an Emphasis of Matter paragraph in the
auditor’s report, the auditor shall ........................................................................ 7.40
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7. Distinction Between Notes on Accounts and Qualifications ............................................ 7.46
8. Distinction Between Audit Report and Certificate ........................................................... 7.48
9. Communication To Management and those Charged with Governance .......................... 7.48
9.1 When All of Those Charged with Governance Are Involved
in Managing the Entity ........................................................................................ 7.48
9.2 Matters to be Communicated .............................................................................. 7.49
9.3 Planned Scope and Timing of the Audit .............................................................. 7.49
9.4 Significant Findings from the Audit ..................................................................... 7.49
10. Reporting Requirements in Case of Comparative Information ........................................ 7.50
10.1 Audit Procedures for Comparative Information .................................................... 7.50
10.2 Audit Reporting .................................................................................................. 7.51
11. SA 720 The Auditor’s Responsibilities Relating to Other Information .............................. 7.52
11.1 Objective ........................................................................................................... 7.53
11.2 Obtaining the Other Information.......................................................................... 7.54
11.3 Responding When a Material Inconsistency Appears to Exist or Other
Information Appears to be Materially Misstated ................................................... 7.55
11.4 Responding When the Auditor Concludes that a Material Misstatement
of the other Information Exists ............................................................................ 7.55
11.5 Responding When a Material Misstatement in the Financial Statements
Exists or the Auditor’s Understanding of the Entity and Its Environment Needs
to be updated ..................................................................................................... 7.56
11.6 Reporting ........................................................................................................... 7.57
11.7 Reporting Prescribed by Law or Regulation ........................................................ 7.57
12. Duties of Auditors ......................................................................................................... 7.58
12.1 Reporting under CARO 2020 .............................................................................. 7.66
13. Illustrative Audit Reports ............................................................................................... 7.73
KEY TAKEAWAYS ................................................................................................................. 7.91
TEST YOUR KNOWLEDGE .................................................................................................... 7.94
© The Institute of Chartered Accountants of India
CHAPTER 2
GENERAL AUDITING
PRINCIPLES AND AUDITOR’S
RESPONSIBILITIES
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand meaning of fraud and its characteristics, fraud risk factors with
examples etc.
Gain knowledge about SA 240 “The Auditor’s Responsibilities Relating to
Fraud in an Audit of Financial Statements”.
Gain knowledge about SA 250 “Consideration of Laws and Regulations in
an Audit of Financial Statements”.
Learn about significance of communication with those charged with
governance and gain knowledge about SA 260 “Communication with
Those Charged with Governance”.
Gain knowledge about SA 299 “Joint Audit of Financial Statements”.
Gain knowledge about SA 402 “Audit Considerations Relating to an Entity
Using a Service Organisation”.
© The Institute of Chartered Accountants of India
2.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
SA 240:"The Auditor’s Responsibilities Relating to Fraud in an
& Auditor's Responsibilities Audit of Financial Statements"
General Auditing Principles
SA 250: “Consideration of Laws and Regulations in an Audit of
Financial Statements”
SA 260: “Communication with Those Charged with Governance”
SA 299 “Joint Audit of Financial Statements”
SA 402: “Audit Considerations Relating to an Entity Using a
Service Organisation”
CA. Bijoy is auditor of a listed company since last three years. Of late, the company is in news in
financial circles for all the wrong reasons. There have been allegations of flouting of Securities
Contracts (Regulation) Rules by clandestinely controlling more than required percentage of
shares than mandated in rules. Besides, the said company has been accused of violating other
provisions of securities laws.
There have also been allegations of manipulating share prices, of artificially keeping share prices
high and failure to disclose all related party transactions. The company is a highly leveraged one.
However, there has been no default and company has kept its commitments. SEBI is also seized
of the matter on its own.
Ever since the above allegations were hurled through media, auditor of the company is in a fix.
What do such allegations reflect? How he should proceed in audit of ensuing year? The regulatory
report would take time and audit has to be completed within timelines. Audits of last years were
conducted in accordance with Standards on auditing and no wrongdoings were noticed and
unmodified opinion was expressed in audit reports. However, given the current scenario, there
seemed to be a heightened level of audit risk. It would be foolish of him not to take notice of such
developments.
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.3
RESPONSIBILITIES
The allegations of violations of securities laws, manipulating share prices and failure to disclose
all related party transactions could be fraud risk factors. While fraud risk factors may not
necessarily indicate the existence of fraud, they have often been present in circumstances where
frauds have occurred. Hence, there are increased risks of material misstatement due to fraud. Due
to assessment of increased risks of material misstatement due to fraud, audit procedures need
to be designed and performed accordingly.
Besides above, suspected non-compliance with laws and regulations may have material effect on
financial statements. It could involve hefty penalties and other issues. If management is not
forthcoming in providing information relating to compliance with laws and regulations, does he
need to obtain legal advice? Whether it would also lead to any impact on his opinion? Such
questions were staring him in the face in current year of his tenure.
If he suspects fraud involving management, should he communicate these suspicions to audit
committee and discuss with them nature, timing, and extent of audit procedures necessary to
complete the audit?
1. GENERAL AUDITING PRINCIPLES AND AUDITOR’S
RESPONSIBILITIES
SA 200 establishes the independent auditor’s overall responsibilities when conducting an audit of
financial statements in accordance with SAs. Audit has to be planned and performed with
professional skepticism recognising that circumstances may exist that cause the financial
statements to be materially misstated. Misstatements can arise from errors or frauds. SA 240 deals
with the auditor’s responsibilities relating to fraud in an audit of financial statements. The auditor has
to remain alert throughout the audit recognizing the possibility that material misstatement due to
fraud could exist.
Entities are subject to various laws and regulations. Non-compliance with laws and regulations may
result in fines, litigation or other consequences for the entity leading to material effect on financial
statements. SA 250 deals with auditor’s responsibilities in this regard while performing an audit of
financial statements. Since many laws and regulations affect entities, auditor has to remain alert to
the possibility of non-compliance with laws and regulations.
Communication with those charged with governance on a timely basis during audit serves many
useful purposes and SA 260 deals with auditor’s responsibilities in this regard. SA 299 details special
consideration relating to responsibilities of auditors in a joint audit.
© The Institute of Chartered Accountants of India
2.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
It is very common for user entities these days to outsource activities from a third-party service
organization. SA 402 dwells upon the user auditor’s responsibility to obtain sufficient appropriate
audit evidence in this respect.
2. SA 240 “THE AUDITOR’S RESPONSIBILITIES
RELATING TO FRAUD IN AN AUDIT OF FINANCIAL
STATEMENTS”
SA 240 deals with the auditor’s responsibilities relating to fraud in an audit of financial statements.
Its requirements assist the auditor in identifying and assessing the risks of material misstatement
due to fraud and in designing procedures to detect such misstatement.
2.1 The objectives of the auditor in accordance with SA 240 are: -
(a) To identify and assess the risks of material misstatement in the financial statements due to
fraud;
(b) To obtain sufficient appropriate audit evidence about the assessed risks of material
misstatement due to fraud, through designing and implementing appropriate responses; and
(c) To respond appropriately to identified or suspected fraud.
To identify and assess the risks of material misstatement in the
Objectives of the Auditor
financial statements due to fraud;
To obtain sufficient appropriate audit evidence about the assessed
risks of material misstatement due to fraud, through designing and
implementing appropriate responses; and
To respond appropriately to identified or suspected fraud.
Meaning of Fraud and its Characteristics
Fraud is an intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal
advantage.
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.5
RESPONSIBILITIES
Misstatements in the financial statements can arise from either fraud or error. The distinguishing
factor between fraud and error is whether the underlying action that results in the misstatement of
the financial statements is intentional or unintentional.
Although fraud is a broad legal concept, the auditor is concerned with fraud that causes a material
misstatement in the financial statements.
Fraud
Misstatements resulting
Misstatements resulting from
from misappropriation of
fraudulent financial reporting
assets
Involves incentive or pressure to commit Involves incentive or pressure to
fraud, a perceived opportunity and some commit fraud, a perceived opportunity
rationalization of act and some rationalization of act
Two types of intentional misstatements are relevant to the auditor: -
• Misstatements resulting from fraudulent financial reporting
• Misstatements resulting from misappropriation of assets
Fraud, whether due to misstatements resulting from fraudulent financial reporting or
misappropriation of assets, involves incentive or pressure to commit fraud, a perceived opportunity
to do so and some rationalization of the act. For example: -
Individuals may be
Incentive or pressure to able to rationalize
commit fraudulent committing a
financial reporting may A perceived fraudulent act. Some
exist when management opportunity to commit individuals possess an
is under pressure, from fraud may exist when attitude, character or
Similarly, individuals
sources outside or an individual believes set of ethical values
may have an incentive
inside the entity, to internal control can be that allow them
to misappropriate
achieve an expected overridden, for knowingly and
assets, for example,
(and perhaps example, because the intentionally to commit
because the
unrealistic) earnings individual is in a a dishonest act.
individuals are living
target or financial position of trust or has However, even
beyond their means.
outcome – particularly knowledge of specific otherwise honest
since the consequences deficiencies in internal individuals can commit
to management for control. fraud in an
failing to meet financial environment that
goals can be significant. imposes sufficient
pressure on them.
© The Institute of Chartered Accountants of India
2.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.2 How Fraudulent Financial Reporting may be caused by entities?
Fraudulent financial reporting involves intentional misstatements including omissions of amounts or
disclosures in financial statements to deceive financial statement users. It can be caused by the
efforts of management to manage earnings in order to deceive financial statement users by
influencing their perceptions as to the entity’s performance and profitability.
Such earnings management may start out with small actions or inappropriate adjustment of
assumptions and changes in judgments by management. Pressures and incentives may lead these
actions to increase to the extent that they result in fraudulent financial reporting. Such a situation
could occur when, due to pressures to meet market expectations or a desire to maximize
compensation based on performance, management intentionally takes positions that lead to
fraudulent financial reporting by materially misstating the financial statements. In some entities,
management may be motivated to reduce earnings by a material amount to minimize tax or to inflate
earnings to secure bank financing.
Fraudulent financial reporting may be accomplished by the following: -
Manipulation, falsification (including forgery), or alteration of accounting records or supporting
documentation from which the financial statements are prepared.
Misrepresentation in or intentional omission from, the financial statements of events,
transactions or other significant information.
Intentional misapplication of accounting principles relating to amounts, classification, manner
of presentation, or disclosure.
Fraudulent financial reporting often involves management override of controls that otherwise
may appear to be operating effectively. Fraud can be committed by management overriding
controls using such techniques as: -
Recording fictitious journal entries, particularly close to the end of an accounting
period, to manipulate operating results or achieve other objectives.
Inappropriately adjusting assumptions and changing judgments used to estimate
account balances.
Omitting, advancing or delaying recognition in the financial statements of events and
transactions that have occurred during the reporting period.
Concealing, or not disclosing, facts that could affect the amounts recorded in the
financial statements.
Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
Altering records and terms related to significant and unusual transactions.
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.7
RESPONSIBILITIES
2.3 How misappropriation of assets may be accomplished by entities?
Misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by
employees in relatively small and immaterial amounts. However, it can also involve management
who are usually more able to disguise or conceal misappropriations in ways that are difficult to
detect.
Misappropriation of assets can be accomplished in a variety of ways including: -
Embezzling receipts (for example, misappropriating collections on accounts receivable or
diverting receipts in respect of written-off accounts to personal bank accounts).
Stealing physical assets or intellectual property (for example, stealing inventory for personal
use or for sale, stealing scrap for resale, colluding with a competitor by disclosing
technological data in return for payment).
Causing an entity to pay for goods and services not received (for example, payments to
fictitious vendors, kickbacks paid by vendors to the entity’s purchasing agents in return for
inflating prices, payments to fictitious employees).
Using an entity’s assets for personal use (for example, using the entity’s assets as collateral
for a personal loan or a loan to a related party).
Misappropriation of assets is often accompanied by false or misleading records or documents in
order to conceal the fact that the assets are missing or have been pledged without proper
authorization.
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the auditor does
not make legal determinations of whether fraud has actually occurred.
2.4 Whose primary responsibility is to prevent and detect fraud?
The primary responsibility for the prevention and detection of fraud rests with both those charged
with governance of the entity and management. It is important that management, with the oversight
of those charged with governance, place a strong emphasis on fraud prevention, which may reduce
opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to
commit fraud because of the likelihood of detection and punishment. This involves a commitment to
creating a culture of honesty and ethical behaviour which can be reinforced by an active oversight
by those charged with governance.
© The Institute of Chartered Accountants of India
2.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.5 Responsibilities of the Auditor
An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable
assurance that the financial statements taken as a whole are free from material misstatement,
whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an
unavoidable risk that some material misstatements of the financial statements may not be detected,
even though the audit is properly planned and performed in accordance with the SAs.
The potential effects of inherent limitations are particularly significant in the case of misstatement
resulting from fraud. The risk of not detecting a material misstatement resulting from fraud is higher
than the risk of not detecting one resulting from error. This is because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate
failure to record transactions, or intentional misrepresentations being made to the auditor. Such
attempts at concealment may be even more difficult to detect when accompanied by collusion.
Collusion may cause the auditor to believe that audit evidence is persuasive when it is, in fact, false.
The auditor’s ability to detect a fraud depends on factors such as the skillfulness of the perpetrator,
the frequency and extent of manipulation, the degree of collusion involved, the relative size of
individual amounts manipulated, and the seniority of those individuals involved. While the auditor
may be able to identify potential opportunities for fraud to be perpetrated, it is difficult for the auditor
to determine whether misstatements in judgment areas such as accounting estimates are caused
by fraud or error.
Furthermore, the risk of the auditor not detecting a material misstatement resulting from
management fraud is greater than for employee fraud, because management is frequently in a
position to directly or indirectly manipulate accounting records, present fraudulent financial
information or override control procedures designed to prevent similar frauds by other employees.
When obtaining reasonable assurance, the auditor is responsible for maintaining professional skepticism
throughout the audit, considering the potential for management override of controls and recognizing the
fact that audit procedures that are effective for detecting error may not be effective in detecting fraud.
What are fraud risk factors?
Fraud risk factors are events or conditions that indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud. For example: -
The need to meet expectations of third parties to obtain additional equity financing may create
pressure to commit fraud;
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.9
RESPONSIBILITIES
The granting of significant bonuses if unrealistic profit targets are met may create an incentive to
commit fraud; and
A control environment that is not effective may create an opportunity to commit fraud.
Examples of fraud risk factors : Following are examples of fraud risk factors relating to misstatements
arising from fraudulent financial reporting and from misappropriation of assets respectively : -
[A] Risk factors relating to misstatements arising from fraudulent financial reporting
The following are examples of risk factors relating to misstatements arising from fraudulent financial
reporting: -
Incentives/Pressures
Financial stability or profitability is threatened by economic, industry, or entity operating
conditions, such as (or as indicated by): -
High degree of competition or market saturation, accompanied by declining margins.
High vulnerability to rapid changes, such as changes in technology, product
obsolescence, or interest rates.
Significant declines in customer demand and increasing business failures in either the
industry or overall economy.
Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover
imminent.
Recurring negative cash flows from operations or an inability to generate cash flows
from operations while reporting earnings and earnings growth.
Rapid growth or unusual profitability especially compared to that of other companies in
the same industry.
New accounting, statutory, or regulatory requirements.
Excessive pressure exists for management to meet the requirements or expectations of third
parties due to the following: -
Profitability or trend level expectations of investment analysts, institutional investors,
significant creditors, or other external parties (particularly expectations that are unduly
aggressive or unrealistic), including expectations created by management in, for example,
overly optimistic press releases or annual report messages.
Need to obtain additional debt or equity financing to stay competitive— including financing of
major research and development or capital expenditures.
© The Institute of Chartered Accountants of India
2.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Marginal ability to meet exchange listing requirements or debt repayment or other debt
covenant requirements.
Perceived or real adverse effects of reporting poor financial results on significant pending
transactions, such as business combinations or contract awards.
Information available indicates that the personal financial situation of management or those
charged with governance is threatened by the entity’s financial performance arising from the
following: -
Significant financial interests in the entity.
Significant portions of their compensation (for example, bonuses, stock options, and
earn-out arrangements) being contingent upon achieving aggressive targets for stock
price, operating results, financial position, or cash flow.
Personal guarantees of debts of the entity.
There is excessive pressure on management or operating personnel to meet financial
targets established by those charged with governance, including sales or profitability
incentive goals.
Opportunities: The nature of the industry or the entity’s operations provides opportunities to engage
in fraudulent financial reporting that can arise from the following: -
Significant related-party transactions not in the ordinary course of business or with related
entities not audited or audited by another firm.
A strong financial presence or ability to dominate a certain industry sector that allows the
entity to dictate terms or conditions to suppliers or customers that may result in inappropriate
or non-arm’s-length transactions.
Assets, liabilities, revenues, or expenses based on significant estimates that involve
subjective judgments or uncertainties that are difficult to corroborate.
Significant, unusual, or highly complex transactions, especially those close to period end that
pose difficult “substance over form” questions.
Significant operations located or conducted across international borders in jurisdictions where
differing business environments and cultures exist.
Use of business intermediaries for which there appears to be no clear business justification.
Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for
which there appears to be no clear business justification.
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.11
RESPONSIBILITIES
The monitoring of management is not effective as a result of the following: -
Domination of management by a single person Oversight by those charged with governance
or small group (in a non owner-managed over the financial reporting process and internal
business) without compensating controls. control is not effective.
There is a complex or unstable organizational structure, as evidenced by following: -
Difficulty in determining the organization or individuals that have controlling interest in the
entity.
Overly complex organizational structure involving unusual legal entities or managerial lines
of authority.
High turnover of senior management, legal counsel, or those charged with governance.
Internal control components are deficient as a result of the following: -
Inadequate monitoring of controls, including automated controls and controls over
interim financial reporting (where external reporting is required).
High turnover rates or employment of accounting, internal audit, or information
technology staff that are not effective.
Accounting and information systems that are not effective, including situations
involving significant deficiencies in internal control.
Attitudes/Rationalizations
Communication, implementation, support, or enforcement of the entity’s values or ethical
standards by management, or the communication of inappropriate values or ethical
standards, that are not effective.
Non-financial management’s excessive participation in or preoccupation with the selection of
accounting policies or the determination of significant estimates.
Known history of violations of securities laws or other laws and regulations, or claims against
the entity, its senior management, or those charged with governance alleging fraud or
violations of laws and regulations.
Excessive interest by management in maintaining or increasing the entity’s stock price or
earnings trend.
The practice by management of committing to analysts, creditors, and other third parties to
achieve aggressive or unrealistic forecasts.
© The Institute of Chartered Accountants of India
2.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Management failing to remedy known significant deficiencies in internal control on a timely
basis.
An interest by management in employing inappropriate means to minimize reported earnings
for tax-motivated reasons.
Low morale among senior management.
The owner-manager makes no distinction between personal and business transactions.
Dispute between shareholders in a closely held entity.
Recurring attempts by management to justify marginal or inappropriate accounting on the
basis of materiality.
The relationship between management and the current or predecessor auditor is strained, as
exhibited by the following: -
• Frequent disputes with the current or predecessor auditor on accounting, auditing, or
reporting matters.
• Unreasonable demands on the auditor, such as unrealistic time constraints regarding
the completion of the audit or the issuance of the auditor’s report.
• Restrictions on the auditor that inappropriately limit access to people or information or
the ability to communicate effectively with those charged with governance.
• Domineering management behaviour in dealing with the auditor, especially involving
attempts to influence the scope of the auditor’s work or the selection or continuance of
personnel assigned to or consulted on the audit engagement.
[B] Risk factors relating to misstatements arising from misappropriation of assets
The following are examples of risk factors relating to misstatements arising from misappropriation
of assets: -
Incentives/Pressures
Personal financial obligations may create pressure on management or employees with access
to cash or other assets susceptible to theft to misappropriate those assets. Adverse
relationships between the entity and employees with access to cash or other assets
susceptible to theft may motivate those employees to misappropriate those assets. For
example, adverse relationships may be created by the following: -
Known or anticipated future employee layoffs
Recent or anticipated changes to employee compensation or benefit plans
Promotions, compensation, or other rewards inconsistent with expectations
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.13
RESPONSIBILITIES
Opportunities
Certain characteristics or circumstances may increase the susceptibility of assets to
misappropriation. For example, opportunities to misappropriate assets increase when there are the
following: -
Large amounts of cash on hand
Inventory items that are small in size, of high value, or in high demand.
Easily convertible assets, such as bearer bonds, diamonds, or computer chips.
Fixed assets which are small in size, marketable, or lacking observable identification of
ownership.
Inadequate internal control over assets may increase the susceptibility of misappropriation of
those assets. For example, misappropriation of assets may occur because there is the
following:
Inadequate segregation of duties or independent checks.
Inadequate oversight of senior management expenditures, such as travel and other
reimbursements.
Inadequate management oversight of employees responsible for assets, for example,
inadequate supervision or monitoring of remote locations.
Inadequate job applicant screening of employees with access to assets.
Inadequate record keeping with respect to assets.
Inadequate system of authorization and approval of transactions (for example, in
purchasing).
Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
Lack of complete and timely reconciliations of assets.
Lack of timely and appropriate documentation of transactions, for example, credits for
merchandise returns.
Lack of mandatory vacations for employees performing key control functions.
Inadequate management understanding of information technology, which enables
information technology employees to perpetrate a misappropriation.
Inadequate access controls over automated records, including controls over and review
of computer systems event logs.
© The Institute of Chartered Accountants of India
2.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Attitudes/Rationalizations
Disregard for the need for monitoring or reducing risks related to misappropriations of assets.
Disregard for internal control over misappropriation of assets by overriding existing controls
or by failing to take appropriate remedial action on known deficiencies in internal control.
Behaviour indicating displeasure or dissatisfaction with the entity or its treatment of the
employee.
Changes in behaviour or lifestyle that may indicate assets have been misappropriated.
Tolerance of petty theft.
Why evaluation of fraud risk factors by auditor is necessary?
The auditor shall evaluate whether one or more fraud risk factors are present. While fraud risk factors
may not necessarily indicate the existence of fraud, they have often been present in circumstances
where frauds have occurred and therefore may indicate risks of material misstatement due to fraud.
The fact that fraud is usually concealed can make it very difficult to detect. Nevertheless, the auditor
may identify fraud risk factors. Fraud risk factors cannot easily be ranked in order of importance.
The significance of fraud risk factors varies widely. Some of these factors will be present in entities
where the specific conditions do not present risks of material misstatement. Accordingly, the
determination of whether a fraud risk factor is present and whether it is to be considered in assessing
the risks of material misstatement of the financial statements due to fraud requires the exercise of
professional judgment.
2.6 Maintaining Professional Skepticism
The auditor shall maintain professional skepticism throughout the audit, recognizing the possibility
that a material misstatement due to fraud could exist, notwithstanding the auditor’s past experience
of the honesty and integrity of the entity’s management and those charged with governance.
Unless the auditor has reason to believe the contrary, the auditor may accept records and documents
as genuine. If conditions identified during the audit cause the auditor to believe that a document may
not be authentic or that terms in a document have been modified but not disclosed to the auditor,
the auditor shall investigate further.
Where responses to inquiries of management or those charged with governance are inconsistent,
the auditor shall investigate the inconsistencies.
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.15
RESPONSIBILITIES
2.7 Discussion among the engagement team
The discussion among the engagement team shall place particular emphasis on how and where the
entity’s financial statements may be susceptible to material misstatement due to fraud, including
how fraud might occur. The discussion shall occur notwithstanding the engagement team members’
beliefs that management and those charged with governance are honest and have integrity.
2.8 Risk assessment procedures and related activities be geared
towards obtaining information for use in identifying risk of material
misstatement due to fraud
When performing risk assessment procedures and related activities to obtain an understanding of
the entity and its environment, including the entity’s internal control, the auditor shall perform the
procedures to obtain information for use in identifying the risks of material misstatement due to fraud
like inquiries of management and others within the entity, obtaining understanding as to how those
charged with governance exercise oversight of management’s processes for identifying and
responding to the risks of fraud in the entity and the internal control that management has
established to mitigate these risks and evaluation of unexpected relationships identified in
performing analytical procedures which may indicate risks of material misstatement due to fraud.
Besides, as discussed already, the auditor shall evaluate whether the information obtained from the
other risk assessment procedures and related activities performed indicates that one or more fraud
risk factors are present.
2.9 Responses to the assessed risks of material misstatement due to
fraud at the financial statement level
In determining overall responses to address the assessed risks of material misstatement due to
fraud at the financial statement level, the auditor shall: -
(a) Assign and supervise (b) Evaluate whether the (c) Incorporate an element of
personnel taking account of selection and application of unpredictability in the
the knowledge, skill and accounting policies by the selection of the nature,
ability of the individuals to entity, particularly those related timing and extent of audit
be given significant to subjective measurements procedures.
engagement responsibilities and complex transactions, may
and the auditor’s be indicative of fraudulent
assessment of the risks of financial reporting resulting
material misstatement due from management’s effort to
to fraud for the engagement; manage earnings; and
© The Institute of Chartered Accountants of India
2.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.10 Audit procedures responsive to assessed risks of material
misstatement due to fraud at the assertion level
The auditor shall design and perform further audit procedures whose nature, timing and extent are
responsive to the assessed risks of material misstatement due to fraud at the assertion level. In
doing so, the auditor may change nature, timing and extent of audit procedures to obtain audit
evidence that is more reliable and relevant or to obtain additional corroborative information.
For example, if the auditor identifies that management is under pressure to meet earnings
expectations, there may be a related risk that management is inflating sales by entering into sales
agreements that include terms that preclude revenue recognition or by invoicing sales before
delivery. In these circumstances, the auditor may, for example, design external confirmations not
only to confirm outstanding amounts, but also to confirm the details of the sales agreements,
including date, any rights of return and delivery terms. In addition, the auditor might find it effective
to supplement such external confirmations with inquiries of non-financial personnel in the entity
regarding any changes in sales agreements and delivery terms.
2.11 Audit procedures responsive to risks related to management
override of controls
Management is in a unique position to perpetrate fraud because of management’s ability to
manipulate accounting records and prepare fraudulent financial statements by overriding controls
that otherwise appear to be operating effectively. This risk is present in all entities. Due to the
unpredictable way in which such override could occur, it is a risk of material misstatement due to
fraud and thus a significant risk.
Irrespective of the auditor’s assessment of the risks of management override of controls, the
auditor shall design and perform audit procedures to: -
(a) Test the appropriateness of journal entries recorded in the general ledger and other
adjustments made in the preparation of the financial statements.
(b) Review accounting estimates for biases and evaluate whether the circumstances
producing the bias, if any, represent a risk of material misstatement due to fraud.
(c) For significant transactions that are outside the normal course of business for the entity,
or that otherwise appear to be unusual given the auditor’s understanding of the entity and its
environment and other information obtained during the audit, the auditor shall evaluate
whether the business rationale (or the lack thereof) of the transactions suggests that they may
have been entered into to engage in fraudulent financial reporting or to conceal
misappropriation of assets.
© The Institute of Chartered Accountants of India
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RESPONSIBILITIES
The auditor shall determine whether, in order to respond to the identified risks of management
override of controls, the auditor needs to perform other audit procedures in addition to those
specifically referred to above.
2.12 Evaluation of Audit Evidence
The auditor shall evaluate whether analytical procedures that are performed when forming an overall
conclusion as to whether the financial statements as a whole are consistent with the auditor’s
understanding of the entity and its environment indicate a previously unrecognized risk of material
misstatement due to fraud.
When the auditor identifies a misstatement, the auditor shall evaluate whether such a misstatement
is indicative of fraud. If there is such an indication, the auditor shall evaluate the implications of the
misstatement in relation to other aspects of the audit, particularly the reliability of management
representations, recognizing that an instance of fraud is unlikely to be an isolated occurrence.
If the auditor identifies a misstatement, whether material or not, and the auditor has reason to believe
that it is or may be the result of fraud and that management (in particular, senior management) is
involved, the auditor shall re- evaluate the assessment of the risks of material misstatement due to
fraud and its resulting impact on the nature, timing and extent of audit procedures to respond to the
assessed risks. The auditor shall also consider whether circumstances or conditions indicate
possible collusion involving employees, management or third parties when reconsidering the
reliability of evidence previously obtained.
When the auditor confirms that, or is unable to conclude whether, the financial statements are
materially misstated as a result of fraud, the auditor shall evaluate the implications for the audit.
2.13 Circumstances in which auditor is unable to continue the
engagement
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: -
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2.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) Determine the professional and legal
Auditor is unable to continue the Engagement
responsibilities applicable in the
circumstances, including whether there is a
requirement for the auditor to report to the
person or persons who made the audit
appointment or, in some cases, to
regulatory authorities;
(i) Discuss with the appropriate
(b) Consider whether it is level of management and those
appropriate to withdraw from the charged with governance, the
engagement, where withdrawal auditor’s withdrawal from the
from the engagement is legally engagement and the reasons
permitted; and for the withdrawal and
(c) If the auditor withdraws: - (ii) Determine whether there is a
professional or legal requirement to
report to the person or persons who
made the audit appointment or, in some
cases, to regulatory authorities, the
auditor’s withdrawal from the
engagement and the reasons for the
withdrawal.
2.14 Management Representations
The auditor shall obtain written representations from management and, where applicable, those
charged with governance that: -
(a) They acknowledge their responsibility for the design, implementation and
maintenance of internal control to prevent and detect fraud;
(b) They have disclosed to the auditor the results of management’s assessment of the
risk that the financial statements may be materially misstated as a result of fraud;
(c) They have disclosed to the auditor their knowledge of fraud or suspected fraud
affecting the entity involving management, employees who have significant roles in
internal control or others where the fraud could have a material effect on the financial
statements; and
(d) They have disclosed to the auditor their knowledge of any allegations of fraud, or
suspected fraud, affecting the entity’s financial statements communicated by employees,
former employees, analysts, regulators or others.
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2.15 Communications to Management and with Those Charged With
Governance
If the auditor has identified a fraud or has obtained information that indicates that a fraud may exist,
the auditor shall communicate these matters on a timely basis to the appropriate level of
management in order to inform those with primary responsibility for the prevention and detection of
fraud of matters relevant to their responsibilities.
Unless all of those charged with governance are involved in managing the entity, if the auditor has
identified or suspects fraud involving management, employees who have significant roles in internal
control or others where the fraud results in a material misstatement in the financial statements, the
auditor shall communicate these matters to those charged with governance on a timely basis.
If the auditor suspects fraud involving management, the auditor shall communicate these suspicions to
those charged with governance and discuss with them the nature, timing and extent of audit procedures
necessary to complete the audit.
The auditor shall communicate with those charged with governance any other matters related to
fraud that are, in the auditor’s judgment, relevant to their responsibilities.
2.16 Communications to Regulatory and Enforcement Authorities
If the auditor has identified or suspects a fraud, the auditor shall determine whether there is a
responsibility to report the occurrence or suspicion to a party outside the entity. Although the
auditor’s professional duty to maintain the confidentiality of client information may preclude such
reporting, the auditor’s legal responsibilities may override the duty of confidentiality in some
circumstances. For example, in case of audit of banks, the auditor has a statutory duty to report the
occurrence of fraud to the supervisory authorities, i.e. RBI.
Also, in some entities the auditor may have a duty to report misstatements to authorities in those
cases where management and those charged with governance fail to take corrective action. In some
clients, requirements for reporting fraud, whether or not discovered through the audit process, may
be subject to specific provisions of the audit mandate or related legislation or regulation.
2.17 Documentation
The auditor’s documentation of the understanding of the entity and its environment and the
assessment of the risks of material misstatement required shall include: -
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2.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) The significant decisions reached
during the discussion among the (b) The identified and assessed risks
engagement team regarding the of material misstatement due to fraud
susceptibility of the entity’s financial at the financial statement level and at
statements to material misstatement the assertion level.
due to fraud; and
The auditor’s documentation of the responses to the assessed risks of material misstatement
required shall include: -
(a) The overall responses to the assessed risks of material misstatement due to fraud at the
financial statement level and the nature, timing and extent of audit procedures, and the linkage
of those procedures with the assessed risks of material misstatement due to fraud at the
assertion level; and
(b) The results of the audit procedures, including those designed to address the risk of
management override of controls.
The auditor shall document communications about fraud made to management, those charged with
governance, regulators and others.
When the auditor has concluded that the presumption that there is a risk of material misstatement
due to fraud related to revenue recognition is not applicable in the circumstances of the engagement,
the auditor shall document the reasons for that conclusion.
TEST YOUR UNDERSTANDING 1
My Décor Limited, presently engaged in manufacturing of fabrics, wants to set up a new plant for
manufacturing of special kind of fabric providing an altogether different texture and feel. This kind of
fabric has become a hit with retail customers. The company needs to set up plant for manufacturing
the above kind of fabric involving huge capital outlays to stay competitive in the market.
You are auditor of the company and find that company’s revenue has increased in financial year
2022-23 to ` 1000 crore from ` 750 crore in last year. By the time, you started the audit, there was
no change in plant capacity and information regarding need to set up new plant has become known
to you during inquiry of company’s personnel.
Discuss, how you should proceed to deal with above situation, as auditor of the company, paying
special attention to risk of material misstatement due to fraudulent financial reporting?
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RESPONSIBILITIES
TEST YOUR UNDERSTANDING 2
CA. Ridhima, internal auditor of Track Store Limited, has pointed out following deficiencies in internal
control of the company, in her reports: -
[i] Receivables are not reconciled at stipulated intervals.
[ii] Customers are provided a credit limit based upon their track record. However, no review of
customer credit limits is undertaken at required intervals.
The statutory auditor of the company finds that no action has been taken by the company on the
said deficiencies pointed out in reports of internal auditor.
What does above situation allude to statutory auditor of company?
3. SA 250 “CONSIDERATION OF LAWS AND
REGULATIONS IN AN AUDIT OF FINANCIAL
STATEMENTS”
SA 250 deals with auditor’s responsibility to consider laws and regulations when performing an audit
of financial statements. However, it does not apply to other assurance engagements in which the
auditor is specifically engaged to test and report separately on compliance with specific laws or
regulations.
The requirements in this SA are designed to assist the auditor in identifying material misstatement
of the financial statements due to non-compliance with laws and regulations.
3.1 Effect of Laws and Regulations on Financial Statements of an Entity
The effect on the financial statements of laws and regulations varies considerably. Those laws and
regulations to which an entity is subject constitute the legal and regulatory framework. The provisions
of some laws or regulations have a direct effect on the financial statements in that they determine
the reported amounts and disclosures in an entity’s financial statements. Other laws or regulations
are to be complied with by management or set the provisions under which the entity is allowed to
conduct its business but do not have a direct effect on an entity’s financial statements.
Some entities operate in heavily regulated industries (such as banks and chemical companies).
Others are subject only to the many laws and regulations that relate generally to the operating
aspects of the business (such as those related to occupational safety and health). Non-compliance
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2.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
with laws and regulations may result in fines, litigation or other consequences for the entity that may
have a material effect on the financial statements.
3.2. Objectives of auditor in accordance with SA 250
The objectives of the auditor in accordance with SA 250 are: -
(a) To obtain sufficient appropriate audit evidence regarding compliance with the provisions of
those laws and regulations generally recognised to have a direct effect on the determination
of material amounts and disclosures in the financial statements;
(b) To perform specified audit procedures to help identify instances of non-compliance with other
laws and regulations that may have a material effect on the financial statements; and
(c) To respond appropriately to non-compliance or suspected non-compliance with laws and
regulations identified during the audit.
(a) To obtain sufficient appropriate audit evidence regarding
compliance with the provisions of those laws and regulations
generally recognised to have a direct effect on the determination of
Objectives of the auditor
material amounts and disclosures in the financial statements;
(b) To perform specified audit procedures to help identify instances of
non-compliance with other laws and regulations that may have a
material effect on the financial statements; and
(c) To respond appropriately to non-compliance or suspected non-
compliance with laws and regulations identified during the audit.
3.3 Responsibility of Management for Compliance with Laws and
Regulations
It is the responsibility of management, with the oversight of those charged with governance, to
ensure that the entity’s operations are conducted in accordance with the provisions of laws and
regulations, including compliance with the provisions of laws and regulations that determine the
reported amounts and disclosures in an entity’s financial statements.
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RESPONSIBILITIES
The following are examples of the types of policies and procedures an entity may implement
to assist in the prevention and detection of non-compliance with laws and regulations: -
Monitoring legal requirements and ensuring that operating procedures are designed to
meet these requirements.
Instituting and operating appropriate systems of internal control.
Developing, publicising and following a code of conduct.
Ensuring employees are properly trained and understand the code of conduct.
Monitoring compliance with the code of conduct and acting appropriately to discipline
employees who fail to comply with it.
Engaging legal advisors to assist in monitoring legal requirements.
Maintaining a register of significant laws and regulations with which the entity has to
comply within its particular industry and a record of complaints.
In larger entities, these policies and procedures may be supplemented by assigning appropriate
responsibilities to an internal audit function, an audit committee, a compliance function.
3.4 Responsibility of the Auditor
The auditor is not responsible for preventing non-compliance and cannot be expected to detect non-
compliance with all laws and regulations. The auditor is responsible for obtaining reasonable
assurance that the financial statements, taken as a whole, are free from material misstatement,
whether caused by fraud or error. In conducting an audit of financial statements, the auditor takes into
account the applicable legal and regulatory framework. Owing to the inherent limitations of an audit,
there is an unavoidable risk that some material misstatements in the financial statements may not be
detected, even though the audit is properly planned and performed in accordance with the SAs.
In the context of laws and regulations, the potential effects of inherent limitations on the
auditor’s ability to detect material misstatements are greater for such reasons as the
following: -
There are many laws and
Non-compliance may involve
regulations, relating
conduct designed to conceal
principally to the operating
it, such as collusion, forgery, Whether an act constitutes
aspects of an entity that
deliberate failure to record non-compliance is ultimately a
typically do not affect the
transactions, management matter for legal determination
financial statements and are
override of controls or by a court of law.
not captured by the entity’s
intentional misrepresentations
information systems relevant
being made to the auditor.
to financial reporting.
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2.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Ordinarily, the further removed non-compliance is from the events and transactions reflected in the
financial statements, the less likely the auditor is to become aware of it or to recognise the non-
compliance.
SA 250 distinguishes the auditor’s responsibilities in relation to compliance with two different
categories of laws and regulations as follows: -
(a) The provisions of those laws and regulations generally recognised to have a direct effect on
the determination of material amounts and disclosures in the financial statements such as tax
and labour laws and
(b) Other laws and regulations that do not have a direct effect on the determination of the
amounts and disclosures in the financial statements, but compliance with which may be
fundamental to the operating aspects of the business, to an entity’s ability to continue its
business, or to avoid material penalties (for example, compliance with the terms of an
operating license, compliance with regulatory solvency requirements, or compliance with
environmental regulations). Non-compliance with such laws and regulations may, therefore,
have a material effect on the financial statements.
Auditor's responsibilities in relation to compliance with laws
and regulations
Responsibilities relating to those laws and
Responsibilities relating to compliance
regulations that do not have a direct effect
with those laws and regulations generally
on the determination of amounts and
recognised to have a direct effect on the
disclosures in FS but their compliance
determination of material amounts and
may be fundamental to operating aspects
disclosures in FS
of business
For the compliance with provisions of those laws and regulations generally recognised to have a
direct effect on the determination of material amounts and disclosures in the financial statements,
the auditor’s responsibility is to obtain sufficient appropriate audit evidence about compliance with
the provisions of those laws and regulations.
For other laws and regulations that do not have a direct effect on the determination of the amounts
and disclosures in the financial statements but compliance with which may be fundamental to the
operating aspects of the business, the auditor’s responsibility is limited to undertaking specified audit
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RESPONSIBILITIES
procedures to help identify non-compliance with those laws and regulations that may have a material
effect on the financial statements.
The auditor is to remain alert to the possibility that other audit procedures applied for the purpose of
forming an opinion on financial statements may bring instances of identified or suspected non-
compliance to the auditor’s attention. Maintaining professional skepticism throughout the audit, is
important in this context, given the extent of laws and regulations that affect the entity.
The Auditor’s consideration of compliance with laws and regulations
As part of obtaining an understanding of the entity and its environment, the auditor shall obtain a
general understanding of: -
(a) The legal and regulatory
framework applicable to the
(b) How the entity is complying
entity and the industry or
with that framework.
sector in which the entity
operates; and
The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the
provisions of those laws and regulations generally recognised to have a direct effect on the
determination of material amounts and disclosures in the financial statements. Such laws, for
example, could relate to form and content of financial statements or industry- specific financial
reporting issues.
The auditor shall perform the following audit procedures to help identify instances of non-
compliance with other laws and regulations that may have a material effect on the financial
statements:
(a) Inquiring of management and, where appropriate, those charged with governance, as to
whether the entity is in compliance with such laws and regulations; and
(b) Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.
Certain other laws and regulations may need particular attention by the auditor because they have
a fundamental effect on the operations of the entity. Non-compliance with laws and regulations that
have a fundamental effect on the operations of the entity may cause the entity to cease operations,
or call into question the entity’s continuance as a going concern.
For example: Non-compliance with the requirements of the entity’s license or other entitlement to
perform its operations could have such an impact (for example, for a bank, non-compliance with
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2.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
capital or investment requirements). An NBFC might have to cease to carry on the business of a
non-banking financial institution if it fails to obtain a certificate of registration issued under RBI Act
and if its Net Owned Funds are less than the amount specified by the RBI in this regard.
There are also many laws and regulations relating principally to the operating aspects of the entity
that typically do not affect the financial statements and are not captured by the entity’s information
systems relevant to financial reporting. As the financial reporting consequences of other laws and
regulations can vary depending on the entity’s operations, the audit procedures as stated above are
directed to bringing to the auditor’s attention instances of non-compliance with laws and regulations
that may have a material effect on the financial statements.
Audit procedures applied to form an opinion on the financial statements may bring instances of non-
compliance or suspected non-compliance with laws and regulations to the auditor’s attention.
During the audit, the auditor shall remain alert to the possibility that other audit procedures applied
may bring instances of non-compliance or suspected non-compliance with laws and regulations to
the auditor’s attention.
The auditor shall request management and, where appropriate, those charged with governance to
provide written representations that all known instances of non-compliance or suspected non-
compliance with laws and regulations whose effects should be considered when preparing financial
statements have been disclosed to the auditor.
3.5 Audit Procedures when Non-Compliance is Identified or Suspected
If the auditor becomes aware of information concerning an instance of non-compliance or suspected
non-compliance with laws and regulations, the auditor shall obtain:
(b) Further information to
evaluate the possible effect on
the financial statements.
(a) An understanding of the nature
of the act and the circumstances
in which it has occurred and
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RESPONSIBILITIES
If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with
management and, where appropriate, those charged with governance. If management or, as
appropriate, those charged with governance do not provide sufficient information that supports that
the entity is in compliance with laws and regulations and, in the auditor’s judgment, the effect of the
suspected non-compliance may be material to the financial statements, the auditor shall consider
the need to obtain legal advice.
If sufficient information about suspected non-compliance cannot be obtained, the auditor shall
evaluate the effect of the lack of sufficient appropriate audit evidence on the auditor’s opinion.
The auditor shall evaluate the implications of non-compliance in relation to other aspects of the audit,
including the auditor’s risk assessment and the reliability of written representations, and take appropriate
action.
3.6 Reporting of Identified or Suspected Non-Compliance
(A) Reporting Non-Compliance to Those Charged with Governance
Unless all of those charged with governance are involved in management of the entity, and therefore
are aware of matters involving identified or suspected non-compliance already communicated by the
auditor, the auditor shall communicate with those charged with governance matters involving non-
compliance with laws and regulations that come to the auditor’s attention during the course of the
audit, other than when the matters are clearly inconsequential.
If, in the auditor’s judgment, the non-compliance referred to above is believed to be intentional and
material, the auditor shall communicate the matter to those charged with governance as soon as
practicable.
If the auditor suspects that management or those charged with governance are involved in non-
compliance, the auditor shall communicate the matter to the next higher level of authority at the
entity, if it exists, such as an audit committee or supervisory board. Where no higher authority exists,
or if the auditor believes that the communication may not be acted upon or is unsure as to the person
to whom to report, the auditor shall consider the need to obtain legal advice.
(B) Reporting non-compliance in the auditor’s report on the financial statements
If the auditor concludes that the non-compliance has a material effect on the financial statements,
and has not been adequately reflected in the financial statements, the auditor shall, in accordance
with SA 705, express a qualified or adverse opinion on the financial statements.
If the auditor is precluded by management or those charged with governance from obtaining
sufficient appropriate audit evidence to evaluate whether non-compliance that may be material to
the financial statements has, or is likely to have, occurred, the auditor shall express a qualified
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2.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
opinion or disclaim an opinion on the financial statements on the basis of a limitation on the scope
of the audit in accordance with SA 705.
If the auditor is unable to determine whether non-compliance has occurred because of limitations
imposed by the circumstances rather than by management or those charged with governance, the
auditor shall evaluate the effect on the auditor’s opinion in accordance with SA 705.
(C) Reporting non-compliance to regulatory and enforcement authorities
If the auditor has identified or suspects non-compliance with laws and regulations, the auditor shall
determine whether the auditor has a responsibility to report the identified or suspected non-
compliance to parties outside the entity.
3.7 Documentation
The auditor shall document identified or suspected non-compliance with laws and regulations and
the results of discussion with management and, where applicable, those charged with governance
and other parties outside the entity.
TEST YOUR UNDERSTANDING 3
FAS Insurance Brokers Limited is a leading online insurance intermediary. During the year, Director
General of GST Intelligence (DGGI) has issued notice to the company for allegedly creating fictitious
invoices for “marketing and sales services” amounting to ` 50 crores in favour of non-life insurance
companies. The premises of company were also searched during the year by DGGI officials. The
matter was also informed to IRDAI by DGGI for violation of norms and regulations in this regard.
Does above situation has any bearing on your responsibilities as statutory auditor of the company?
Outline briefly in context of possible non-compliance with laws by the company.
4. SA 260 “COMMUNICATION WITH THOSE CHARGED
WITH GOVERNANCE”
SA 260 deals with the auditor’s responsibility to communicate with those charged with governance
in an audit of financial statements.
Who are “Those charged with governance”?
“Those charged with governance” denote the person(s) or organization(s) (e.g., a corporate trustee)
with responsibility for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity. This includes those overseeing the financial reporting process. For some
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GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.29
RESPONSIBILITIES
entities, those charged with governance may include management personnel, for example, executive
members of a governance board of a private or public sector entity, or an owner-manager.
Governance structures vary by entities, reflecting influences such as different cultural and legal
backgrounds, size and ownership characteristics. For example, in some entities, a supervisory board
exists that is separate from executive board. In other entities, both supervisory and executive
functions are performed by a single board. In some entities, those charged with governance hold
positions that are an integral part of the entity’s legal structure. For example, company directors. In
some cases, some or all of those charged with governance are involved in managing the entity. In
others, those charged with governance and management comprise different persons.
In most entities, governance is the collective responsibility of a governing body, such as a board of
directors, a supervisory board, partners, proprietors, a committee of management, trustees, or
equivalent persons. In some smaller entities, however, one person may be charged with governance,
for example, the owner-manager where there are no other owners, or a sole trustee.
Such diversity means that it is not possible to specify for all audits the persons with whom the auditor
is to communicate particular matters. Also, in some cases, the appropriate persons with whom to
communicate may not be clearly identifiable from the applicable legal framework or other
engagement circumstances, for example, entities where the governance structure is not formally
defined, such as some family-owned entities and some not-for-profit organizations.
In such cases, the auditor may need to discuss and agree with the engaging party the relevant
persons with whom to communicate. In deciding with whom to communicate, the auditor’s
understanding of an entity’s governance structure and processes obtained in accordance with SA
315 is relevant. The appropriate persons with whom to communicate may vary depending on the
matter to be communicated.
Significance of Communication with Those charged with governance
Communication from auditor is important with those charged with governance. An effective two-way
communication is important in assisting:
[a] The auditor and those charged with governance in understanding matters related to the audit in context,
and in developing a constructive working relationship. This relationship is developed while maintaining the
auditor’s independence and objectivity.
[b] The auditor in obtaining from those charged with governance information relevant to the audit. For
example, those charged with governance may assist the auditor in understanding the entity and its
environment, in identifying appropriate sources of audit evidence, and in providing information about
specific transactions or events and
[c] Those charged with governance in fulfilling their responsibility to oversee the financial reporting
process, thereby reducing the risks of material misstatement of the financial statements.
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2.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4.1 Objectives of Auditor in Accordance with SA 260
The objectives of the auditor are: -
(a) To communicate clearly with those charged with governance responsibilities of the auditor in
relation to the financial statement audit, and an overview of the planned scope and timing of the
audit;
(b) To obtain from those charged with governance information relevant to the audit;
(c) 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
(d) To promote effective two-way communication between the auditor and those charged with
governance.
To communicate clearly with those charged with governance responsibilities of the auditor in
relation to the financial statement audit, and an overview of the planned scope and timing of
the audit;
Objectives of the auditor
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.
Determining appropriate persons with whom to communicate : The auditor shall determine the
appropriate person(s) within the entity’s governance structure with whom to communicate.
4.2 Matters to be Communicated by the Auditor
Following matters are required to be communicated by auditor with those charged with governance:-
[a] The auditor’s responsibilities in relation to the financial statement audit
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.
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GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.31
RESPONSIBILITIES
The auditor’s responsibilities in relation to the financial statement audit are often included in the
engagement letter or other suitable form of written agreement that records the agreed terms of the
engagement. Law, regulation or the governance structure of the entity may require those charged
with governance to agree the terms of the engagement with the auditor. When this is not the case,
providing those charged with governance with a copy of that engagement letter or other suitable
form of written agreement may be an appropriate way to communicate with them.
[b] Planned scope and timing of the audit
Communication regarding the planned scope and timing of the audit may: -
• Assist those charged with governance to understand better the consequences of the auditor’s
work, to discuss issues of risk and the concept of materiality with the auditor, and to identify
any areas in which they may request the auditor to undertake additional procedures and
• Assist the auditor to understand better the entity and its environment.
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.
Communicating significant risks identified by the auditor helps those charged with
governance understand those matters and why they require special audit consideration. The
communication about significant risks may assist those charged with governance in fulfilling
their responsibility to oversee the financial reporting process.
While communication with those charged with governance may assist the auditor to plan the
scope and timing of the audit, it does not change the auditor’s sole responsibility to establish
the overall audit strategy and the audit plan, including the nature, timing and extent of
procedures necessary to obtain sufficient appropriate audit evidence.
Care is necessary when communicating with those charged with governance about the
planned scope and timing of the audit so as not to compromise the effectiveness of the audit,
particularly where some or all of those charged with governance are involved in managing
the entity. For example, communicating the nature and timing of detailed audit procedures
may reduce the effectiveness of those procedures by making them too predictable.
[c] Significant findings from the audit
The auditor shall communicate with those charged with governance: -
(i) The auditor’s views about significant qualitative aspects of the entity’s accounting practices,
including accounting policies, accounting estimates and financial statement disclosures.
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2.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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;
(ii) Significant difficulties, if any, encountered during the audit;
(iii) Unless all of those charged with governance are involved in managing the entity: -
(1) Significant matters arising
during the audit that were
(2) Written representations the
discussed, or subject to
auditor is requesting
correspondence, with
management;
(iv) Circumstances that affect the form and content of the auditor’s report, if any and
(v) 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.
The communication of findings from the audit may include requesting further information from those
charged with governance in order to complete the audit evidence obtained. For example, the auditor
may confirm that those charged with governance have the same understanding of the facts and
circumstances relevant to specific transactions or events.
Significant difficulties encountered during the audit may include such
matters as: -
Significant
delays by
management, the
unavailability of
Management’s
entity personnel,
Extensive unwillingness to
or an An unreasonably
unexpected effort Restrictions make or extend
unwillingness by brief time within The unavailability
required to obtain imposed on the its assessment of
management to which to of expected
sufficient auditor by the entity’s ability
provide complete the information.
appropriate audit management. to continue as a
information audit.
evidence. going concern
necessary for the
when requested.
auditor to
perform the
auditor’s
procedures.
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In some circumstances, such difficulties may constitute a scope limitation that leads to a modification
of the auditor’s opinion.
Significant matters that were discussed, or subject to correspondence with management may
include such matters as: -
• Significant events or transactions that occurred during the year.
• Business conditions affecting the entity, and business plans and strategies that may
affect the risks of material misstatement.
• Concerns about management’s consultations with other accountants on accounting or
auditing matters.
• Discussions or correspondence in connection with the initial or recurring appointment
of the auditor regarding accounting practices, the application of auditing standards, or
fees for audit or other services.
• Significant matters on which there was disagreement with management, except for
initial differences of opinion because of incomplete facts or preliminary information that
are later resolved by the auditor obtaining additional relevant facts or information.
The agreed terms of the audit engagement are required to be recorded in an audit engagement letter
or other suitable form of written agreement and include, among other things, reference to the
expected form and content of the auditor’s report. Communication in this respect is intended to
inform those charged with governance about circumstances in which the auditor’s report may differ
from its expected form and content or may include additional information about the audit that was
performed.
Circumstances in which the auditor is required or may otherwise consider it necessary to
include additional information in the auditor’s report in accordance with the SAs, and for
which communication with those charged with governance is required, include when: -
• The auditor expects to modify the opinion in the auditor’s report in accordance with SA 705.•
A material uncertainty related to going concern is reported in accordance with SA 570.
• Key audit matters are communicated in accordance with SA 701.
• The auditor considers it necessary to include an Emphasis of Matter paragraph or Other
Matter paragraph in accordance with SA 706 or is required to do so by other SAs.
• The auditor has concluded that there is an uncorrected material misstatement of the other
information in accordance with SA 720.
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2.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In such circumstances, the auditor may consider it useful to provide those charged with governance
with a draft of the auditor’s report to facilitate a discussion of how such matters will be addressed in
the auditor’s report.
4.3 Communication of Auditor’s Independence in Case of Listed Entities
In the case of listed entities, the auditor shall communicate with those charged with governance: -
(a) A statement that the engagement team and others in the firm as appropriate, the firm and,
when applicable, network firms have complied with relevant ethical requirements regarding
independence; and
(b) i. All relationships and other matters between the firm, network firms, and the entity
that, in the auditor’s professional judgment, may reasonably be thought to bear on independence.
This shall include total fees charged during the period covered by the financial statements for
audit and non-audit services provided by the firm and network firms to the entity and components
controlled by the entity. These fees shall be allocated to categories that are appropriate to assist
those charged with governance in assessing the effect of services on the independence of the
auditor; and
ii. The related safeguards that have been applied to eliminate identified threats to
independence or reduce them to an acceptable level.
The Communication process
The auditor shall communicate with those charged with governance the form, timing and expected
general content of communications.
The auditor shall communicate in writing with those charged with governance regarding significant
findings from the audit if, in the auditor’s professional judgment, oral communication would not be
adequate. Written communications need not include all matters that arose during the course of the
audit. The auditor shall communicate in writing with those charged with governance regarding auditor
independence when required in case of listed entities.
The auditor shall communicate with those charged with governance on a timely basis.
Adequacy of the communication process
The auditor shall evaluate whether the two-way communication between the auditor and those
charged with governance has been adequate for the purpose of the audit. If it has not, the auditor
shall evaluate the effect, if any, on the auditor’s assessment of the risks of material misstatement
and ability to obtain sufficient appropriate audit evidence, and shall take appropriate action.
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4.4 Documentation
Where matters required by SA 260 to be communicated are communicated orally, the auditor shall
include them in the audit documentation, and when and to whom they were communicated. Where
matters have been communicated in writing, the auditor shall retain a copy of the communication as
part of the audit documentation.
TEST YOUR UNDERSTANDING 4
CA. Vallabh Sundar is auditor of a leading private sector bank. “IT Systems and controls” is under
his consideration to be reported as “Key audit matter” in audit report of the bank due to high level of
automation and complexity of the IT architecture and its impact on the financial reporting system.
At what time he should communicate such identified “Key audit matter”? What are relevant
considerations in this regard and their usefulness?
5. SA 299 “JOINT AUDIT OF FINANCIAL STATEMENTS”
SA 299 lays down the principles for effective conduct of joint audit to achieve the overall objectives
of the auditor as laid down in SA 200. It deals with the special considerations in carrying out audit
by joint auditors.
However, it does not deal with the relationship between a principal auditor who is appointed to report
on the financial statements of an entity and another auditor who is appointed to report on the financial
statements of one or more component (divisions, branches, subsidiary, joint venture, associates,
other entity) included in the financial statements of the entity.
What is joint audit of financial statements?
A joint audit is an audit of financial statements of an entity by two or more auditors appointed with
the objective of issuing the audit report. Such auditors are described as joint auditors.
The practice of appointing more than one auditor to conduct the audit of large entities has been in
vogue for a long time, sometimes voluntarily by the shareholders or sometimes due to the
requirements of laws or regulations. Such auditors, known as joint auditors, conduct the audit jointly
and report on the financial statements of the entity.
For example, section 139(3) of Companies Act, 2013 provides that members of a company may
resolve to provide that the audit shall be conducted by more than one auditor.
© The Institute of Chartered Accountants of India
2.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
5.1 Objectives in accordance with SA 299
The objectives in accordance with SA 299 are as under: -
(a) To lay down broad principles for the joint auditors in conducting the joint audit.
(b) To provide a uniform approach to the process of joint audit.
(c) To identify the distinct areas of work and coverage thereof by each joint auditor.
(d) To identify individual responsibility and joint responsibility of the joint auditors in relation to
audit.
To lay down broad principles for the joint auditors in conducting the
joint audit.
Objectives of the auditor
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.
To identify individual responsibility and joint responsibility of the joint
auditors in relation to audit.
5.2 Audit planning, Risk Assessment and Allocation of Work
The engagement partner and other key members of the engagement team from each of the joint
auditors shall be involved in planning the audit. Overall audit strategy that sets the scope, timing
and direction of the audit, and that guides the development of the audit plan shall be established
jointly.
Prior to the commencement of the audit, the joint auditors shall discuss and develop a
joint audit plan. In developing the joint audit plan, the joint auditors shall: -
(a) Identify division of audit areas and common audit areas amongst the joint auditors that
define the scope of the work of each joint auditor. Where joint auditors are appointed, they
should, by mutual discussion, divide the audit work among themselves. The division of
work would usually be in terms of audit of identifiable units or specified areas. In some
cases, due to the nature of the business of the entity under audit, such a division of work
may not be possible. In such situations, the division of work may be with reference to items
of assets or liabilities or income or expenditure. Certain areas of work, owing to their
importance or owing to the nature of the work involved, would often not be divided and
would be covered by all the joint auditors.
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RESPONSIBILITIES
(b) Ascertain the reporting objectives of the engagement to plan the timing of the audit and
the nature of the communications required
(c) Consider and communicate among all joint auditors the factors that, in their
professional judgment, are significant in directing the engagement team’s efforts
(d) Consider the results of preliminary engagement activities and, where applicable,
whether knowledge gained on other or similar engagements performed earlier by the
respective engagement partner for the entity is relevant.
(e) Ascertain the nature, timing and extent of resources necessary to perform the
engagement.
At this stage, risks of material misstatement need to be considered and assessed by each of
the joint auditors and shall be communicated to other joint auditors, and documented, whether
pertaining to the overall financial statements level or to the area of allocation among the other joint
auditors.
The joint auditors shall discuss and document the nature, timing, and the extent of the audit
procedures for common and specific allotted areas of audit to be performed by each of the joint auditors
and the same shall be communicated to those charged with governance.
The joint auditors shall obtain common engagement letter and common management representation
letter.
After identification and allocation of work among the joint auditors, the work allocation
document shall be signed by all the joint auditors and the same shall be communicated to those
charged with governance of the entity.
The documentation of allocation of work helps in avoiding any dispute or confusion which may arise
among the joint auditors regarding the scope of work to be carried out by them. Further, the
communication of allocation of work to the entity helps in avoiding any dispute or confusion which
may arise between the entity and the joint auditors.
5.3 Responsibility and Co-ordination among Joint Auditors
The audit process involves obtaining and evaluating information and explanations from the
management. This responsibility is shared by all the joint auditors unless they agree upon a specific
pattern of distribution of this responsibility.
In respect of audit work divided among the joint auditors, each joint auditor shall be responsible
only for the work allocated to such joint auditor including proper execution of the audit procedures.
In cases where specific divisions, zones or units are allocated to different joint auditors, it is the
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2.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
separate and specific responsibility of each joint auditor to obtain information and explanations from
the management in respect of such divisions/zones/units and to evaluate the information and
explanations so obtained by said joint auditor. The joint auditors shall have proper coordination and
rationality wherever required.
All the joint auditors shall be jointly and severally responsible for: -
(a) the audit work which is not divided among the joint auditors and is carried out by all joint auditors
(b) 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.
(c) 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
(d) examining that the financial statements of the entity comply with the requirements of the relevant
statutes
(e) presentation and disclosure of the financial statements as required by the applicable financial
reporting framework
(f) 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.
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.
It shall be the responsibility of each joint auditor to determine the nature, timing and extent
of audit procedures to be applied in relation to the areas of work allocated to said joint auditor. It
is the individual responsibility of each joint auditor to study and evaluate the prevailing system of
internal control and assessment of risk relating to the areas of work allocated to said joint auditor.
As regards 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, all the joint auditors are responsible only in respect of the appropriateness of the
decisions concerning the nature, timing and extent of the audit procedures agreed upon among them,
proper execution of these audit procedures is the individual responsibility of the joint auditor concerned.
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RESPONSIBILITIES
5.4 Audit Conclusion and Reporting
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 SA 706.
Each Joint Auditor is entitled to assume that: -
(a) The other joint auditors have carried out their part of the audit work and the work
has actually been performed in accordance with the Standards on Auditing issued by
the Institute of Chartered Accountants of India. It is not necessary for a joint auditor to
review the work performed by other joint auditors or perform any tests in order to
ascertain whether the work has actually been performed in such a manner.
(b) The other joint auditors have brought to said joint auditor’s notice any departure
from applicable financial reporting framework or significant observations that are
relevant to their responsibilities noticed in the course of the audit.
Where financial statements of a division/branch are audited by one of the joint auditors, the
other joint auditors are entitled to proceed on the basis that such financial statements comply with
all the legal and regulatory requirements and present a true and fair view of the state of affairs and
of the results of operations of the division/branch concerned.
Before finalizing their audit report, the joint auditors shall discuss and communicate with each
other their respective conclusions that would form the content of the audit report.
5.5 Communication with Those Charged with Governance
When the joint auditors expect to modify the opinion in the auditor’s report, the joint auditors shall
communicate with those charged with governance the circumstances that led to the expected
modification and the proposed wording of the modification to ensure compliance with SA 705. If the
joint auditors expect to include an Emphasis of Matter or an Other Matter paragraph in the auditor’s
report, the joint auditors shall communicate with those charged with governance regarding this
expectation and the proposed wording of this paragraph to ensure compliance with SA 706.
© The Institute of Chartered Accountants of India
2.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 5
Four audit firms viz. GPR & Co., MKS & Co., CY & Associates and DES & Associates have been
appointed for conducting statutory audit of KNB Bank, a public sector bank in accordance with
regulatory guidelines. The professional work was divided by audit firms on the basis of zones of
bank. However, work relating to “IT Systems and controls” was not allocated by them due to its very
nature.
While planning for the above common work area, it was decided to test IT general controls,
application controls and IT dependent manual controls. Planned key audit procedures relating to this
common area also included testing design and operating effectiveness of controls over “computer
operations including back-up, batch-processing and data centre security”.
The actual audit procedures pertaining to “testing controls over batch processing” were performed
by team of DES & Associates. In case work in relation to above audit procedures is not performed
professionally by DES & Associates, discuss where responsibility for such lapses would lie in line
with SA 299?
6. SA 402 “AUDIT CONSIDERATIONS RELATING TO AN
ENTITY USING A SERVICE ORGANISATION”
SA 402 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 organisations. Specifically, it expands
on how the user auditor applies SA 315 and SA 330 in obtaining an understanding of the user entity,
including internal control relevant to the audit, sufficient to identify and assess the risks of material
misstatement and in designing and performing further audit procedures responsive to those risks.
• Service organisation is a third-party organisation (or segment of a
What is a Service third-party organisation) that provides services to user entities that
are part of those entities’ information systems relevant to financial
organization? reporting. User entity is an entity that uses a service organisation
and whose financial statements are being audited.
Who is a service • Service auditor is an auditor who, at the request of the service
organisation, provides an assurance report on the controls of a
auditor? service organisation. User auditor is an auditor who audits and
reports on the financial statements of a user entity.
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RESPONSIBILITIES
Many entities outsource aspects of their business to organisations that provide services ranging
from performing a specific task under the direction of an entity to replacing an entity’s entire business
units or functions, such as the tax compliance function. Many of the services provided by such
organisations are integral to the entity’s business operations; however, not all those services are
relevant to the audit.
When services provided by a service organization are relevant to the audit of a user entity’s financial
statements?
Services provided by a service organisation are relevant to the audit of a user entity’s financial
statements when those services, and the controls over them, are part of the user entity’s information
system, including related business processes, relevant to financial reporting. Although most controls
at the service organisation are likely to relate to financial reporting, there may be other controls that
may also be relevant to the audit, such as controls over the safeguarding of assets.
A service organisation’s services are part of a user entity’s information system, including related
business processes, relevant to financial reporting if these services affect any of the following: -
(a) The classes of transactions in the user entity’s operations that are significant to the user
entity’s financial statements
(b) The procedures, within both information technology (IT) and manual systems, by which the
user entity’s transactions are initiated, recorded, processed, corrected as necessary, transferred
to the general ledger and reported in the financial statements
(c) The related accounting records, either in electronic or manual form, supporting information
and specific accounts in the user entity’s financial statements that are used to initiate, record,
process and report the user entity’s transactions
(d) How the user entity’s information system captures events and conditions, other than
transactions, that are significant to the financial statements
(e) The financial reporting process used to prepare the user entity’s financial statements, including
significant accounting estimates and disclosures and
(f) Controls surrounding journal entries, including non-standard journal entries used to record non-
recurring, unusual transactions or adjustments
The nature and extent of work to be performed by the user auditor regarding the services provided by a
service organisation depend on the nature and significance of those services to the user entity and the
relevance of those services to the audit.
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2.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
6.1 Objectives of user auditor in accordance with SA 402
The objectives of the user auditor, when the user entity uses the services of a service organisation,
are:-
(a) To obtain an 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,
sufficient to identify and assess the risks of material misstatement; and
(b) To design and perform audit procedures responsive to those risks.
To obtain an understanding of the nature and significance of the
Objectives of the auditor
services provided by the service organisation and their effect on the
user entity’s internal control relevant to the audit, sufficient to
identify and assess the risks of material misstatement; and
To design and perform audit procedures responsive to those risks.
6.2 Type 1 report and Type 2 report
Type 1 report is a report that comprises: -
(ii) A report by the service auditor with
(i) A description, prepared by the objective of conveying reasonable
management of the service assurance that includes the service
organisation, of the service auditor’s opinion on the description of
organisation’s system, control the service organisation’s system,
objectives and related controls that control objectives and related controls
have been designed and implemented and the suitability of the design of the
as at a specified date; and controls to achieve the specified control
objectives.
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Type 2 report is a report that comprises: -
(ii) A report by the service auditor with the objective of
(i) A description, prepared conveying reasonable assurance that includes: -
by management of the
service organisation, of the
service organisation’s
system, control objectives a. The service auditor’s
and related controls, their opinion on the description
design and implementation of the service organisation’s
as at a specified date or system, control objectives
throughout a specified b. A description of the
and related controls, the
period and, in some cases, service auditor’s tests of the
suitability of the design of
their operating effectiveness controls and the results
the controls to achieve the
throughout a specified thereof.
specified control objectives,
period; and and the operating
effectiveness of the
controls; and
6.3 Obtaining an Understanding of the Services
1. Obtaining an understanding of the services provided by a service organisation,
including internal control: When obtaining an understanding of the user entity in
accordance with SA 315, the user auditor shall obtain an understanding of how a user entity
uses the services of a service organisation in the user entity’s operations, including: -
(a) The nature of the services provided by the service organisation and the significance of those
services to the user entity, including the effect thereof on the user entity’s internal control. Information
on nature of services provided by a user organization may be available from sources such as user
manuals, contract between the user entity and service organization, reports by service auditors etc.
(b) The nature and materiality of the transactions processed or accounts or financial reporting
processes affected by the service organisation. In certain situations, the transactions processed and
the accounts affected by the service organisation may not appear to be material to the user entity’s
financial statements, but the nature of the transactions processed may be significant and the user
auditor may determine that an understanding of those controls is necessary in the circumstances.
(c) The degree of interaction between the activities of the service organisation and those of the user
entity. The degree of interaction refers to the extent to which a user entity is able to and elects to
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2.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
implement effective controls over the processing performed by the service organisation. For example,
a high degree of interaction exists between the activities of the user entity and those at the service
organisation when the user entity authorises transactions and the service organisation processes and
does the accounting for those transactions
(d) The nature of the relationship between the user entity and the service organisation, including the
relevant contractual terms for the activities undertaken by the service organisation.
2. When obtaining an understanding of internal control relevant to the audit in
accordance with SA 315, the user auditor shall evaluate the design and implementation
of relevant controls at the user entity that relate to the services provided by the service
organisation, including those that are applied to the transactions processed by the service
organisation.
3. 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.
4. If the user auditor is unable to obtain a sufficient understanding from the user entity,
the user auditor shall obtain that understanding from one or more of the following
procedures: -
(c) Visiting the service
organisation and
performing procedures
that will provide the
(a) Obtaining a necessary information
Type 1 or Type about the relevant
2 report, if controls at the service
available organisation or
(b) Contacting (d) Using another
the service auditor to perform
organisation, procedures that will
through the provide the
user entity, to necessary
obtain specific information about
information the relevant controls
at the service
organisation.
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6.4 Using Type 1 or Type 2 Report
Using A Type 1 Or Type 2 Report to Support the User Auditor’s Understanding of The Service
Organisation : In determining the sufficiency and appropriateness of the audit evidence provided by
a Type 1 or Type 2 report, the user auditor shall be satisfied as to: -
(a) The service auditor’s professional
competence (except where the service
(b) The adequacy of the standards
auditor is a member of the Institute of
under which the Type 1 or Type 2
Chartered Accountants of India) and
report was issued.
independence from the service
organisation; and
If the user auditor plans to use a Type 1 or Type 2 report as audit evidence to support the user
auditor’s understanding about the design and implementation of controls at the service organisation,
the user auditor shall:
(a) Evaluate whether the description and design of controls at the service organisation is at a
date or for a period that is appropriate for the user auditor’s purposes;
(b) Evaluate the sufficiency and appropriateness of the evidence provided by the report for the
understanding of the user entity’s internal control relevant to the audit; and
(c) Determine whether complementary user entity controls identified by service organisation are
relevant to the user entity and, if so, obtain an understanding of whether the user entity has
designed and implemented such controls.
Complementary user entity controls refer to controls that the service organisation assumes, in the
design of its service, will be implemented by user entities, and which, if necessary to achieve control
objectives, are identified in the description of its system.
6.5 Responding to the Assessed Risks of Material Misstatement
In responding to assessed risks in accordance with SA 330, the user auditor shall: -
(a) Determine whether sufficient appropriate audit evidence concerning the relevant financial
statement assertions is available from records held at the user entity; and, if not,
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2.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) Perform further audit procedures to obtain sufficient appropriate audit evidence or use
another auditor to perform those procedures at the service organisation on the user auditor’s
behalf.
6.6 Tests of Controls
When the user auditor’s risk assessment includes an expectation that controls at the service
organisation are operating effectively, the user auditor shall obtain audit evidence about the
operating effectiveness of those controls from one or more of the following procedures: -
(c) Using another auditor to
(b) Performing appropriate
(a) Obtaining a Type 2 perform tests of controls at
tests of controls at the
report, if available; the service organisation on
service organisation; or
behalf of the user auditor.
Using a Type 2 report as audit evidence that controls at the service organisation are operating
effectively
If, the user auditor plans to use a Type 2 report as audit evidence that controls at the service
organisation are operating effectively, the user auditor shall determine whether the service auditor’s
report provides sufficient appropriate audit evidence about the effectiveness of the controls to
support the user auditor’s risk assessment by:
(a) Evaluating whether the description, design and operating effectiveness of controls at the
service organisation is at a date or for a period that is appropriate for the user auditor’s purposes ;
(b) Determining whether complementary user entity controls identified by the service
organisation are relevant to the user entity and, if so, obtaining an understanding of whether
the user entity has designed and implemented such controls and, if so, testing their operating
effectiveness;
(c) Evaluating the adequacy of the time period covered by the tests of controls and the time
elapsed since the performance of the tests of controls; and
(d) Evaluating whether the tests of controls performed by the service auditor and the results
thereof, as described in the service auditor’s report, are relevant to the assertions in the user
entity’s financial statements nd provide sufficient appropriate audit evidence to support the user
auditor’s risk assessment.
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6.7 Fraud, non-compliance with laws and regulations and uncorrected
misstatements in relation to activities at the service organisation
The user auditor shall inquire of management of the user entity whether the service organisation has
reported to the user entity, or whether the user entity is otherwise aware of, any fraud, non-
compliance with laws and regulations or uncorrected misstatements affecting the financial
statements of the user entity. The user auditor shall evaluate how such matters affect the nature,
timing and extent of the user auditor’s further audit procedures, including the effect on the user
auditor’s conclusions and user auditor’s report.
6.8 Reporting by the user auditor
The user auditor shall modify the opinion in the user auditor’s report in accordance with SA 705 if
the user auditor is unable to obtain sufficient appropriate audit evidence regarding the services
provided by the service organisation relevant to the audit of the user entity’s financial statements.
The user auditor shall not refer to the work of a service auditor in the user 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 user auditor’s report shall indicate that the reference does not diminish the user auditor’s
responsibility for the audit opinion.
If reference to the work of a service auditor is relevant to an understanding of a modification to the
user auditor’s opinion, the user auditor’s report shall indicate that such reference does not diminish
the user auditor’s responsibility for that opinion.
Integrated Case Scenario:
CA. Biswajit is conducting audit of “Have More Limited”. He is auditor of the company since last
three years and has found nothing unusual in operations and financial statements of the company.
The company has many locations where substantial inventories are stored and lying. During his
fourth year stint, he finds that inventory quantities have risen disproportionately as compared to past
few years trends. He has assessed existence of risk of material misstatement due to fraud.
The company has revenue of ` 750 crore during the year. He has deeply verified all aspects
pertaining to revenue recognition of the company and has concluded that there is no risk of material
misstatement due to fraud related to revenue recognition.
During the course of audit, it has come to his knowledge that company is also required to install
online air pollution control monitoring systems in its plant as mandated in state pollution control
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2.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
legislation and regulations. Non-installation of such online air pollution control monitoring systems
may lead to fines and even sealing of plant.
While verifying payroll data of the company, it has come to notice that provisions of law preventing
employment of child labour are not being adhered to and company is employing child labour in
flagrant violation of rules in this regard. The company also exports part of its turnover and matter
has gone unnoticed in compliance audits carried out by agencies of overseas buyers.
On the basis of above, answer the following questions: -
1. Considering description of disproportionate rise in inventory quantities, which of the
following is not likely to be an appropriate response to outlined assessed risk of material
misstatement due to fraud?
(a) Observing inventory counts at all locations at same date by employing necessary resources.
(b) Observing inventory counts at certain locations after prior intimation.
(c) More rigorous examination of packed items during observing inventory count process.
(d) Observing inventory count at end of reporting period to minimize risk of manipulation.
2. It has been concluded by auditor that there is no risk of material misstatement due to fraud
related to revenue recognition. Which of the following statements is most appropriate in this
respect?
(a) The auditor needs to document reasons for arriving at conclusion that there is no risk of
material misstatement due to fraud related to revenue recognition.
(b) Identified and assessed risks of material misstatement due to fraud need to be documented.
Since no risk of material misstatement due to fraud pertaining to revenue recognition was
identified, separate documentation in this respect is not needed.
(c) The auditor needs only to document that no risk of material misstatement due to fraud relating
to revenue recognition was identified.
(d) The auditor needs to give reference to discussion among engagement team members to
document that no risk of material misstatement due to fraud relating to revenue recognition
was identified.
3. Which of the following statements most appropriately describes responsibilities of auditor
in relation to compliance with state pollution control legislation and regulations?
(a) Sufficient appropriate evidence needs to be obtained by auditor to verify compliance.
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(b) Physical verification of workability of such systems is required from an auditor.
(c) Only inquiry of company management personnel and review of correspondence with
regulatory authorities are suffice to verify compliance.
(d) Only physical verification of workability of such systems and review of correspondence with
regulatory authorities are suffice to verify compliance.
4. The auditor has observed non-compliance of law prohibiting employment of child labour.
Which is the most appropriate course of action for him to proceed in this matter?
(a) He should obtain further information to evaluate the possible effect on financial statements.
(b) He must report the matter to concerned government department.
(c) He should obtain further information to evaluate the possible effect on financial statements.
Besides, he should evaluate implications of non-compliance for audit risk assessment.
(d) He should express a modified opinion in audit report.
5. Which of the following statements is most appropriate about documentation of non-
compliance with laws and regulations by an auditor in context of SA 250?
(a) Instances of identified non-compliance with laws and regulations need to be documented.
(b) Instances of suspected non-compliance with laws and regulations need to be documented.
(c) Instances of non-compliance with laws and regulations finally determined by Courts of law
need to be documented.
(d) Instances of identified as well as suspected non-compliance with laws and regulations need
to be documented.
Key Takeaways
Fraud is an intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or
illegal advantage.
SA 240 deals with the auditor’s responsibilities relating to fraud in an audit of financial statements.
Its requirements assist the auditor in identifying and assessing the risks of material misstatement
due to fraud and in designing procedures to detect such misstatement.
Fraud risk factors are events or conditions that indicate an incentive or pressure to commit fraud
or provide an opportunity to commit fraud.
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2.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The effect on the financial statements of laws and regulations varies considerably. The provisions
of some laws or regulations have a direct effect on the financial statements in that they determine
the reported amounts and disclosures in an entity’s financial statements. Other laws or regulations
are to be complied with by management or set the provisions under which the entity is allowed to
conduct its business but do not have a direct effect on an entity’s financial statements.
Non-compliance with laws and regulations may result in fines, litigation or other consequences for
the entity that may have a material effect on the financial statements.
SA 250 deals with auditor’s responsibility to consider laws and regulations when performing an
audit of financial statements.
Communication from auditor is important with those charged with governance. SA 260 deals with
the auditor’s responsibility to communicate with those charged with governance in an audit of
financial statements.
A joint audit is an audit of financial statements of an entity by two or more auditors appointed with
the objective of issuing the audit report. Such auditors are described as joint auditors.
SA 299 lays down the principles for effective conduct of joint audit to achieve the overall objectives
of the auditor as laid down in SA 200. It deals with the special considerations in carrying out audit
by joint auditors.
Service organisation is a third-party organisation (or segment of a third-party organisation) that
provides services to user entities that are part of those entities’ information systems relevant to
financial reporting. User entity is an entity that uses a service organisation and whose financial
statements are being audited.
SA 402 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 organisations.
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS WISDOM:
SCAN ME !
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RESPONSIBILITIES
TEST YOUR KNOWLEDGE
Theoretical Questions
1 A, B and C are joint auditors of a company. B is of the opinion that there are material
misstatements in financial statements of a company which, if accounted for, would turn profit
reflected in financial statements for ` 25 crore to a loss of ` 5 crore. He, therefore, wants an
adverse opinion to be expressed in audit report. However, A and B do not concur with his
views and are inclined to accept management’s version. Is B required to go by majority
opinion of 2-1?
2. CA. Shelly Goel is offered appointment as auditor of RUTE Limited, a listed company. The
audit committee of the company wants her to justify independence in relation to company
through proper communication. Although she has ensured that there are no threats to her
independence, she feels requirement of audit committee to be beyond its purview. What is
your opinion in this regard?
3. You are auditor of a social media company. Of late, government has tightened noose around
companies operating in this segment by bringing in a maze of regulatory legislations to protect
interests of users. How you can proceed to verify that company is compliant with new
regulatory requirements? Besides, what does above situation underscore to you as an
auditor?
4. Discuss why the potential effects of inherent limitations of an auditor’s ability to detect
material misstatements described in SA 200 are far greater in respect of non-compliance with
laws and regulations?
5. MN & Associates are the statutory auditors of ABC Ltd. for the FY 2021-22. During the course
of audit, the engagement partner, Mr. Manohar notices a misstatement resulting from a
suspected fraud that brings into question the audit team’s ability to continue performing the
audit. How should the audit team deal with the situation?
6. CA Anand is the engagement partner for the audit assignment of NHT Ltd. engaged in
manufacture of Iron and Steel bars. The company has its plants in the state of Sikkim. While
verifying the wages record of the company, CA Anand found that maximum of the labour
employed in the plants of the company was child labour. He questioned the management of
the company about the same to which the management replied that looking into the
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2.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
compliance of such law is outside his scope of financial audit. Give your comments with
respect to such situation.
7. Magnet Interiors Ltd. is a listed company engaged in the manufacture of office furniture. The
company has its activities divided into four geographic regions. The company has appointed
two joint auditors, namely, AB & Co. and CD & Co. to conduct the joint audit of the financial
statements of the company for the year ending 31.03.2023. The engagement partners from
both the firms, CA Amar and CA Chetanya along with their audit teams had a meeting to
discuss the areas of the work to be divided and their respective responsibilities. Explain the
responsibilities of the joint auditors with respect to such joint audit.
8. MNO Ltd. gets its accounting data processed by a service organisation. CA Riya is the
statutory auditor of MNO Ltd. CA Riya wants to obtain an understanding as to how MNO Ltd.
is using the services of the service organisation. What all understanding should she obtain?
9. UVW & Associates are the statutory auditors of Moon Ltd., a listed company, for the financial
year 2022-23. CA Udhav is the engagement partner for the audit assignment. He was of the
understanding that as per the requirement of one of the SAs he has a responsibility to
communicate following matters to those charged with governance:
(a) The auditor’s responsibilities in relation to the financial statement audit.
(b) Planned scope and timing of the audit.
(c) Auditor independence
Which of the matters is not included in the list prepared by CA Udhav. Discuss such matter
in detail.
Answers to Test your Understanding:
1. The given situation highlights need for the company to set up new plant for manufacturing of
special kind of fabric to stay competitive in the market. Setting up of such plant involves huge
capital outlays which could entail financing arrangements. Therefore, excessive pressure
exists for management to be involved in fraudulent financial reporting. In such a situation,
management may be tempted to inflate its revenues to show rosy picture. It is a fraud risk
factor and needs to be evaluated by the auditor.
The revenues of company have jumped from ` 750 crore in last year to ` 1000 crore in year
2022-23 without any change in plant capacity. The auditor may consider abovesaid fraud risk
factor for assessing risk of material misstatement due to fraud.
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RESPONSIBILITIES
In case of auditor assessing risk of material misstatement due to fraudulent financial
reporting, audit procedures to address such risk like performing substantive analytical
procedures relating to revenue, use of computer assisted audit techniques to identify unusual
revenue transactions and testing controls pertaining to revenue transactions need to be
performed.
2. Management failing to remedy known significant deficiencies in internal control on a timely
basis is a fraud risk factor for misstatements arising from fraudulent financial reporting.
When management does not correct significant deficiencies in internal control on a timely
basis, it reflects an attitude, character or set of ethical values that allow them knowingly and
intentionally to commit a dishonest act.
Failure to rectify known control deficiencies pertaining to reconciliation of receivables and
review of customer credit limits has the potential to fraud. Lack of timely reconciliation of
receivables may lead to intentional misstatements. Further, non-reviewing customer limit may
lead to grant of credit beyond creditworthiness of customers. It may result in intentional tying
up of company’s funds with risky customers due to collusion.
The above situation is a fraud risk factor for fraudulent financial reporting.
3. When the auditor becomes aware of the existence of or has information about investigations
by government departments and regulatory organizations, it may be an indication of non-
compliance with laws and regulations.
In the instant case, notice has been served upon the company by DGGI for allegedly creating
fictitious invoices in guise of providing “marketing and sales services” for ` 50 crores. Issuing
an invoice without supply of services is a serious offence under GST laws and it could involve
penalties and imprisonment. Such suspected non-compliance may have a direct effect on
financial statements.
The matter has also been informed to regulator i.e. IRDAI. Violation of IRDAI regulations
may result in fines, litigation or other consequences for the entity that may have a material
effect on the financial statements.
If the auditor becomes aware of information concerning an instance of non-compliance or
suspected non-compliance with laws and regulations, the auditor shall obtain: -
(a) An understanding of the nature of the act and the circumstances in which it has
occurred and
(b) Further information to evaluate the possible effect on the financial statements.
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2.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with
management and, where appropriate, those charged with governance. If management or, as
appropriate, those charged with governance do not provide sufficient information that
supports that the entity is in compliance with laws and regulations and, in the auditor’s
judgment, the effect of the suspected non-compliance may be material to the financial
statements, the auditor shall consider the need to obtain legal advice.
If sufficient information about suspected non-compliance cannot be obtained, the auditor shall
evaluate the effect of the lack of sufficient appropriate audit evidence on the auditor’s opinion.
4. SA 260 requires the auditor to communicate with those charged with governance on a timely
basis.
SA 701 states that the appropriate timing for communications about key audit matters will
vary with the circumstances of the engagement. However, the auditor may communicate
preliminary views about key audit matters when discussing the planned scope and timing of
the audit, and may further discuss such matters when communicating about audit findings.
Doing so may help to alleviate the practical challenges of attempting to have a robust two-
way dialogue about key audit matters at the time the financial statements are being finalized
for issuance.
Communication with those charged with governance enables them to be made aware of the
key audit matters that the auditor intends to communicate in the auditor’s report, and provides
them with an opportunity to obtain further clarification where necessary. The auditor may
consider it useful to provide those charged with governance with a draft of the auditor’s report
to facilitate this discussion.
Communication with those charged with governance recognizes their important role in
overseeing the financial reporting process, and provides the opportunity for those charged
with governance to understand the basis for the auditor’s decisions in relation to key audit
matters and how these matters will be described in the auditor’s report. It also enables those
charged with governance to consider whether new or enhanced disclosures may be useful in
light of the fact that these matters will be communicated in the auditor’s report.
5. In respect of common areas, the joint auditors are only responsible for appropriateness of
nature, timing and extent of planned audit procedures agreed among them. The responsibility
of individual execution lies with concerned joint auditor.
© The Institute of Chartered Accountants of India
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RESPONSIBILITIES
In the instant case, audit procedures relating to testing design and operating effectiveness of
controls over computer operations including back-up, batch-processing and data center
security have been planned jointly as it is a common area.
However, audit procedures relating to testing controls over batch processing were actually
performed by team of DES & Associates although these were planned jointly. In case of any
lapses in performing such procedures, DES & Associates would be responsible.
Answers to Integrated Case Scenario:
1. (b)
2. (a)
3. (c)
4. (c)
5. (d)
Hints /Answers to Theoretical Questions:
1. 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. Therefore, B is not required to go
by majority opinion of 2-1.
In such circumstances, the audit report issued by the joint auditors shall make a reference to
the separate audit report issued by the other joint auditor. 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 SA 706.
2. As required in SA 260, in the case of listed entities, the auditor shall communicate with those
charged with governance: -
(a) A statement that the engagement team and others in the firm as appropriate, the firm
and, when applicable, network firms have complied with relevant ethical requirements
regarding independence and
i. All relationships and other matters between the firm, network firms, and the entity
that, in the auditor’s professional judgment, may reasonably be thought to bear on
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2.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
independence. This shall include total fees charged during the period covered by
the financial statements for audit and non-audit services provided by the firm and
network firms to the entity and components controlled by the entity. These fees
shall be allocated to categories that are appropriate to assist those charged with
governance in assessing the effect of services on the independence of the auditor
and
ii. The related safeguards that have been applied to eliminate identified threats to
independence or reduce them to an acceptable level.
Further, as per the Companies Act, 2013 requires audit committee to review and monitor
auditor’s independence. Therefore, audit committee requiring auditor to justify her
independence is well within its purview.
3. It needs to be verified that the company has put in place systems and procedures to meet
with new regulatory requirements. The same can be verified by examining policies and
procedures developed by company in this regard like devising appropriate system of internal
control, sensitizing employees regarding new rules, engaging legal advisors etc.
Further, financial stability of the company may be threatened due to new regulatory requirements.
The management may be under pressure. It is also a fraud risk factor and may need to be
evaluated by auditor.
4. In the context of laws and regulations, the potential effects of inherent limitations on the
auditor’s ability to detect material misstatements are greater for such reasons as the
following: -
There are many laws and regulations, relating principally to the operating aspects of an
entity that typically do not affect the financial statements and are not captured by the
entity’s information systems relevant to financial reporting.
Non-compliance may involve conduct designed to conceal it, such as collusion, forgery,
deliberate failure to record transactions, management override of controls or intentional
misrepresentations being made to the auditor.
Whether an act constitutes non-compliance is ultimately a matter for legal determination
by a court of law.
5. During the course of audit, the engagement partner, Mr. Manohar notices a misstatement
resulting from a suspected fraud that brings into question the audit team’s ability to continue
performing the audit. In such a situation the audit team should:
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RESPONSIBILITIES
(a) Determine the professional and legal responsibilities applicable in the circumstances,
including whether there is a requirement for the auditor to report to the person or
persons who made the audit appointment or, in some cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal
from the engagement is legally permitted; and
(c) If the auditor withdraws: -
(i) Discuss with the appropriate level of management and those charged with
governance, the auditor’s withdrawal from the engagement and the reasons for the
withdrawal and
(ii) Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to regulatory
authorities, the auditor’s withdrawal from the engagement and the reasons for the
withdrawal.
6. As per SA 250 “Considerations of Laws and Regulations in an Audit of Financial Statements”,
the auditor is not responsible for preventing non-compliance and cannot be expected to detect
non-compliance with all laws and regulations. The auditor is responsible for obtaining
reasonable assurance that the financial statements, taken as a whole, are free from material
misstatement, whether caused by fraud or error. In conducting an audit of financial
statements, the auditor takes into account the applicable legal and regulatory framework.
For the compliance with provisions of those laws and regulations generally recognised to
have a direct effect on the determination of material amounts and disclosures in the financial
statements, the auditor’s responsibility is to obtain sufficient appropriate audit evidence about
compliance with the provisions of those laws and regulations.
For other laws and regulations that do not have a direct effect on the determination of the
amounts and disclosures in the financial statements but compliance with which may be
fundamental to the operating aspects of the business, the auditor’s responsibility is limited to
undertaking specified audit procedures to help identify non-compliance with those laws and
regulations that may have a material effect on the financial statements.
In the instant case, maximum of the labour employed in the plants of the company was child
labour. When CA Anand questioned the management of the company about the same, the
management replied that looking into the compliance of such law is outside his scope of
financial audit. Such reply by the management is not acceptable as such situation may have
a material effect on the financial statements. Therefore, CA Anand should ensure as to
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2.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
whether any penal provisions will be there for non- compliance of such law and also whether
the same has been duly disclosed by the company. If CA Anand concludes that such non-
compliance has a material effect on the financial statements and the same has not been
adequately reflected in the financial statements by the company, he shall express an adverse
or a qualified opinion on the financial statements.
7. As per SA 299 “Joint Audit of Financial Statements”, in respect of audit work divided among
the joint auditors, each joint auditor shall be responsible only for the work allocated to such
joint auditor including proper execution of the audit procedures. In cases where specific
divisions, zones or units are allocated to different joint auditors, it is the separate and specific
responsibility of each joint auditor to obtain information and explanations from the
management in respect of such divisions/zones/units and to evaluate the information and
explanations so obtained by said joint auditor. The joint auditors shall have proper
coordination and rationality wherever required.
All the joint auditors shall be jointly and severally responsible for: -
a. the audit work which is not divided among the joint auditors and is carried out by all
joint auditors
b. 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.
c. 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
d. examining that the financial statements of the entity comply with the requirements of
the relevant statutes
e. presentation and disclosure of the financial statements as required by the applicable
financial reporting framework
f. 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.
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
© The Institute of Chartered Accountants of India
GENERAL AUDITING PRINCIPLES AND AUDITOR’S 2.59
RESPONSIBILITIES
auditors, the said joint auditor shall communicate the same to all the other joint auditors in
writing prior to the completion of the audit.
It shall be the responsibility of each joint auditor to determine the nature, timing and extent of
audit procedures to be applied in relation to the areas of work allocated to said joint auditor.
It is the individual responsibility of each joint auditor to study and evaluate the prevailing
system of internal control and assessment of risk relating to the areas of work allocated to
said joint auditor.
As regards 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, all the joint auditors are responsible only in respect of the
appropriateness of the decisions concerning the nature, timing and extent of the audit
procedures agreed upon among them, proper execution of these audit procedures is the
individual responsibility of the joint auditor concerned.
8. When obtaining an understanding of MNO Ltd. (user entity) in accordance with SA 315, CA
Riya shall obtain an understanding of how MNO Ltd. uses the services of a service
organisation in its operations, including: -
(a) The nature of the services provided by the service organisation and the significance
of those services to the user entity, including the effect thereof on the user entity’s
internal control. Information on nature of services provided by a user organization may
be available from sources such as user manuals, contract between the user entity and
service organization, reports by service auditors etc.
(b) The nature and materiality of the transactions processed or accounts or financial
reporting processes affected by the service organisation. In certain situations, the
transactions processed and the accounts affected by the service organisation may not
appear to be material to the user entity’s financial statements, but the nature of the
transactions processed may be significant and the user auditor may determine that an
understanding of those controls is necessary in the circumstances.
(c) The degree of interaction between the activities of the service organisation and those
of the user entity. The degree of interaction refers to the extent to which a user entity
is able to and elects to implement effective controls over the processing performed by
the service organisation. For example, a high degree of interaction exists between the
activities of the user entity and those at the service organisation when the user entity
authorises transactions and the service organisation processes and does the
accounting for those transactions
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2.60 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) The nature of the relationship between the user entity and the service organisation,
including the relevant contractual terms for the activities undertaken by the service
organisation.
9. SA 260 “Communication with Those Charged with Governance” deals with auditor’s
responsibility to communicate with those charged with governance in relation to an audit of
financial statements. Among various matters as included by CA Udhav in his list, one of the
matters that is not mentioned in the list is Significant findings from the audit. With respect to
such matter, 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;
(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.
The communication of findings from the audit may include requesting further information from
those charged with governance in order to complete the audit evidence obtained. For
example, the auditor may confirm that those charged with governance have the same
understanding of the facts and circumstances relevant to specific transactions or events.
(Note: Content of SA 200 Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Standards on Auditing; SA 210 Agreeing the Terms of Audit
Engagements and SA 230 Audit Documentation is covered in depth at Intermediate level.
Thus, application part of above SAs may be discussed in the form of Case Study at Final
level.)
© The Institute of Chartered Accountants of India
CHAPTER 3
7
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.
© The Institute of Chartered Accountants of India
3.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Audit Audit
Execution Strategy
Audit Planning
CA. B has qualified final Chartered Accountancy exams. Plunging into the field of auditing
practice after setting up his own office, he accepted audit of a company engaged in emerging
“fintech” sector. The company relies heavily on big data and artificial intelligence. It is also
expected to lean upon Blockchain technology in coming years and is working in that
direction. Company is also a participant in Regulatory sandbox i.e., of live testing of new
products and services under controlled environment.
While planning audit, he felt need for involvement of an expert IT specialist for gaining an
insight into various IT controls and IT laws & rules in heavily tech laden company. Is such
consideration a factor to be considered in establishing overall audit strategy? In case he
chose to involve an expert IT specialist, would his overall responsibility as an auditor be
shared in some way? Would it be prudent for him to enter into a formal agreement with the
expert detailing out nature, scope and objectives of his work? Besides, he had this nagging
doubt in mind over confidentiality requirements pertaining to expert. Involving expert in
exercise of understanding controls may split open company’s systems and sensitive data
before him. Wouldn’t it tantamount to violation of confidentiality principle of professional
ethics? He was keeping his fingers crossed.
As the company and its business-both were new to him, he was keen on gaining knowledge
about business of the company. Vividly remembering that knowledge of client’s business is
foremost requirement for developing an overall audit plan, he proceeded to gain broad
regulatory requirements pertaining to fintech sector. Learning that not only RBI, but Ministry
of Electronics and Information technology (MeitY) has also a role to play in this sector under
flagship Digital India programme. He was also trying to understand revenue recognition
practices of the industry. He also came to know that “Ombudsman scheme for digital
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.3
transactions” for filing consumer complaints was in existence. Would such knowledge be
helpful to him in understanding about the company as far as audit was concerned?
The company also has an internal audit department. He finds that internal audit department
of the company is scantily staffed and is headed by a banker retired from the post of Chief
manager of a public sector bank. He didn’t appear to be tech-savvy. On enquiry, he came to
know that he got the job on recommendation of some government official. In these
circumstances, would it be advisable for him to rely upon work performed by internal auditor?
He needed to take a decision in this regard.
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 audit, 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 ♣
♣
Source : Forum Auditorías
© The Institute of Chartered Accountants of India
3.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 areas
(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-
(i) Size and Complexity of the Auditee - If the size and complexity of
organization of which audit is to be conducted is large, then much more
planning activities would be required as compared to an entity whose
size and complexity is small.
(ii) Past Experience & Expertise - The key engagement team
members’ previous experience & expertise also contributes towards
variation in planning activities.
(iii) Change in Circumstances - Another factor contributing towards
variation in planning activities is change in circumstances.
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 forming audit programme.
1. Planning includes the need to consider such matters as:
The analytical procedures to be applied as risk assessment procedures.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.5
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.
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 should 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 should be satisfied that appropriate
procedures regarding the acceptance and continuance of client relationships and audit engagements
have been followed, and should 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
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3.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 should 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.7
2. 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 should 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
(ii) evidence
(i) result of changes in
unexpecte obtained from
conditions, the results of
d events,
or audit
procedures.
Further, the auditor would also have to 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.
3. 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, government. policies
which may warrant updating of overall audit strategy.
TEST YOUR UNDERSTANDING 1
XWL Limited was engaged in dealing in commodity futures trading based in Surat. CA P, based at
Delhi, was auditor of the company. The auditor did not even once visit office of the company and
failed to understand the nature of business of the company. All the papers and account books were
received on emails and audit was concluded.
© The Institute of Chartered Accountants of India
3.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
There were also included in his working papers checklists which had a requirement of test checking
of cost of raw material consumed & cost of stores and spares. There was nothing in his working
papers showing understanding of nature of business of company. What does it reflect upon planning
of audit by CA P?
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 defines 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) Considering result of preliminary engagement activities: 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 like review of valuation, hedging transactions.
(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
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AUDIT PLANNING, STRATEGY & EXECUTION 3.9
at material locations, the extent of review of other auditors’ work in the case of group audits,
or the allocation of audit budgeted hours 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 or close to key cut-off dates.
(iv) Management of Resources: How such resources shall be 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.
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3.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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 needs to maintain an inquisitive/
questioning mind and exercise professional skepticism and unpredictability.
(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 controls.
(viii) Volume of transactions which may determine reliance on internal control.
(ix) Importance attached to internal control.
(x) Significant business developments affecting the entity.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.11
(xi) Significant industry specific developments and development in the economic
environment.
(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 and regulatory
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. Documentation of these matters assists
auditor 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 additional 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 strategy and plan: A record of the significant
changes to the overall audit strategy and the audit plan, and resulting changes to the
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3.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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. ∗
The audit strategy is prepared before the audit plan. The audit plan is more detailed 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.
4. 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
lowered 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 in line with 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.
∗
Source : msp-c.com
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AUDIT PLANNING, STRATEGY & EXECUTION 3.13
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 you to know how to formulate 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 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 documents pass before each
transaction is authorised and recorded; the record that is kept and the type of books maintained.
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 audit programme after considering the technical, financial
and accounting set-up of the company.
(b) Overall plan: 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 that specific
matter may be taken in the audit programme. The framework provided under 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 controls in
© The Institute of Chartered Accountants of India
3.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
5. 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 controls. 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.
(c) System of
(a) Nature of internal (e) Information
business in which control and regarding the
the organisation is accounting organisation of
engaged. procedures. business.
(b) Overall (d) Size of the (f)
plan organisation Accounting
prepared for and structure policies
the audit. of its followed by
management. 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
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.15
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 (first
time/ opening balance audit procedures) that are required 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:
(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.
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.
(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.
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3.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(4) When a suspicion has 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
TEST YOUR UNDERSTANDING 2
CA. Pradyuman is planning for audit of a listed company headquartered in NOIDA. While doing this
exercise, he has made a list of various procedures intended to be performed by him during the
course of audit. He has further made up his mind to decide about sample size at time of performing
various planned procedures. Is above approach proper?
TEST YOUR UNDERSTANDING 3
CA. Nikita is conducting audit of a leading society engaged in promoting awareness regarding
usefulness of internet among the disadvantaged sections of society through easily understandable
means and methods. The society is also registered under FCRA, 2010 for receipt of foreign
contributions. During the course of audit, she embarked upon extensive procedures relating to
verification of receipt of foreign contributions to rule out “round-tripping” in comparison to procedures
originally thought of. She is documenting various procedures performed by her including relevant
audit findings.
However, she doesn’t not feel need for putting into writing about how she planned the whole
exercise. Does she require refreshening of her knowledge?
4. AUDIT EXECUTION
Key phases in the audit execution stage are Execution Planning, Risk and Control Evaluation,
Testing and Reporting.
Risk and
Execution
Control Testing Reporting
Planning
Evaluation,
Image showing Stages of Audit Execution
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.17
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
bear in mind the Materiality levels as the same is linked to Audit Risks.
(Note: Students may refer Chapter 4 for understanding and evaluation of the Risk and Control
for more details)
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.
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3.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 7 of this study material)
4.5 Other Important Considerations
In addition to above, there are certain other considerations which auditor is required to take care
while executing the audit, that 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 Auditor who uses the work
perform the work on which the auditor has to rely in forming performed by other auditors is
his opinion, such as in the case of the work of branch Principal auditor.
auditors appointed under the Companies Act, the auditor’s
report should expressly state the fact of such reliance.”
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.
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.19
• the auditor with responsibility for reporting on the financial
information of an entity
Principal Auditor • when that financial information includes the financial
information of one or more components audited by another
auditor.
• an auditor, other than the principal auditor,
Other 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.
principal auditor
to determine
When the principal uses the work of how the work of
auditor another auditor 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.
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.
© The Institute of Chartered Accountants of India
3.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
I. ACCEPTANCE AS PRINCIPAL AUDITOR
The auditor would consider the following before
accepting his work as Principal auditor:
the performance of
additional procedures as
the risk of material
the materiality of the the principal auditor's set out in this SA regarding
misstatements in the
portion of the financial degree of knowledge the components audited by
financial information of the
information which the regarding the business of other auditor(s) resulting in
components audited by the
principal auditor audits; the components; the principal auditor having
other auditor(s); and
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
6. 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
7. 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 procedures given in diagram above.
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.21
Procedures to be performed by Principal Auditor
while using the work of other auditor
(a)advise the other auditor (b) advise the other auditor of the
regarding use of his (other auditor) significant accounting, auditing and
work and report and make sufficient reporting requirements and obtain
arrangements for co-ordination at representation as to compliance
the planning stage of the audit. with them.
The principal auditor
would inform the
other auditor of
matters such as :
procedures for the
identification of
areas requiring
inter-component the time-table for
special
transactions that completion of audit;
consideration,
may require
disclosure and
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.
Nature, timing Nature, timing and
extent of This knowledge
The principal and extent of may have been
procedures procedures depend
auditor may on principal enhanced from
also wish to visit depend on the review of
circumstances auditor's
the other knowledge of the the previous
auditor. of engagement audit work of
& Materiality professional
competence of the the other
aspect auditor.
other auditor.
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 procedures that supplement tests of the
records or the financial statements of the component, if deemed necessary. Such tests may,
depending upon the circumstances, be performed by the principal auditor or the other auditor.
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3.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
8. 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.
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.
9. 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-
10. 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.23
The principal auditor should
Sufficient liaison
The other auditor advise the other auditor of
between the principal
should co-ordinate with any matters having an
auditor and the other
the principal auditor. important bearing on the
auditor.
other auditor’s work.
The other auditor The principal auditor
should respond to such may require the other
questionnaire on a auditor to answer a
timely basis. detailed questionnaire
Diagram Showing Coordination Between the Auditors
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.
11. 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
12. 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. However, if the Principal Auditor notices any material
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3.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
discrepancies, the same has to be brought to the knowledge of other Auditor. This should be
incorporated in the Audit Report.
TEST YOUR UNDERSTANDING 4
CA. Sourabh is engagement partner conducting statutory audit of BBI Bank for SBT & Associates.
The bank has 1034 branches spread all over the country which are audited by branch auditors. In
respect of one large branch audited by a branch auditor, there were errors in NPA classification of
many advances which were not pointed out by branch auditor in his report through memorandum of
changes and NIL memorandum of changes was reported electronically.
During overall review of financial statements of bank by statutory auditor, the above said errors did
not come into light. The statutory auditor had also called soft copies of internal inspection report and
concurrent audit reports of above branch as part of overall review procedures. However, these
reports did not point towards any irregularities in such accounts.
Would statutory auditor of bank be liable for above lapses? What precautions have to be taken by
him while expressing opinion considering possibilities of such situations?
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
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.
© The Institute of Chartered Accountants of India
AUDIT PLANNING, STRATEGY & EXECUTION 3.25
that responsibility is not by the external auditor’s use of
reduced the work of the internal audit
function or
The external auditor has sole
responsibility for the audit
opinion expressed
internal auditors to provide
direct assistance on the
engagement
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 objectives of the external auditor, where the entity has an internal audit function
To determine whether the work If using the work of the internal If using internal auditors to
of the internal audit function or audit function, to determine provide direct assistance, to
direct assistance from internal whether that work is adequate appropriately direct, supervise
auditors can be used for purposes of the audit and review their work.
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3.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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:
Activities Relating to Activities Relating to Risk Activities Relating to Internal
Governance Management Control
The internal audit function may • The internal audit function • Evaluation of internal control
assess the governance process may assist the entity by • Examination of financial and
in its accomplishment of identifying and evaluating operating information
objectives on : significant exposures to • Review of operating activities.
• ethics and values, risk.
• Review of compliance with
performance management •The internal audit function laws and regulations.
and accountability, may perform procedures to
assist the entity in the
• communicating risk and detection of fraud.
control information.
IV. EVALUATING WHETHER WORK OF THE INTERNAL AUDIT FUNCTION CAN BE USED
FOR PURPOSES OF THE AUDIT
(i) The external auditor shall determine (ii) The external auditor shall not use
whether the work of the internal audit function the work of the internal audit function if
can be used for purposes of the audit by the external auditor determines that:
evaluating the following: (a) The function’s organizational status
(a) The extent to which the internal audit and relevant policies and procedures
function’s organizational status and do not adequately support the
relevant policies and procedures support objectivity of internal auditors;
the objectivity of the internal auditors; (b) The function lacks sufficient
(b) The level of competence of the internal competence; or
audit function; and (c) The function does not apply a
(c) Whether the internal audit function applies systematic and disciplined approach,
a systematic and disciplined approach, including quality control.
including quality control.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.27
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.
13. 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) 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.
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3.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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,
share 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.29
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.
14. 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.
(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.
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3.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The external auditor shall not use an internal auditor to provide direct assistance if:
(b)The internal auditor lacks sufficient competence to perform
the proposed work. As the function of Internal Auditor is again a
(a) There are concept of evaluation of Internal Control mechanism, it would
significant threats to
amount to weaknesses in Internal Control System in case
the objectivity of the
internal auditor; or internal auditor does not apply required test procedures
considering the Materiality 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:
Planning &
performing relevant
Amount of judgement wrt: audit
procedures
The E.A. shall Assessed risk of material misstatement
consider : Evaluation of the
audit evidence
Evaluation of existence & significance of gathered.
threats
Nature & Extent of
work that can be
assigned to Internal Making significant judgements in the audit
auditors providing
Direct Assistance The E.A. shall
not use internal
auditors to Relate to higher assessed risks of material misstatement
provide direct where the judgement required is more than limited.
assistance to
perform
Relate to work which is reported to management or TCWG
procedures :
by Internal audit function
Relate to decisions the E.A. makes in accordance with SA .
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 doing so:
(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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.31
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.]
TEST YOUR UNDERSTANDING 5
CA. Keshavraj is conducting statutory audit of a listed company “Live with Nature Limited”. The
company is engaged in producing environment-friendly niche products for new-born babies. There
is also a well-functioning internal audit department in the company. On perusal of internal audit
reports, he finds that not only verification of inventories was attended by internal auditor at regular
intervals during the year, workings were also made in respect of inventory valuation as at year end.
He has also attended inventory count at end of financial year and no prima facie adverse inferences
were drawn by him. However, on going through inventory reports, he gathers that inventories are
being held for considerably long period before being sold. The internal audit reports have not taken
this aspect into consideration. Should he choose to rely upon inventory valuation work performed by
internal auditor?
Illustration 1
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”, 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
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3.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
Situations where The auditor’s use of the work of an
the engagement individual or organisation possessing
team includes a expertise in a field other than
SA-620 does member with accounting or auditing, whose work in
not deal with: expertise in that field is used by the entity to assist
specialised area the entity in preparing the financial
of accounting or statements (a management’s expert),
auditing which is dealt with in SA 500
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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.33
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.
The valuation of
complex financial
instruments, land and
buildings, plant and
machinery etc.
The analysis
of complex or The actuarial
unusual tax Expertise in a field
calculation of
compliance other than
liabilities
issues. accounting or
auditing
The
interpretation The estimation
of contracts, of oil and gas
laws and reserves.
regulations
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.
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3.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• 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.
15. 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
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AUDIT PLANNING, STRATEGY & EXECUTION 3.35
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.
16. 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
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3.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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.
17. In case where 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.
18. A particular actuary may specialise in property and casualty insurance, but
has limited expertise regarding pension calculations.
• The auditor’s expert’s competence with respect to relevant accounting and auditing
requirements
19. 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.37
20. 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;
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3.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.39
• 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 point’s 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.
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3.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
21. 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.
22. 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.41
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 2
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.
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3.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
The auditor’s
responsibilities
regarding related
accounting disclosures in an
Scope of SA 540
estimates, audit of financial
including fair statements.
value accounting
estimates,
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.
The degree of estimation
The information available
uncertainty affects, in
to management for which affects the degree
turn, the risks of material
making of an accounting of estimation uncertainty.
misstatement of
estimate varies widely,
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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.43
23. 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
“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.
24. For some accounting estimates, however, there may be relatively high
estimation uncertainty, particularly where they are based on significant
assumptions, for example:
o Accounting estimates relating to the outcome of litigation.
o Fair value accounting estimates for derivative financial instruments not publicly traded.
o 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
The degree of estimation uncertainty varies based on :
the extent to which there is a
the subjectivity of the
the nature of the accounting generally accepted method
assumptions used to make the
estimate, used to make the accounting
accounting estimate
estimate,
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3.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1. Not all financial statement items requiring measurement at fair value, involve
estimation uncertainty.
25. 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 circumstances
prevailing at the time, for example, illiquidity in a particular market, may impact estimation
uncertainty.
26. 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.
27. 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.45
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 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
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3.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
28. 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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.47
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 based on 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.
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3.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Terms of transactions that gave rise to accounting estimates that 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
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AUDIT PLANNING, STRATEGY & EXECUTION 3.49
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.
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3.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Whether the methods for making the accounting estimates are
appropriate and have been applied consistently
• If there are changes in accounting estimates or in the method used
for making those from prior period, are those appropriate in the
present circumstances.
(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
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AUDIT PLANNING, STRATEGY & EXECUTION 3.51
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 (b) In relation to accounting estimate
in accordance with the applicable having significant risk, even where the
financial reporting framework includes disclosures are in accordance with the
adequate disclosure of material applicable financial reporting
matters. These disclosures may framework, the auditor may conclude
include, that the disclosure of estimation
• The assumptions used. uncertainty is inadequate in light of the
circumstances and facts involved.
• 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.
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.
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3.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SA 540-Auditing Accounting Estimates, Including Fair Value Accounting
Estimates and Related Disclosures
Scope : Auditor's
Responsibility regarding
use of accounting
estimates by management
Auditor's
Management's
Responsibility/Audit Audit Reporting
Responsibility-
Procedure
Follow an
unbiased Perform risk Adequate
approach in assessment disclosure of
preparing for procedure and material matter, If significant risk exist even after
accounting related activites such as adequate disclosure the auditor
estimates may conclude that the disclosure
of estimation uncertainty is
inadequate in light of the
Identify and the assumptions circumstances and facts
assess the risk of and method of involved.
material estimates used
misstatements
basis of selection
To make of estimates
Response to the
appropriate assessed risk of
disclosure in FS material
about the misstatements any change in the method of
assertion and estimates as compared to
estimates made. prior period
Evaluate the
reasonableness of the source and implication of
accounting estimation uncertainty
estimates
4.5.5 CONTROL OF QUALITY OF AUDIT WORK
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
(b) The reports issued by the firm or engagement partners are appropriate in the circumstances.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.53
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. SA 220 deals with audit quality at individual
engagement level.
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 (b) The auditor’s report issued is
and regulatory and legal requirements; and appropriate in the circumstances.
(Students may refer Chapter 1 Quality Control 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
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3.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
with the auditor’s understanding of the entity.
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.
Integrated Case Scenario
CA. Anoothi has been offered appointment as auditor of an NSE listed company. She has already
ticked checkboxes relating to her independence vis-à-vis company and integrity of promoters and
key management personnel. Being satisfied on this count and after sending formal engagement
letter to the company, she is in midst of planning activities for company’s audit. Owner of country’s
one of topmost writing instrument brands, above said company is in business of producing ball pens,
gel pens, markers, folders and such general stationery products.
Business profile of the company including its brief history, detail of its key managerial persons and
brief description of company’s activities was obtained by her. She has also studied reports relating
to growth of India’s stationery market due to greater demand and impact of government driven
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AUDIT PLANNING, STRATEGY & EXECUTION 3.55
schemes like Sarv Shiksha Abhiyaan (SSA). Besides, she has also obtained risk management policy
of the company which contained company’s strategy to contain various risks.
On perusal of financial statements of company, it is noticed that the company’s inventories as at
close of financial year stood at Rs. 200 crore which constitutes about 25% of its total assets. She is
planning to identify significant audit risks pertaining to valuation of inventories.
She is also considering about materiality level for financial statements as a whole.
Keeping in view above, answer the following questions: -
1 The compliance with independence requirements and verification of integrity of promoters and
key management personnel has been ensured by CA. Anoothi. In this regard, which of the following
statements is likely to be a complete statement?
(a) Such activities are required to performed strictly in terms of requirements and procedures
outlined in code of ethics issued by ICAI.
(b) Such activities are required to be performed in respect of an audit engagement in accordance
with SA 220 and these preliminary engagement activities are specifically identified in SA 210.
(c) Such activities are required to performed in respect of an audit engagement in accordance with
SA 220 and these preliminary engagement activities form part of planning an audit in accordance
with SA 300.
(d) Such activities are required to be performed in terms of requirements and procedures outlined
in code of ethics issued by ICAI and are specifically identified in SA 210.
2. The auditor has obtained risk management policy of the company. Which of the following
statements is most appropriate in this regard?
(a) The understanding of company’s risk management policy is required by auditor. It may help the
auditor in identifying risks of material misstatement that management failed to identify.
(b) The understanding of company’s risk management policy is not required by auditor. It deals
with business risks of company. Audit risk is not influenced by company’s business risks.
(c) The understanding of company’s risk management policy is required by auditor. However, it
cannot help the auditor in identifying risks of material misstatement that management failed to
identify.
(d) The understanding of company’s risk management policy is sufficient for an auditor to develop
an audit plan.
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3.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3. Which of the following is not likely to be a procedure for auditor to understand the company?
(a) Performing an online search to identify press reports relating to the company
(b) Reviewing any new SEBI and stock exchange requirements
(c) Reviewing whether fresh moneys were raised from public
(d) Seeking confirmation letters from bankers regarding outstanding balances
4. Considering auditor’s intention to identify significant audit risks pertaining to inventory
valuation, which of the following statements is likely to be true?
(a) Procedures planned to identify significant audit risks pertaining to inventory valuation forms
part of overall audit plan.
(b) Procedures planned to identify significant audit risks pertaining to inventory valuation forms
part of overall audit strategy.
(c) Procedures planned to identify significant audit risks pertaining to inventory valuation forms
part of tests of controls.
(d) Procedures planned to identify significant audit risks pertaining to inventory valuation forms
part of tests of details.
5. In relation to materiality levels for financial statements as a whole, which of the following
statements is most appropriate?
(a) Materiality has to be decided by auditor after identification and assessment of risks of material
misstatements.
(b) Materiality has to be decided by auditor prior to identification and assessment of risks of
material misstatements.
(c) Materiality has to be decided by auditor after performing risk assessment procedures.
(d) Materiality has to be decided by auditor at time of designing tests of controls and substantive
procedures.
Key Takeaways
Planning an audit involves establishing the overall audit strategy for the engagement and
developing an audit plan.
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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.57
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.
The audit 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 means to
control the proper execution of work.
During audit execution, there are certain other considerations which auditor is required to
take care while executing the audit including responsibilities to use work of other auditor,
work of internal auditors, work of auditor’s expert. Besides, auditor has responsibilities
regarding estimates. He has to apply analytical procedures towards finalization of audit in
accordance with SA 520. Engagement has to be performed in qualitative manner in
accordance with SA 220.
SA 600 discusses the principal auditor’s responsibility in relation to his use of the work of the
other auditor.
SA 610 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.
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 540 deals with the auditor’s responsibilities regarding accounting estimates, including fair
value accounting estimates, and related disclosures in an audit of financial statements. It also
includes requirements and guidance on misstatements of individual accounting estimates,
and indicators of possible management bias.
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS WISDOM:
SCAN ME !
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3.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 audit for the financial year 2022-23. 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 actuarial 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, was 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?
5. During the audit of FMP Ltd, a listed company, Engagement Partner (EP) completed his
reviews and also ensured compliance with independence requirements that apply to the audit
engagement. The engagement files were also reviewed by the Engagement Quality Control
Reviewer (EQCR) except the independence assessment documentation. Engagement
Partner was of the view that matters related to independence assessment are the
responsibility of the Engagement Partner and not Engagement Quality Control Reviewer.
Engagement Quality Control Reviewer objected to this and refused to sign off the
documentation. Please advise as per SA 220.
6. AKJ Ltd is a small-sized 30 years old company having business of manufacturing of pipes.
Company has a plant based out of Dehradun and have their corporate office in Delhi. Recently
the company appointed new firm of Chartered Accountants as their statutory auditors.
The statutory auditors want to enter into an engagement letter with the company in respect
of their services but the management has contended that since the statutory audit is
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AUDIT PLANNING, STRATEGY & EXECUTION 3.59
mandated by law, engagement letter may not be required. Auditors did not agree to this and
have shared a format of engagement letter with the management for their reference before
getting that signed. In this respect management would like to understand that as per SA 210
(auditing standard referred to by the auditors), if the agreed terms of the engagement shall
be recorded in an engagement letter or other suitable form of written agreement, what should
be included in terms of agreed audit engagement letter?
7. A private company is engaged in the business of real estate. The auditor of the company
requested the information from the management to review the outcome of accounting
estimates (like estimated costs considered for percentage completion etc) included in the
prior period financial statements and their subsequent re-estimation for the purpose of the
current period.
The management has refused the information to the auditor saying that the review of prior
period information should not be done by the auditor. Please advise.
8. X Ltd had a net worth of INR 1300 crores because of which Ind AS became applicable to
them. The company had various derivative contracts – options, forward contracts, interest
rate swaps etc. which were required to be fair valued for which company got the fair valuation
done through an external third party. The statutory auditors of the company involved an
auditor’s expert to audit valuation of derivatives. Auditor and auditor’s expert were new to
each other i.e. they were working for the first time together but developed a good bonding
during the course of the audit. The auditor did not enter into any formal agreement with the
auditor’s expert. Please advise.
9. Cineplex, a movie theatre complex, is the foremost theatre located in Delhi. Along with the
sale of tickets over the counter and online booking, the major proportion of income is from
the cafe, shops, pubs etc. located in the complex. Its other income includes advertisements
exhibited within/outside the premises such as hoardings, banners, slides, short films etc. The
facility for parking of vehicles is also provided in the basement of the premises.
Cineplex appointed your firm as the auditor of the entity. Being the head of the audit team,
you are, therefore, required to draw an audit programme initially in respect of its revenue and
expenditure considering the above mentioned facts along with other relevant points relating
to such complex.
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3.60 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Test your Understanding
1. SA 300 requires the auditor to plan the audit in such a manner that it is performed effectively.
It also requires auditor to establish overall audit strategy including identifying the
characteristics of the engagement, facilitating him to define its scope and planning of nature,
timing and extent of audit procedures required to be performed to achieve the objective of
audit.
SA 300 further requires the auditor to document the overall audit strategy, the audit plan and
any significant changes made during the audit engagement to such plans.
In the given situation, auditor didn’t even once visit the company and failed to understand
about business of the company. Therefore, he has flouted requirement of SA 300 to plan the
audit in such a manner that it is performed effectively. The auditor has to plan the audit
commensurate to the nature and complexity of the business of the entity and identify and
assess the risk of material misstatement.
Further, working papers of auditor also do not show his understanding of nature of business
which is again a blatant violation of requirement of SA 300 which requires the auditor to
document the overall audit strategy, the audit plan and any significant changes made during
the audit engagement to such plans.
Inclusion of a checklist in working papers having requirement of test checking of cost of raw
material consumed & cost of stores and spares shows that it was a general checklist and
specifics of business were never understood and audit was not planned to be conducted in
an effective manner in accordance with requirements of SA 300.
2. SA 300 states that audit plan shall include description about nature, timing and extent of audit
procedures. The extent of audit procedures also includes deciding about sample sizes to be
tested for performing audit procedures. Therefore, the said approach is not proper. Various
procedures planned to be undertaken should also include considerations relating to sample
sizes to be tested.
3. SA 300 requires auditor to document audit plan and significant changes made during the
audit engagement to the audit plan. It also requires auditor to document reasons for such
changes.
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
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AUDIT PLANNING, STRATEGY & EXECUTION 3.61
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.
Further, changes to audit plan along with reasons thereof due to embarking upon extensive
procedures related to verification of foreign contributions in comparison to what was originally
envisaged need to be documented.
Failure to document audit plan could entail risk of not conducting audit according to
professional standards in a qualitative manner.
4. SA 600 states that 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.
In the given situation, nothing has come to light of statutory auditor which would arouse his
suspicion about reliability of work performed by branch auditor. Therefore, he would not be
responsible for work performed by branch auditor.
Further, it should be clearly stated in the report that 1034 branches of bank have been audited
by branch auditors.
5. For a particular account balance, class of transaction or disclosure, the higher an assessed
risk of material misstatement at the assertion level, the more judgment is often involved in
planning and performing the audit procedures and evaluating the results thereof. In such
circumstances, the external auditor will need to perform more procedures directly and
accordingly, make less use of the work of the internal audit function in obtaining sufficient
appropriate audit evidence. Furthermore, as explained in SA 200, the higher the assessed
risks of material misstatement, the more persuasive the audit evidence required by the
external auditor will need to be, and, therefore, the external auditor will need to perform more
of the work directly.
In the given situation, inventories are being held for considerably long period before being
sold. As company is dealing in niche products for new-born babies, there is a risk of inventory
obsolescence due to changes in customer preferences. It carries a significant risk of material
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3.62 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
misstatement and requires more judgment on part of statutory auditor in planning and
performing procedures.
In such circumstances, statutory auditor needs to perform procedures directly like comparing
net realizable value of products with costs to verify completeness of provisions, recomputing
of provisions for obsolete stocks etc.
Therefore, in the given situation, he should perform procedures directly in accordance with
SA 610.
Answers to Integrated Case Scenario
1. (c)
2. (a)
3. (d)
4. (a)
5. (b)
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.
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AUDIT PLANNING, STRATEGY & EXECUTION 3.63
(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 auditors 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 was found faulty. Further, Mr. Z is not in agreement 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 gross 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.
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3.64 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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:
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AUDIT PLANNING, STRATEGY & EXECUTION 3.65
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.
5. As per SA 220, Engagement Partner shall form a conclusion on compliance with
independence requirements that apply to the audit engagement. In doing so, Engagement
Partner shall:
• Obtain relevant information from the firm and, where applicable, network firms, to
identify and evaluate circumstances and relationships that create threats to
independence;
• Evaluate information on identified breaches, if any, of the firm’s independence policies
and procedures to determine whether they create a threat to independence for the
audit engagement; and
• Take appropriate action to eliminate such threats or reduce them to an acceptable
level by applying safeguards, or, if considered appropriate, to withdraw from the audit
engagement, where withdrawal is permitted by law or regulation. The engagement
partner shall promptly report to the firm any inability to resolve the matter for
appropriate action.
Engagement Partner shall take responsibility for reviews being performed in accordance with
the firm’s review policies and procedures.
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3.66 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
As per SA 220, “Quality Control for Audit of Financial Statements”, for audits of financial
statements of listed entities, Engagement Quality Control Reviewer (EQCR), on performing
an engagement quality control review, shall also consider the engagement team’s evaluation
of the firm’s independence in relation to the audit engagement.
In the given case, Engagement Partner is not right. The independence assessment
documentation should also be given to Engagement Quality Control Reviewer for his review.
6. As per SA 210 ‘Agreeing the Terms of Audit Engagements’, the auditor shall agree the terms
of the audit engagement with management or those charged with governance, as appropriate.
The agreed terms of the audit engagement shall be recorded in an audit engagement letter
or other suitable form of written agreement and shall include:
(i) The objective and scope of the audit of the financial statements;
(ii) The responsibilities of the auditor;
(iii) The responsibilities of management;
(iv) Identification of the applicable financial reporting framework for the preparation of the
financial statements; and
(v) Reference to the expected form and content of any reports to be issued by the auditor
and a statement that there may be circumstances in which a report may differ from its
expected form and content.
7. As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates,
and Related Disclosures”, 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.
The outcome of an accounting estimate will often differ from the accounting estimate
recognised in the prior period financial statements. By performing risk assessment
procedures to identify and understand the reasons for such differences, the auditor may
obtain:
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AUDIT PLANNING, STRATEGY & EXECUTION 3.67
• Information regarding the effectiveness of management’s prior period estimation
process, from which the auditor can judge the likely effectiveness of management’s
current process.
• Audit evidence that is pertinent to the re-estimation, in the current period, of prior
period accounting estimates.
• Audit evidence of matters, such as estimation uncertainty, that may be required to be
disclosed in the financial statements.
The review of prior period accounting estimates may also assist the auditor, in the current
period, in identifying circumstances or conditions that increase the susceptibility of accounting
estimates to, or indicate the presence of, possible management bias. The auditor’s
professional skepticism assists in identifying such circumstances or conditions and in
determining the nature, timing and extent of further audit procedures.
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.
In the given case, the management is not correct in refusing the relevant information to the
auditor.
8. As per SA 620, Using the work of an Auditor’s Expert, the nature, scope and objectives of the
auditor’s expert’s work may vary considerably with the circumstances, as may the respective
roles and responsibilities of the auditor and the auditor’s expert, and the nature, timing and
extent of communication between the auditor and the auditor’s expert. It is therefore required
that these matters are agreed between the auditor and the auditor’s expert.
In certain situations, the need for a detailed agreement in writing is required like -
• The auditor’s expert will have access to sensitive or confidential entity information.
• The matter to which the auditor’s expert’s work relates is highly complex.
• The auditor has not previously used work performed by that expert.
• The greater the extent of the auditor’s expert’s work, and its significance in the context
of the audit.
In the given case, considering the complexity involved in the valuation and volume of
derivatives and also due to the fact that the auditor and auditor’s expert were new to each
other, auditor should have signed a formal agreement/ engagement letter with the auditor’s
expert in respect of the work assigned to him.
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3.68 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
9. Audit Programme of Movie Theatre Complex:
(i) Peruse the Memorandum of Association and Articles of Association of the entity.
(ii) Ensure the object clause permits the entity to engage in this type of business.
(iii) In the case of income from sale of tickets:
(1) Verify the control system as to how it is ensured that the collections on sale of
tickets of various shows are properly and accurately accounted.
(2) Verify the system relating to online booking of various shows and the system of
realization of money.
(3) Check that there is overall system of reconciliation of collections with the
number of seats available for different shows in a day.
(iv) Verify the internal control system and its effectiveness relating to the income from café,
shops, pubs, game zone etc., located within the multiplex.
(v) Verify the system of control exercised relating to the income receivable from
advertisements exhibited within the premises and inside the hall such as hoarding,
banners, slides, short films etc.
(vi) Verify the system of collection from the parking areas in respect of the vehicles parked
by the customers.
(vii) In the case of payment to the distributors verify the system of payment which may be
either through out right payment or percentage of collection or a combination of both.
Ensure at the time of settlement, any payment of advance made to the distributor is
also adjusted against the amount due.
(viii) Verify the system of payment of salaries and other benefits to the employees and
ensure that statutory requirements are complied with.
(ix) Verify the payments effected in respect of the maintenance of the building and ensure
the same is in order.
(x) Verify the insurance premium paid and ensure it covers the entire assets.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 4
7
MATERIALITY, RISK
ASSESSMENT AND
INTERNAL CONTROL
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the concept of Risk Based Audit, Internal Control and Risk
Assessment.
Identify the components of Audit Risk and Internal Control.
Learn to review the systems of Internal Control.
Know the Internal Control System-Nature, Scope, Objective and
Structure.
Gain knowledge of reporting to clients on Internal Control weaknesses.
Know the framework of Reporting of Internal Control.
Practicality of above concepts using examples and case study.
© The Institute of Chartered Accountants of India
4.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Audit Risk and
Risk Based
Audit
Reporting to Internal Control
clients on System - Nature,
Internal Control Scope, Objective
Weaknesses and Structure
Framework on MATERIALITY, RISK
Components of
Reporting of ASSESSMENT AND Internal Control
Internal Controls INTERNAL CONTROL
Internal Control Review of the
and Risk System of
Assessment Internal Controls
Manner of
Evaluation of
Internal Control
System
CA. Y, auditor of a company for last three years, is set to assess audit risk for the engagement.
Before he proceeded, a question struck his mind. Is such an exercise useful for him practically?
How assessing audit risk is useful for an auditor every year? He seemed to be caught in SALY
approach (Same as last year). Turning to a webinar on the topic helped him illuminate his insight.
Not only assessing audit risk is mandatory under Standards on Auditing, it leads to audit
effectiveness and audit quality. Besides, it helps auditors to plan audits in a better way.
© The Institute of Chartered Accountants of India
MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.3
By understanding the company and its internal control, auditor can identify those areas which are
prone to misstatements whether due to errors or frauds. The risk assessment need not be same
as of last year due to new developments like change in laws, change in business model of the
company or due to changes in industry in which the client company operates or due to other
factors.
He also learnt how understanding business risks of the company and strategy formulated by the
company to deal with business risks influences audit risk. Where the company has an established
plan to deal with business risks peculiar to it, auditor gains comfort regarding management’s
ability to deal with such business risks by evaluating such plans.
Evaluation of controls of a company helps auditor in zeroing in those areas where controls are
deficient. It also aids in discovering those areas where controls may be missing and non-existent.
If controls are not effective or are missing, risk of material misstatement also increases due to
increase in control risk. By using needed risk assessment procedures like inquiries, inspection
and observation, auditors can understand areas of risks of material misstatement. It would
ultimately lead to performing an effective and qualitative audit.
What happens when an auditor identifies significant deficiencies in internal control system of the
company? Besides having an impact on audit risk, auditor has also a responsibility to
communicate such deficiencies to the management, to those responsible for governing the
company. It may induce those sitting in board rooms to take note of the same and initiate
corrective actions. Besides, such communications also end up saving auditor’s skin. It is due to
the reason that he has already taken pre-emptive steps in this regard. Significant deficiencies
have already been communicated to management and this could come to defence of auditor later.
1. MATERIALITY & RISK ASSESSMENT
As per SA 320, the concept of materiality is applied by the auditor both in planning and performing
the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected
misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.
Materiality and audit risk are considered throughout the audit, in particular, when identifying and
assessing the risks of material misstatement, determining the nature, timing and extent of further
audit procedures; and evaluating the effect of uncorrected misstatements, if any, on the financial
statements and in forming the opinion in the auditor’s report.
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4.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Risk assessment assesses the level of risk in the various business processes. Risk assessment
focuses on the business environment, regulatory environment, organisation structure, organizational
and business environmental changes and specific concerns of management and the audit committee
to determine the areas of greatest risk.
1.1 Identification of Risks
Audit risk is the risk of expressing an inappropriate audit opinion on financial statements that are
materially misstated.
Fig.: Risks of Material Misstatement ∗
1.2 Audit Risk Components
The major components of audit risk are described in the Table below
∗
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.5
Nature Description Commentary
Inherent Risk Susceptibility of an assertion to a These are the business and other risks that
misstatement that could be arise from the entity’s objectives, nature of
material, individually or when operations and industry, the regulatory
aggregated with other environment in which it operates and its
misstatements, assuming that size and complexity. The risks of material
there are no related controls. misstatement will vary based on the nature
Inherent risk is addressed at both of the account balance or class of
the financial statement level and transaction.
at the assertion level. Risks of particular concern to the auditor
For example, technological might include:
developments might make a • Complex calculations which could be
particular product obsolete, misstated;
thereby causing inventory to be • High value inventory;
more susceptible to
• Accounting estimates that are subject
overstatement.
to significant measurement
uncertainty;
• Lack of sufficient working capital to
continue operations;
• A declining or volatile industry with
many business failures; and
• Technological developments that
might make a particular product
obsolete.
Control Risk Risk that the entity’s internal The entity should identify and assess its
(Do internal control system will not prevent, or business and other risks (such as fraud)
controls in detect and correct on a timely and respond by designing and
place basis, a misstatement that could implementing a system of internal control.
mitigate the be material, individually or when Entity level controls such as board
inherent aggregated with other oversight, IT general controls, and HR
risks?) misstatements. policies are pervasive to all assertions
whereas activity level controls
generally, relate to specific assertions.
Some control risk will always exist because
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4.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
of the inherent limitations of any internal
control system.
The auditor is required to understand the
entity’s internal control and perform
procedures to assess the risks of material
misstatement at the assertion level.
Detection This is the risk that the auditor will The auditor identifies assertions where
Risk not detect a misstatement that there are risks of material misstatement
exists in an assertion that could be and concentrates audit procedures on
material, either individually or those areas.
when aggregated with other In designing and evaluating the results of
misstatements. The acceptable performing procedures, the auditor should
level of detection risk for a given consider the possibility of:
level of audit risk bears an inverse
• Selecting an inappropriate audit
relationship to the risks of material
procedure;
misstatement at the assertion
level • Misapplying an appropriate audit
procedure; or
• Misinterpreting the results from an
audit procedure.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.7
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
Audit Risk has two components: Risk of material misstatement (the risk that the financial
statements contain a material misstatement Prior to Audit) and detection risk (the risk that the auditor
will not be able to detect such misstatement).
The relationship can be defined as follows.
Audit Risk = Risk of Material Misstatement X Detection Risk
Risk of material Misstatement: - Risk of material misstatement is anticipated risk that a
material misstatement may exist in financial statement before start of the audit. It has two
components inherent risk and control risk. The relationship can be defined as
Risk of material Misstatement = Inherent risk X Control risk
Detection risk: It is a risk that a material misstatement remained undetected even if all
audit procedures applied.
It should be noted that the combined level of Inherent Risk and Control Risk is inversely related
with Detection Risk, and Audit Materiality is also inversely related with Audit Risk.
Objective of the Audit to
Two key elements of reduce audit risk to an
Audit Risk
Audit Risk: acceptably low level, the
auditor has to:
Risk of expressing an The risk that the financial
inappropriate audit statements contain a material Assess the risks of
opinion when FS are misstatement prior to audit material misstatement;
containing material • (inherent and control risk); and
misstatement.
The risk that the auditor will
not detect such a
misstatement Limit the detection risk
• (detection or engagement risk)
The objective of the audit is to reduce this audit risk to an acceptably low level. This may be achieved
by performing procedures that respond to the assessed risks at the financial statement, class of
transactions, account balance and assertion levels. Number of embedded assertions are included
in management’s representations about the financial statements. These relate to the recognition,
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4.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
measurement, presentation and disclosure of the various elements (amounts and disclosures) in the
financial statements.
1. Management of ABC Ltd. may assert to the auditor that the sales balance in the
accounting records contains all the sales transactions (completeness assertion), the
transactions took place and are valid (occurrence assertion), and transactions have
been properly recorded in the accounting records and in the appropriate accounting period
(accuracy and cut-off assertion).
SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the
Entity and Its Environment” categorises the types of assertions used by the auditor to consider the
different types of potential misstatements that may occur, as follows:
Assertions (i) Occurrence— transactions and events that have been
recorded have occurred and pertain to the
about classes entity.
of (ii) Completeness— all transactions and events that should
have been recorded have been recorded.
transactions
and events (iii) Accuracy— amounts and other data relating to
recorded transactions and events have
for the period been recorded appropriately.
under audit: (iv) Cut-off— transactions and events have been
recorded in the correct accounting period.
(v) Classification- transactions and events have been
recorded in the proper accounts.
assets, liabilities, and equity interests exist.
Assertions (i) Existence—
about account
balances at the entity holds or controls the rights to assets,
(ii) Rights and
the period obligations—
and liabilities are the obligations of the entity.
end:
(iii) Completeness— all assets, liabilities and equity interests that
should have been.
assets, liabilities, and equity interests are
(iv) Valuation and included in the FS at appropriate amounts and
allocation— any resulting valuation or allocation
adjustments are appropriately recorded.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.9
Assertions (i) Occurrence and rights and disclosed events, transactions, and other
matters have occurred and pertain to the
about obligations — entity.
presentation (ii) Completeness— all disclosures that should have been
and included in the financial statements have
been included.
disclosure:
(iii) Classification and financial information is appropriately
presented and described, and
understandability— disclosures are clearly expressed.
(iv) Accuracy and valuation— financial and other information are
disclosed fairly and at appropriate
amounts.”
Auditors are required to assess the risks of material misstatement at two levels. The first is at the
overall financial statement level, which refers to risks of material misstatement that relate pervasively
to the financial statements as a whole and potentially affect many assertions.
2. If the top accountant is not competent enough for the assigned tasks, it is quite
possible that errors could occur in the financial statements. However, the nature of
such errors will not often be confined to a single account balance, transaction stream
or disclosure. In addition, the error is not likely be confined to a single assertion such as the
completeness of sales. It could easily relate to other assertions such as accuracy, existence and
valuation.
The second relates to risks identifiable with specific assertions at the class of transactions, account
balance, or disclosure level. This means that for each account balance, class of transactions and
disclosure, an assessment of risk (such as high, moderate, or low) should be made for each
individual assertion (C, E, A, and V in the diagram below) being addressed.
3. While considering the valuation assertion, the auditor could assess the risk of error
in payables as low; however, for inventory where obsolescence is a factor, the auditor
would assess the valuation risk as high. Another example would be where the risks of
material misstatement due to completeness (missing items) in the inventory balance are low, but
high in relation to the sales balance.
The difference between assessing risk at the overall financial statement level and the
assertion level is illustrated (in partial form only) below.
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4.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1.3 Steps for Risk Identification
Assess the significance of the assessed risk, impact of its occurrence and also revise the
materiality accordingly for the specific account balance.
Determine the likelihood for assessed risk to occur and its impact on auditing procedures.
Document the assertions that are effected.
Consider the impact of the risk on each of the assertions.
(completeness, existence, accuracy, validity, valuation and presentation) relevant to the
account balance, class of transactions, or disclosure.
Identify the degree of significant risks that would require separate attention and response
by the auditor. Planned audit procedures should directly address these risks.
Enquire and document the management’s response.
Consider the nature of the internal control system in place and its possible effectiveness in
mitigating the risks involved. Ensure the controls:
Routine in nature (occur daily) or periodic such as monthly.
Designed to prevent or detect and correct errors.
Manual or automated.
Consider any unique characteristics of the risk.
Consider the existence of any particular characteristics (inherent risks) in the class of
transactions, account balance or disclosure that need to be addressed in designing further
audit procedures.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.11
Examples could include high value inventory, complex contractual agreements, absence of
a paper trail on certain transaction streams or a large percentage of sales coming from a
single customer.
Possible potential misstatements - Indicators
Completeness Existence Recording Cut-Off
•Transactions not •Fictitious or •Source Procedures
identified. unauthorised documents •Transactions that
•Source transactions entered on captured occur in one
documents not source documents. inaccurately. period are
prepared. •Source documents •Processing of recorded in
•Source overstated. transactions is another period.
documents not •Transactions duplicated inaccurate.
captured. on source documents. •Inaccurate
•Rejected source •Capture of source adjustments
documents not documents duplicated. made in
represented •Invalid source subsidiary
documents captured on ledgers.
subsidiary ledgers.
ILLUSTRATION 1
Background: During the process of extracting the exception reports, the auditors noted
numerous purchase entries without valid purchase orders.
Analysis: In terms of percentage, about 40% of purchases were made without valid purchase
orders and also few purchase orders were validated after the actual purchase. Also there was
no reconciliation between the goods received and the goods ordered.
Assertions: Validity of purchases
Pervasive/Account Balance Level: Account Balance level
Account Balance(s) affected : (i) Purchases, (ii) Account Payable
Audit Procedures: The following procedures may address the validity of the account balance:
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4.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Make a selection of the purchases, review correspondence with the vendors, purchase
requisitions (internal document) and reconciliations of their accounts.
• Review Vendor listing along with the ageing details. Follow up the material amounts paid
before the normal credit period and analyse the reasons for exceptions.
• Meet with the company's Purchase officer and obtain responses to our inquiries
regarding the purchases made without purchase orders.
• Discuss the summary of such issues with the client.
2. RISK-BASED AUDIT APPROACH
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 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.
Risk Based Audit 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 on the financial statements 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.13
2.1 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.
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.
2.2 General Steps in the Conduct of Risk Based Audit
The auditor’s objective in a risk-based audit is to obtain reasonable assurance that no material
misstatements whether caused by fraud or errors exist in the financial statements.
This involves the following three key steps:
• Assessing the risks of material misstatement in the financial statements
• Designing and performing further audit procedures that respond to assessed risks and reduce
the risks of material misstatements in the financial statements to an acceptably low level; and
• Issuing an appropriate audit report based on the audit findings.
The risk-based audit process is presented in three distinct phases:
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4.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Risk assessment.
Risk response; and
Reporting.
2.2.1. Risk Assessment
The risk assessment phase of the audit involves the following steps:
• Performing client acceptance or continuance procedures;
• Planning the overall engagement;
• Performing risk assessment procedures to understand the business and identify inherent and
control risks;
• Identifying relevant internal control procedures and assessing their design and
implementation (those controls that would prevent material misstatements from occurring or
detect and correct misstatements after they have occurred);
• Assessing the risks of material misstatement in the financial statements;
• Identifying the significant risks that require special audit consideration and those risks for
which substantive procedures alone are not sufficient;
• Communicating any material weaknesses in the design and implementation of internal control
to management and those charged with governance; and
• Making an informed assessment of the risks of material misstatement at the financial
statement level and at the assertion level.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.15
2.2.2. Risk response
This phase of the audit is to design and perform further audit procedures that respond to the
assessed risks of material misstatement and will provide the evidence necessary to support the audit
opinion.
Some of the matters the auditor should consider when planning the audit procedures
include:
• Assertions that cannot be addressed by substantive procedures alone. This can occur
where there is highly automated processing of transactions with little or no manual
intervention.
• Existence of internal control that, if tested, could reduce the need/scope for other
substantive procedures.
• The potential for substantive analytical procedures that would reduce the need/scope for
other types of procedures.
• The need to incorporate an element of unpredictability in procedures performed.
• The need to perform further audit procedures to address the potential for management
override of controls or other fraud scenarios.
• The need to perform specific procedures to address “significant risks” that have been
identified.
Audit procedures designed to address the assessed risks could include a mixture of:
• Tests of the operational effectiveness of internal control; and
• Substantive procedures such as tests of details and analytical procedures.
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4.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. 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.
2.2.3. Reporting
The final phase of the audit is to assess the audit evidence obtained and determine whether it is
sufficient and appropriate to reduce the overall Audit Risk to an acceptably low level.
It is important at this stage to determine:
• If there had been a change in the assessed level of risk;
• Whether conclusions drawn from work performed are appropriate; and
• If any suspicious circumstances have been encountered.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.17
Any additional risks should be appropriately assessed, and further audit procedures performed as
required.
When all procedures have been performed and conclusions reached:
• Audit findings should be reported to management and those charged with governance; and
• An audit opinion should be formed, and a decision made on the appropriate wording for the
auditor’s report.
TEST YOUR UNDERSTANDING 1
CA. R is conducting statutory audit of a Divisional office (DO) of a public sector insurance company.
On going through delegation of powers laid down by company’s head office, it is noticed that
surveyors in claims under property insurance policies beyond estimated amounts of `30 lac are to
be appointed by Divisional Claims Committee (DCC). However, on going through surveyor
appointment details of 10 such claims during the year, 5 instances have come to his notice where
above delegation of powers has not been followed and appointments were made by Divisional
manager in place of DCC.
In the beginning, the auditor had assessed risks of material misstatement to be low. Describe why
above finding would change auditor’s assessment in relation to above.
TEST YOUR UNDERSTANDING 2
You have recently been appointed as an auditor of NGO working in the field of “upholding
democracy” for the first time. The last year accounts of NGO were unaudited and its activities were
limited at a small scale. However, it is only in the current year that NGO has received substantial
donations including foreign funds. The said NGO is also crowdfunding its donations. The government
has now legislative power to cancel FCRA certificate of NGO. Since it is working in field which
encompasses political and social fields, accusations and counter-accusations are flying thick and
fast.
What factors you may consider for assessing audit risk?
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4.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3. 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.
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.
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, 2013 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 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.
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.
An auditor’s judgement as to what is sufficient and appropriate audit evidence is affected by the
degree of risk of misstatement. The auditor should obtain audit evidence through tests of control to
© The Institute of Chartered Accountants of India
MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.19
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 the consistency with by whom they were
applied, which they were applied applied.
during the period and
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 errors. 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.
5. 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.
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 following are the Nature, Scope, Objectives and Structure of an Internal Control System:
© The Institute of Chartered Accountants of India
4.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3.1 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.
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.
3.2 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.
6. If production statistics were used as a basis for an analytical procedure, the
controls to ensure the accuracy of such data would be relevant.
If non-compliance with certain laws and regulations has a direct and material effect
on the financial statements, the controls for detecting and reporting on such non-compliance
© The Institute of Chartered Accountants of India
MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.21
would be relevant.
Facilitates the effectiveness and efficiency of operations.
INTERNAL CONTROL
SYSTEM: Helps ensure the reliability of internal and external financial
reporting.
Assists compliance with laws and regulations.
Helps safeguarding the assets of the entity.
3.3 Objectives of Internal Control System
The objectives of internal control system are determined by the management, after considering the
nature of business, scale operations, the extent of professionalism of the management etc.
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:
Ensure all transactions are
Properly
Recorded Properly Recorded Properly Classified Properly
Real
Valued Timely Posted and Summarized.
Disclosed
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4.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
If the response to all the above answer is positive, the auditor would be justified in limiting his account
balance tests considerably.
In the case of excellent companies, 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.
7. 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.
3.3.1 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.
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.
3.4 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:
3.4.1 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
© The Institute of Chartered Accountants of India
MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.23
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 too 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.
3.4.2 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 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.
3.4.3 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.
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4.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
3.4.4 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.
3.4.5 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.
4. 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;
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.25
(iii) Control activities;
(iv) Information system and communication;
(v) Monitoring of Controls
Components of Internal Control
Entity’s risk Information
Control Control Monitoring of
assessment system and
environment activities controls
process communication
4.1 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.
(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.
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4.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
4.2 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.27
8. 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.
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4.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4.3 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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.29
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.
4.4 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.
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4.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4.5 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 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 the 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.31
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 the 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 workflow. 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.
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4.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
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 Chapter on Internal Audit in Module 3.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.33
TEST YOUR UNDERSTANDING 3
RK Living Limited is engaged in manufacturing and processing of textile fabrics. It purchases its raw
material from a company based in Silvassa taxable @ 12%. It takes about 3-4 days for raw materials
to reach the company’s plant. Recently, the company has revamped its internal control system for
recording its transactions. You have also assumed charge as head of internal audit department of
the company few days before.
It is noticed that information system requires booking of purchases in purchase ledger and stock
records from date of purchase invoice only. How you would deal with above matter as internal auditor
of the company?
TEST YOUR UNDERSTANDING 4
A company as part of its internal control set up has a system under which quarterly budgeted targets
in respect of sales are analysed with respect to actual performance achieved. It also involves fixing
responsibilities of different product departmental heads and taking timely correction. In case of
product departmental heads not achieving quarterly budgeted targets, they have to give a detailed
justification for the same and also lay down how shortfalls would be compensated in ensuing
quarters.
Identify and explain component of internal control alluded to in above scenario.
5. 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.
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4.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
9. 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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.35
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 –
(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
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4.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
6. 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.
10. 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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.37
important that in key commercial functions, the job rotation is regularly followed to avoid
degeneration of controls.
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.
6.1 Techniques of evaluation of Internal control
The following are the techniques of evaluation of internal control:
6.1.1 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
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4.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 reflect 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.39
(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.
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.
6.1.2 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.
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4.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
11. 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. In ICQ, questions are usually answered by company executives. However, in a check
list, the same are required to be answered by auditor/auditor staff.
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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.41
6.1.3 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;
(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
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4.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.43
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.
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.
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4.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 -
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.45
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.
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4.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.47
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.
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4.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
7. 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.
12. 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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.49
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.
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4.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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 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
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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.51
Based upon risks of material misstatements identified and assessed by the auditor, auditor
develops responses to assessed risks.
SA 330, “The Auditor’s Responses to Assessed Risks” 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.
The objective of the auditor in accordance with SA 330 is to obtain sufficient appropriate audit evidence
about the assessed risks of material misstatement, through designing and implementing appropriate
responses to those risks.
SA 330 states that:
The auditor shall design and
implement overall responses to
address the assessed risks of The auditor shall design and perform
material misstatement at the further audit procedures whose
financial statement level. nature, timing and extent are based
on and are responsive to the
assessed risks of material
misstatement at the assertion level.
In designing the further audit procedures to be performed, the auditor shall:
(a) Consider the reasons for the assessment given to the risk of material
misstatement at the assertion level for each class of transactions, account balance,
and disclosure, including:
(i) The likelihood of material misstatement due to the particular characteristics of the
relevant class of transactions, account balance, or disclosure (i.e., the inherent risk); and
(ii) Whether the risk assessment takes into account the relevant controls (i.e., the
control risk), thereby requiring the auditor to obtain audit evidence to determine whether
the controls are operating effectively (i.e., the auditor intends to rely on the operating
effectiveness of controls in determining the nature, timing and extent of substantive
procedures); and
(b) Obtain more persuasive audit evidence the higher the auditor’s assessment
of risk.
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4.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The auditor shall design and perform tests of controls to obtain sufficient appropriate audit
evidence as to the operating effectiveness of relevant controls when:
(a) The auditor’s assessment of risks of material misstatement at the assertion level includes an
expectation that the controls are operating effectively (i.e., the auditor intends to rely on the operating
effectiveness of controls in determining the nature, timing and extent of substantive procedures); or
(b) Substantive procedures alone cannot provide sufficient appropriate audit evidence at the
assertion level.
In designing and performing tests of controls, the auditor shall obtain more persuasive audit
evidence the greater the reliance the auditor places on the effectiveness of a control.Irrespective of
the assessed risks of material misstatement, the auditor shall design and perform substantive
procedures for each material class of transactions, account balance, and disclosure.
TEST YOUR UNDERSTANDING 5
CA. S is statutory auditor of a listed company. On reviewing internal controls of the company, he is
of the view that there can be possible situations where insurance premiums for keeping insurance
policies current in respect of various assets of company may have become due and payable but
internal control systems established by the company may not be able to capture it.
Elaborate how he should proceed to deal with the above matter.
8. 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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.53
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.
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.
8.1 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
17 basic principles representing the fundamental concepts associated with its five components:
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4.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 Control Information and Monitoring
Assessment Activities Communication
Demonstrates Specifies Selects and Uses relevant Conducts
commitment to suitable develops information ongoing
integrity and ethical objectives control Communicates and/or
values Identifies activities internally separate
Exercises oversight and Selects and evaluations
Communicates
responsibility analyses develops externally Evaluates and
Establishes risk general communicate
structure, authority, Assesses controls deficiencies
and responsibility fraud risk over
technology
Demonstrates Identifies
commitment to and Deploys
competence analyses through
significant policies and
Enforces
change procedures
accountability
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
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.55
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 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. 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
• 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.
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4.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.57
• 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
Section 404 of Sarbanes-Oxley Act (Sarbanes-Oxley Act Section 404) of United States of America
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, has
revamped federal regulations pertaining to publicly traded companies’ corporate governance and
reporting obligations. It was followed up with constitution of PCAOB (Public Company Accounting
Oversight Board). It regulates the audits of public companies and SEC-registered brokers and
dealers in order to protect investors and further the public interest in the preparation of informative,
accurate, and independent audit reports.
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.
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4.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Case Study
Following is extract of information taken from draft financial statements of Find me Limited engaged in
manufacturing of bicycles put up before you for audit for year 2022-23: - (` In lacs)
Particulars 2022-23 2021-22
Revenue from operations 35000 25000
Cost of sales 26950 20000
Gross Profit 8050 5000
Operating expenses 3825 3825
Finance costs 225 275
Depreciation and amortization expenses 1200 1300
Profit before tax 2800 (400)
Tax expense – current tax 750 0
Deferred tax (50) (385)
Total tax expense 700 (385)
Profit after tax 2100 15
Trade receivables 6000 3000
Inventories 10000 6000
The company has not made any substantial additions in its plant capacity during year 2022-23. It
has reduced its dealer network and is approaching customers directly using its online platform.
Encouraging response has been received from customers and sales have gathered momentum
through online platform.
You are planning to use analytical procedures as risk assessment procedures. Keeping in view
above, answer the following questions: -
1. The revenue from operations of company has increased by 40% in year 2022-23 as
compared to last year. There are no additions in plant capacity. Which of the following
statements is most appropriate in this regard?
(a) There is audit risk that revenue from operations is overstated.
(b) There is audit risk that revenue from operations is not overstated.
(c) There is audit risk that fresh customers of company do not make payments.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.59
(d) There is audit risk that company is overutilizing its plant capacity leading to rapid plant
obsolescence.
2. The operating expenses of financial year 2021-22 and 2022-23 are same. Which of the
following statements is most appropriate in overall context of case study?
(a) Operating expenses figures of two years can be same. There is no audit risk involved.
(b) It is an anomaly. However, there is no audit risk involved.
(c) There is audit risk that previous year figures need to be revised under Companies Act.
(d) There is audit risk that previous year figures have been presented in place of current year
figures in draft financial statements.
3. Trade receivables turnover ratio has increased from 1.44 months in year 2021-22 to more
than 2 months in year 2022-23. Identify the most appropriate statement.
(a) In direct distribution through online platform, trade receivables turnover ratio is estimated to be
high. Therefore, there is no audit risk involved.
(b) In direct distribution through online platform, trade receivables turnover ratio should have fallen.
Therefore, there is no audit risk involved.
(c) In direct distribution through online platform, trade receivables turnover ratio should have fallen.
It is possible that some of the dealers may not be meeting their commitments of past contracts.
Therefore, there is audit risk that trade receivables could be undervalued.
(d) In direct distribution through online platform, trade receivables turnover ratio should have fallen.
It is possible that some of the dealers may not be meeting their commitments of past contracts.
Therefore, there is audit risk that trade receivables could be overvalued.
4. The gross profit ratio of company has increased by 3% during year 2022-23 in
comparison to last year. Which of the following statements is most appropriate?
(a) There is audit risk that there is overstatement of cost of sales.
(b) There is audit risk that margins with customers may have increased.
(c) There is audit risk that closing inventories may be undervalued.
(d) There is audit risk that cost of sales may not be completely recorded.
5. Inventory turnover ratio has increased from 2.88 months in year 2021-22 to about 3.42
months in year 2022-23. Which of the following statements is likely to be in accordance with
overall context of case study?
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4.60 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) Revenue jump in current year may have led to need for raising inventory holding levels.
Therefore, there is audit risk pertaining to misstatement of inventories.
(b) Raising of inventory levels may raise locked up funds in inventories. There is audit risk that it
can lead to rise in costs.
(c) Revenue jump in current year may have led to need for raising inventory holding levels.
However, there is also a risk that some of inventories with dealers could have become obsolete. It
leads to audit risk that inventories may be overvalued.
(d) There is audit risk on account of both the factors stated at [b] & [c].
Key Takeaways
Audit risk is the risk of expressing an inappropriate audit opinion on financial statements that
are materially misstated. The components of audit risk include inherent risk, control risk and
detection risk. 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
Auditors are required to assess the risks of material misstatement at two levels. The first is
at the overall financial statement level, which refers to risks of material misstatement that
relate pervasively to the financial statements as a whole and potentially affect many
assertions and second one relates to risks identifiable with specific assertions at the class of
transactions, account balance, or disclosure level.
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.
Internal control is 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, 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.61
Components of internal control include control environment, entity’s risk assessment process,
the information system, including the related business processes, relevant to financial
reporting, and communication, control activities and monitoring of controls.
Review of internal control system enables auditor 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 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.
In accordance with SA 265, it is auditor’s responsibility 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.
Based upon risks of material misstatements identified and assessed by the auditor, auditor
develops responses to assessed risks.SA 330 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.
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.
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS
WISDOM: SCAN ME !
Note : Content of SA 315-Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and its Environment and SA 320-Materiality in Planning and Performing an
Audit is covered in depth at Intermediate level. Thus, application part of above SAs may be
discussed in the form of Case Study at Final level.
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4.62 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR KNOWLEDGE
Theoretical Questions
1. CA. B was appointed as the auditor of ABC Limited for the financial year 2022-23. During the
course of planning for the audit, CA. B intends to apply the concept of materiality for the
financial statements as a whole. Please guide him with respect to the factors that may affect
the identification of an appropriate benchmark for this purpose.
What benchmark should be adopted by CA. B, if ABC Limited is engaged in:
(i) the manufacture and sale of air conditioners and is having regular profits.
(ii) the construction of large infrastructure projects and incurred losses in the previous two
financial years, due to pandemic.
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. As auditor of Z Ltd., you would like to limit your examination of account balance tests. What
are the control objectives you would like the accounting control system to achieve to suit your
purpose?
6. New Life Hospital is a multi-speciality hospital which has been facing a lot of pilferage and
troubles regarding their inventory maintenance and control. On investigation into the matter
it was found that the person in charge of inventory inflow and outflow from the store house is
also responsible for purchases and maintaining inventory records. According to you, which
basis system of control has been violated? Also list down the other general conditions
pertaining to such system which needs to be maintained and checked by the management.
7. Compute the overall Audit Risk if looking to the nature of business there are chances that
40% bills of services provided would be defalcated, inquiring on the same matter
management has assured that internal control can prevent such defalcation to 75%.At his
part the Auditor assesses that the procedure he could apply in the remaining time to complete
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.63
Audit gives him satisfaction level of detection of frauds & error to an extent of 60%. Analyse
the Risk of Material Misstatement and find out the overall Audit Risk.
8. ST Ltd is a growing company and currently engaged in the business of manufacturing of tiles.
The company is planning to expand and diversify its operations. The management has
increased the focus on the internal controls to ensure better governance. The management
had a discussion with the statutory auditors to ensure the steps required to be taken so that
the statutory audit is risk based and focused on areas of greatest risk to the achievement of
the company’s objectives. Please advise the management and the auditor on the steps that
should be taken for the same.
9. 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.
10. The effectiveness of controls cannot rise above the integrity and ethical values of the people
who create, administer, and monitor them. Explain.
11. Your engagement team is seeking advice from you as engagement partner regarding steps
for risk identification. Elaborate.
12. BSF Limited is engaged in the business of trading leather goods. You are the internal auditor
of the company for the year 2019-20. In order to review internal controls of the Sales
Department of the company, you visited the Department and noticed the work division as
follows:
(1) An officer was handling the sales ledger and cash receipts.
(2) Another official was handling dispatch of goods and issuance of Delivery challans.
(3) One more officer was there to handle customer/ debtor accounts and issue of receipts.
As an internal auditor, you are required to briefly discuss the general condition pertaining to
the internal check prevalent in internal control system. Do you think that there was proper
division of work in BSF Limited? If not, why?
Answers to Case Study Question
1. (a)
2. (d)
3. (d)
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4.64 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. (d)
5. (c)
Answers to Test your Understanding Question
1. Evaluation of internal controls influences auditor’s assessment of risks of material
misstatement. Risks of material misstatement also consists of control risk.
In the given situation of statutory audit of a Divisional office of a public sector insurance
company, it is noticed that procedure relating to delegation of powers has not been followed
and surveyor appointments have been made in violation of laid down procedures. It is a
serious violation and shows that controls are not operating effectively as laid down by
company management.
Such deviations from established controls may lead auditor to conclude that control risk needs
to be revised. Revision of control risk assessment is likely to lead to revision in risks of
material misstatement. It may also result in modification of nature, timing and extent of
planned substantive procedures.
2. For assessing audit risk, auditor shall consider all components of audit risk. The said NGO is
working in a political-cum-social field which can make its activities inherently risky.
Crowdfunding donations may have to be seen in relation to constitution of NGO which may
make these risky. Since the NGO is in receipt of foreign funds, it may make transactions
inherently risky. The credibility and integrity of persons behind NGO is important. Shady
NGOs can be involved in money laundering activities and may be involved in mis utilizing
funds from donors. Since last year accounts were unaudited, it also increases inherent risk
due to probable effect of misstatements, if any, of last year. Non-compliance with strict laws
has the potential to make activities of NGO inherently risky.
Since NGO has received substantial donations in current year and its activities were on a
relatively small scale during last year, formal controls may not be in place. Lack of formal
controls may lead to non-compliance with laws. Non-compliance with FCRA can have serious
consequences including cancelling such certificate of NGO. Therefore, control risk could be
high.
Further, audit for NGO has been accepted for the first time. There may be a lack of
understanding of activities of NGO. It may lead to higher detection risk due to inappropriate
sampling procedures or faulty application of audit procedures.
3. Internal audit involves continuous and critical appraisal of functioning of an entity with a view
to suggest improvements thereto and add value to and strengthen the overall governance
mechanism of the entity including its strategic risk management and internal control system.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.65
Internal audit also involves evaluation of internal control to provide assurance to management
regarding design, implementation and operating effectiveness of control.
In the given situation, information system requires booking of purchases in purchase ledger
and stock records from date of invoice. Such a control system is likely to present a distorted
picture of stocks of the company. It would show stocks of raw material as received whereas
these goods could be in transit. Therefore, design of the control itself is faulty which allows
booking from date of purchase invoice only. Further, such a system can have implications
with respect to GST laws.
The internal auditor should report above matter asking management for corrective action.
4. The above referred component of internal control is “Control activities”. Control activities that
may be relevant to an audit include policies and procedures that pertain to “performance
reviews”.
Such 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.
The control activities pertaining to analysis of budgeted target of sales with respect to actual
performance, fixing of responsibilities and taking timely corrective action falls in nature of
performance reviews. Such performance reviews are part of control activities which is a
component of internal control.
5. A deficiency in internal control exists when: -
(i) A control is designed, implemented or operated in such a way that it is unable to
prevent, or detect and correct, misstatements in the financial statements on a timely
basis or
(ii) A control necessary to prevent, or detect and correct, misstatements in the financial
statements on a timely basis is missing.
In above situation, there is a possibility that internal control systems established by the
company may not be able to capture insurance premiums which may have become due and
payable. It is a significant deficiency as failure to keep insurance policies current would render
assets of the company uninsured. It may lead to losses for the company in case of any
eventuality.
Further, in accordance with SA 265, the significance of a deficiency or a combination of
deficiencies in internal control depends not only on whether a misstatement has actually
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4.66 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
occurred, but also on the likelihood that a misstatement could occur and the potential
magnitude of the misstatement. Significant deficiencies may, therefore, exist even though the
auditor has not identified misstatements during the audit.
The susceptibility to loss of an asset is a factor in determining whether a deficiency constitutes
significant deficiency in internal control.
The auditor shall communicate in writing significant deficiency in internal control to those
charged with governance and 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.
Answers to Theoretical Questions
1. Use of Benchmarks in Determining Materiality for the Financial Statements as a Whole:
As per SA 320, determining materiality involves the exercise of professional judgment. A
percentage is often applied to a chosen benchmark as a starting point in determining
materiality for the financial statements as a whole.
Factors that may affect the identification of an appropriate benchmark include the
following:
• The elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
• Whether there are items on which the attention of the users of the particular entity’s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
• The nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is
financed solely by debt rather than equity, users may put more emphasis on assets,
and claims on them, than on the entity’s earnings); and
• The relative volatility of the benchmark.
Determining a percentage to be applied to a chosen benchmark involves the exercise of
professional judgment. There is a relationship between the percentage and the chosen
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.67
benchmark, such that a percentage applied to profit before tax from continuing operations
will normally be higher than a percentage applied to total revenue.
In case if ABC Limited is engaged in manufacture and sale of air conditioner, and is having
regular profits: CA. B, the auditor may consider profit before tax /Earnings.
In case if ABC Limited is engaged in the construction of large infrastructure projects and
incurred losses in the previous two financial years, due to pandemic: CA. B, the auditor may
consider Revenue or Gross Profit as benchmarking. Alternatively, CA B, the auditor may
consider the criteria relevant for audit of the entities doing public utility programs/ projects,
Total cost or net cost (expenses less revenues or expenditure less receipts) may be
appropriate benchmarks for that particular program/project activity. Where an entity has
custody of the assets, assets may be an appropriate benchmark.
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 Governance and
Management”, the auditor shall include in the written communication of significant
deficiencies 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 to
understand 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 suggestions for
improvement.
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4.68 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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 6.1.3
5. Basic Accounting Control Objectives: The basic accounting control objectives which are
sought to be achieved by any accounting control system are -
(i) Whether all transactions are recorded;
(ii) Whether recorded transactions are real;
(iii) Whether all recorded transactions are properly valued;
(iv) Whether all transactions are recorded timely;
(v) Whether all transactions are properly posted;
(vi) Whether all transactions are properly classified and disclosed;
(vii) Whether all transactions are properly summarized.
6. Basic system of Control: Internal Checks and Internal Audit are important constituents of
Accounting Controls. 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.
In the given case of New Life Hospital, the person-in-charge of inventory inflow and outflow
from the store house is also responsible for purchases and maintaining inventory records.
Thus, one of the basic system of control i.e. internal check which includes segregation of
duties or maker and checker has been violated where 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 general condition pertaining to the internal check system may be summarized as under-
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.69
(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.
7. According to SA-200, “Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with Standards on Auditing”, the Audit Risk is a risk that Auditor will issue
an inappropriate opinion while Financial Statements are materially misstated.
Audit Risk, has two components: Risk of material Misstatement and Detection Risk. The
relationship can be defined as follows.
Audit Risk = Risk of material Misstatement X Detection Risk
Risk of material Misstatement: - Risk of Material Misstatement is anticipated risk that a
material Misstatement may exist in Financial Statement before start of the Audit. It has two
components Inherent risk and Control risk. The relationship can be defined as
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4.70 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Risk of material Misstatement = Inherent risk X control risk
Inherent risk: it is a susceptibility of an assertion about account balance; class of transaction,
disclosure towards misstatements which may be either individually or collectively with other
Misstatement becomes material before considering any related internal control which is 40%
in the given case.
Control risk: it is a risk that there may be chances of material Misstatement even if there is a
control applied by the management and it has prevented defalcation to 75%.
Hence, control risk is 25% (100%-75%)
Risk of material Misstatement: Inherent risk X control risk i.e. 40% X 25 % = 10%
Chances of material Misstatement are reduced to 10% by the internal control applied by
management.
Detection risk: It is a risk that a material Misstatement remained undetected even if all Audit
procedures applied, Detection Risk is 100-60=40%
In the given case, overall Audit Risk can be reduced up to 4% as follows:
Audit Risk: Risk of Material Misstatement X Detection Risk = 10X 40% = 4%
8. Refer Para 2.2
9. 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.
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MATERIALITY, RISK ASSESSMENT AND INTERNAL CONTROL 4.71
(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.
10. Communication and enforcement of integrity and ethical values: Refer Para 4.1
11. Refer Para 1.3
12. The general condition pertaining to the internal check system may be summarized as under:
refer para 4.5
In the given scenario, Company has not done proper division of work as:
(i) the receipts of cash should not be handled by the official handling sales ledger and
(ii) delivery challans should be verified by an authorised official other than the officer
handling despatch of goods.
© The Institute of Chartered Accountants of India
CHAPTER 5
AUDIT EVIDENCE
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Refreshen up your knowledge about procedures relating to Audit
Evidence.
Glance through relevant SAs-SA 500, SA 501, SA 505, SA 510, SA 530
and SA 550 pictorially.
Gain application-based knowledge of above SAs.
Understand the concepts through use of analytical examples and case
studies.
Gain knowledge about varied practical situations for an auditor while
performing such procedures.
© The Institute of Chartered Accountants of India
5.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Audit Evidence
SA 501 Audit Evidence
- Specific
SA 500 Audit Evidence
Considerations for
Selected Items
SA 510 Initial Audit
SA 505 External
Engagements –
Confirmations
Opening Balances
SA 530 Audit Sampling SA 550 Related Parties
CA. Kartik is intrinsically efficient and has an inherent dislike for wasting time on frivolous things.
He wants to do everything perfect- spick and span- and in a cost- effective manner. Adopting the
same approach, in the course of his professional work as an auditor, he is very particular in
completing work quickly in a time bound manner.
During one such audit of a company's accounts, he chose to select some specific items for
performing “tests of details” according to his judgment. Like, he decided to verify sales
transactions above the threshold amount of ` 25 lacs. Fresh additions to “Property, Plant and
Equipment” above the threshold of the same amount were selected by him for detailed
verification.
He also grew suspicious about certain sales transactions aggregating to ` 50 lacs. Such
transactions were at fag end of the year, and goods moved out from the company’s premises
were purportedly sent through non-motorised conveyance without accompanying e-way bills to
a single customer over a span of few days. It was agreed to send external confirmation request
to this customer only. Besides, it was decided to go through all related party transactions in a
detailed manner without exception to dig out any material misstatement.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.3
Litigation claims involving the company were considered a misstatement prone area and came
for detailed examination on his radar. Such a testing approach, he thought, would be efficient and
cost-effective for obtaining audit evidence.
Can above approach followed by auditor be construed as “audit sampling”? What does it signify
and to what kind of risk such an approach is subject to? Such a testing approach to obtain audit
evidence relates to “selective examination of specific items” from class of transactions and
account balances. While “selective examination of specific items” as a testing means to obtain
audit evidence could be an efficient way of obtaining audit evidence, it does not constitute audit
sampling.
The results of audit procedures to items selected in this way cannot be projected to the entire
population. “Selective examination of specific items” does not provide audit evidence concerning
the remainder of the population. Such an approach is subject to non-sampling risk. It is the risk
of an auditor reaching an erroneous conclusion due to inappropriate audit procedures,
misinterpretation of audit evidence and failure to recognise a misstatement or deviation.
Whereas” audit sampling” refers to the application of audit procedures to less than 100% of items
within a population relevant under the audit, such that all the items in the population have an
equal chance of selection. Being subject to sampling risk, testing on the basis of samples may
also lead to erroneous conclusions. It can be due to the risk that the auditor’s conclusion based
on a sample may be different from the conclusion if the entire population were subjected to the
same audit procedure. Such a risk is always there in audit sampling!
1. SA 500 AUDIT EVIDENCE
SA 500 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. It also explains what constitutes audit evidence in an audit of financial
statements.
Audit evidence is the information used by the auditor in arriving at the conclusions on which the
auditor’s opinion is based. Audit evidence includes both information contained in the accounting
records underlying the financial statements and other information.
© The Institute of Chartered Accountants of India
5.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SA 500 - "Audit Evidence"
Scope of the Information to be Audit procedures Inconsistency in
Objective of the used as audit or doubts over
SA auditor to obtain audit
evidence evidence reliability of
audit evidence
The auditor shall
This SA deals To design
consider the
with the auditor's and perform Audit evidence to
relevance and
responsibility to audit draw reasonable
reliability of the The auditors
design and procedures in conclusions on which
information to be shall determine
perform audit such a way to base the auditor's
used as audit what
procedures to as to enable opinion is obtained
evidence. modifications or
obtain sufficient the auditor to by performing:
When information additions to audit
and appropriate obtain
from management procedures are
audit evidence to sufficient
expert is used, the 1.Risk Assessment necessary to
be able to draw appropriate
auditor shall evaluate procedures resolve the
reasonable audit
the competence, matter and shall
conclusions on evidence to 2. Further audit
objectivity of the consider the
which to base the be able to procedures
expert, effect of the
auditor's opinion. draw comprising of:
appropriateness of matter, if any, on
reasonable Test of controls and
This SA is the expert's work. oother aspects of
conclusions Substantive
applicable to all When using the audit.
on which to procedures.
the audit information produced
base
evidence by the entity, the
auditor's
obtained during auditor shall evaluate
opinion.
the course of the reliability,
audit. completeness,
accuracy of the
information.
TEST YOUR UNDERSTANDING 1
During the course of the audit of TK Home Private Limited, a recognized export house engaged in
manufacturing of T-shirts under brand name of “TK”. CA Tripti is verifying export revenues of the
company for the year 2022-23. She has verified transactions entered in “Export Sales” account
maintained in accounting software from relevant export invoices. The export sales are being made
on payment of IGST, for which a refund is automatically credited in the account of the company after
the goods are shipped.
On enquiring from internal audit staff regarding the recognition of export revenues, she is told that
export sales are recognised for the year on the basis of “Bills of Lading”. However, she is not
convinced with such a response and feels that the same does not appear to be proper.
She finds that three export invoices bearing dates in the month of March 2023 having a value of
` 75.00 lacs have not been recognized in export revenue on the ground that bills of lading for these
invoices were issued in the month of April 2023.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.5
Discuss from what sources she can obtain reliable audit evidence in this regard. How can she
challenge management’s assertion regarding the completeness of export revenues for the year
2022-23?
2. SA 501 AUDIT EVIDENCE - SPECIFIC
CONSIDERATIONS FOR SELECTED ITEMS
SA 501 - "Audit Evidence" - Specific Considerations for
Selected Items"
Scope of the SA Objective of the Segment
auditor Inventory Litigations & Claims
Information
To obtain sufficient a) If inventory is material, a) Auditor to perform audit
This SA deals and appropriate obtain evidence for existence procedures to identify litigation
with specific audit evidence and condition of inventory by: and claims by:
considerations regarding: Auditor to obtain audit
1. Attence at physical 1. Inquiry of management.
by the auditor evidence regarding
in obtaining 1. Existence and inventroy counting.
2. Reviewing minutes of meetings. presentation and
sufficient condition of 2. Performating audit disclosure of segment
appropriate inventroy procedures over the entity's 3. Reviewing legal expense
accounts information in
audit evidence 2. Completness of final inventory records. accordance with
withy respect litigation and b) If inventory counting b) If auditor assesses risk of applicable FRF by:
to inventory, claims involving the conducted at date other than material misstatement, seek direct
litigation and the date of financial communication with entity's 1. Understanding the
entity. methods used by the
claims and statements, perform external legal counsel.
3. Presentation and additional procedures with management in
segment c) If auditor is unable to
disclosure of respect to inventory between determing segment
information in communicate with the external
segment count date and date of information
an audit of legal counsel, modify the opinion
information in financial statements. Performating analytical
financial as per SA 705.
accordance with procedures.
statements. c) If auditor is unable to
applicable FRF. d) Obtain Written Representation
attend the physical inventroy that all known actual or possible
counting due to unforsean litigation and claims have been
circumstances, auditor to disclosed to the auditor and
make/observe some physical appropriately accounted for as per
count on alternate date and appllicable FRF.
perform audit procedures on
intervening transactions.
d) If attendance at inventory
count is impracticable,
auditor to perform alternate
procedures. If it is not
possibel to do so, modify the
opinion.
e) When inventory is under
custory of third party, request
confirmation from third party
and perform inspection and
other procedures.
SA 501 deals with specific considerations by the auditor in obtaining sufficient appropriate audit
evidence with respect to certain aspects of inventory, litigation and claims involving the entity,
and segment information in an audit of financial statements.
© The Institute of Chartered Accountants of India
5.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 2
CA Prabhjot has planned observing the physical count of inventories at the plant of a company
located in remote area in the state of Uttarakhand as part of a statutory audit exercise as at
close of year ending 31 st March 2023. He has already informed the management of his
intention to reach the plant site by evening of 29 th March 2023. He plans to inspect inventories,
observe the counting process and perform test counts among other matters.
The management has made all necessary arrangements to facilitate the above exercise.
However, an agitation in Himalayan hills has started on 28 th March 2023 for the promulgation
of a strict law relating to the conversion of agricultural land for commercial use. Many civil
society groups are participating in the agitation. NH-7 leading to the plant site is blocked by
protestors. The plant is not accessible through any other mode. The blockade is lifted after
one month when state government announced the formation of a committee to look into
protestors’ demands.
Does the above case highlight to a situation of “impracticability of attendance” at inventory
counting in terms of requirements of SA 501?
How should the auditor proceed in above situation?
TEST YOUR UNDERSTANDING 3
On reviewing legal expenses account of Zed Ltd., CA. Sunitha, auditor of company, finds that
legal fees amounting to ` 10 lac was paid to B. George, a reputed lawyer, during the year 2022-
23. On inquiry with management regarding the purpose of such expenditure, evasive reply was
received from management stating that a lot of work is performed by the said lawyer on behalf
of the company. However, no specific details were provided.
She finds it proper to correspond directly with the lawyer. She obtains the address and mail id
of the lawyer from his professional services bill. She shoots off an inquiry letter asking for the
nature and status of litigation claims against the company on her letterhead.
Is her approach proper? Irrespective of the merits of the approach followed by her, what she is
trying to achieve by corresponding with lawyer of the company?
TEST YOUR UNDERSTANDING 4
On going through financial statements and records of “TS Ltd.,” during the course of statutory
audit, CA Tanmaya finds that substantial inventories of the company consisting of mast lighting
poles remain with “Super Industries” for certain finishing works. While planning audit procedures,
he had planned about seeking confirmation from “Super Industries” regarding existence and
condition of such mast lighting poles belonging to TS Ltd. lying with them as on 31st March, 2023.
However, the premises of “Super Industries” were raided by DGGI officials (Director General of
GST Intelligence) in connection with the busting of a fake billing scam. The proprietor of the firm
was arrested in November 2022 and came out on bail in the month of March 2023. The details
of proprietor and his firm were flashed prominently in local newspapers of the city where
company is located. CA. Tanmaya also belongs to the same place. Discuss how he should
proceed in the above matter as auditor of TS Ltd.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.7
3. SA 505 EXTERNAL CONFIRMATIONS
SA 505 - "External Confirmations"
Scope of the SA & External Confirmation Results of the External
Objective of the auditor Management's refusal to allow the Confirmation procedures
Procedures audit to send a confirmation request
Scope A) Reliablity of responses to
confirmation requests:
This SA deals with 1. Determining the 1. Inquire as to management's If auditor has doubt about reliability of
auditor's use of external information to be reasons for the refusal, and seek
confirmation response, auditor to obtain further audit
confirmed/requested. audit evidence as to their validity
procedures to obtain evidcence. If auditor determiners
2. Selecting the and reasonableness. response is not reliable, auditor to
audit evidence. appropriate confirming 2. Evaluate the implications of evalute the implications on the
party. management's refusal on the assessment of risk of material
3. Designing the auditor's assessment of the misstatement.
confirmation requests. relevant risks of material B) Non Response: Auditor shall perform
4. Sending the misstatement, including the risk of alternative audit procedures.
requests, including fraud, and on the nature, timing C) When a response to positive
Objective follow-up requests. and extent of other audit confirmation is necessary and the
procedures, and same is not received: Determine the
To design and
perform external 3. Perfom alternative audit implications on the audit and the auditors
confirmation procedures designed to obtain opinion.
procedures to relevant and reliable audit D) Exception: Auditor shall investigate
obtain relevant and evidence. exceptions to deterine whether or not
reliable audit If management's refusal is they are indicative of misstatement.
evidence. unreasonable, then communicate E) Negative Confirmation: Auditor to
with TCWG and consider the use negative confirmation as sole
implications on audit and auditor's substantive audit procedure when:
opinion. 1. Assessed Risk of Material
misstatement is low and relevant
controls are effective.
2. The population comprise of large
number of small, homogeneous
transactions.
3. A very low exception rate is expected.
4. The auditor is not aware of
circumstances that would cause
recipients of negative confirmation
requests to disregard such requests.
SA 505 deals with the auditor’s use of external confirmation procedures to obtain audit evidence in
accordance with the requirements of SA 500. It is intended to assist the auditor in designing and
performing external confirmations procedures to obtain relevant and reliable audit evidence.
TEST YOUR UNDERSTANDING 5
As auditor of Groom Limited, you have sent positive confirmation requests to 30 creditors of the
company in March 2023. All of the creditors in informal sector are small concerns. You choose to
send positive confirmation requests to all the above parties at their business addresses stated on
respective bills after discussing the matter with CFO of the company. The CFO is cooperative and
does not raise any hassles in the matter.
© The Institute of Chartered Accountants of India
5.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Responses to confirmation requests are received within a week’s time. Your articled clerk informs
you that out of above 30 creditors, GST registrations of 25 concerns have been cancelled during
financial year 2022-23 itself by collating information from GST portal. He further informs you that
there are no fresh registrations pertaining to PANs of these parties.
How you would proceed to deal with the situation as auditor of the company?
4. SA 510 INITIAL AUDIT ENGAGEMENTS-OPENING
BALANCES
SA 510 - "Intitial Audit Engagements - Opening Balances"
Audit Procedures Audit Conclusion and
Scope of the SA reporting
This SA deals with
auditor's responsibilities
relating to opening Opening Balances:
balances when Opening Balances:
conducting an initial audit Relevant
The auditor shall: Consistency of Information in 1. If audit is unable to obtain
engagement. audit evidence regarding
1. Read the most Accounting Policies: the
recent financial Obtain audit evidence Predecessor's opening balances -
statements and as to whether the Auditor's Qualified/disclaier of opinion.
predecessor's auditor's accounting policies are Report: 2. If auditor condudes
Objective of the report. consisstently applied 1. If modification opening balances contain
auditor 2. Determine whether and in case of any in predecessor misstatement, not properly
To obtain sufficient prior period's closing changes, whether auditor's report, presented/disclosed -
appropriate audit balance has been properly accounted for, evaluate the Qualified / Adverse Opinion.
evidince about: correctly brought presented and effect of the
forward. matter giving Consistency of Accounting
1. Whether opening disclosed.
3. Determine whether rise to such Policies:
balances contain
misstatements that the opening balances modification with
respect to If auditor concludes that
materially affect the reflect appropriate accounting policies are not
accounting policies. current period's
current period's consistently applied in
financial
financial 4. Perform audit relation to opening balances
statements. statements.
procedures on opening or changes are not properly
2. Whether balances. accounted for. Qualified/
apprpriate 5. If current period Adverse Opinion.
accounting policieis financial statements
are consistently are misstated due to
applied and any Modification to the opinion
misstatement in in the predecessor's
changes where to opening balances,
has been propertly communicate with auditor's report:
accounted for management or If the modication is relevant
presented and TCWG. and material to the current
disclosed. period's financial statements,
auditor shall modify the
current period audit report.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.9
SA 510 deals with the auditor’s responsibilities relating to opening balances when conducting an
initial audit engagement. An initial audit engagement is an engagement in which either the financial
statements for prior period were not audited or were audited by a predecessor auditor.
TEST YOUR UNDERSTANDING 6
CA M. Hussain is appointed auditor of a firm for year 2022-23 on 31st July, 2022. The accounts of
firm were unaudited in year 2021-22. The firm had material inventories reflected in its financial
statements even as on close of 31st March, 2022.
He is performing audit procedures, including attending physical inventory count as on 31st March,
2023. However, there is a lingering doubt in his mind regarding opening inventories reflected in
financial statements.
Does there exist any responsibility on his part in such a situation?
5. SA 530 AUDIT SAMPLING
SA 530 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.
TEST YOUR UNDERSTANDING 7
CA. Ritesh Deshpande has drawn some samples during the course of audit of a manufacturing
company for testing controls as well as for tests of details. On the basis of the samples selected, he
reaches an erroneous conclusion that access controls on applications are less effective.
Further, on the basis of samples selected, he concludes erroneously that work-in progress
inventories amounting to ` 5 crore in financial statements are materially misstated.
Outlining the above risk involved, discuss how it is going to affect his audit of the company.
© The Institute of Chartered Accountants of India
5.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SA 530
"Audit Sampling"
Scope of the SA & Sample design, size
Performing Audit
Objective of the and selection of Other points of
Procedures
auditor items for testing consideration
Scope
This SA applies
when the auditor 1. The auditor shall 1. The auditor shall
1. While designing perform appropriate
has decided to use audit sample, the investigate the nature
audit sampling in audit procedure on and cause of
auditor shall consider each item selected.
performing audit the purpose of the deviation or
procedures. It audit procedure and 2. If audit procedure is misstatement
deals with auditor's the characteristics of not applicable on the identified and evalute
use of statistical the population. selected item, apply its possible effect.
and non statistical the procedure on a 2. When a
sampling. 2. The auditor shall replacement item.
determine sample deviation/misstateme
size sufficient to 3. If the auditor is nt is considered as
reduce sampling risk unable to apply the anomaly, the auditor
to an acceptably low designed audit shall perform audit
level. procedure to a procedures to obtain
Objective selected item, treat high degree of
3. The auditor shall that item as a certainity that it is not
To provide a select items for the deviation fromk the representative of the
reasonable basis for sample such that prescribed control, in population.
the auditor to draw each sampling unit in case of tests of
conclusions about the population has a 3. For test of details,
controls, or a the auditor shall
the population from chance of selection. misstatement, in the
which the sample is project misstatements
case of tests of found in the sample to
selected. details. the population.
4. The auditor shall
evaluate the results of
Definition the sample and
whether the use of
Audit Sampling audit sampling has
The application of audit procedures to less than 100% of provided a reasonable
items within a population of audit relevance such that all basis for conclusion
the sampling units have a chance of selection in order to about the population
provide the auditor with a reasonable basis on which to tested.
draw conclusions about the entire population.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.11
6. SA 550 RELATED PARTIES
SA 550- " Related Parties"
Scope of the Objectives of Requirements of Identification Identified Other
SA the auditor the SA of previously significant important
unidentified or related party points
undisclosed transactions
related part outside the
transactions. entity's normal
course of
business
The auditor shall
obatin Written
Representation
This SA deals that:
with the auditor's a) all the related
responsibilities To obtain an 1. Risk Assessment
parties and
regarding related understanding of procedures and related 1. Auditor shall
determine related party
party the related party activities.
relationships and whether the transactions
transactions to: 2. Understanding the
transactions. It underlying 1. Inspect the have been
1. recognize fraud Entity's related party
expands on how circumstances underlying disclosed to the
risk factors relationships and
SA 315, SA 330, confirm the contracts and auditor and
arising from such transactions.
SA 240 are to be existence of such evaluate: b) all such
transactions. 3. Maintaining transactions.
applied in relation transactions have
2. conclude alertness for related a) the business
to related party 2. Communicate been properly
whether financial party information when rationale of the
relationships and within the team. accounted for and
statements in so reviewing records or transactions.
transactions. disclosed.
far as they are documents. 3. Request b) whether the
4. Sharing related managment to terms of
affected by such identify all Communication
transactions party information with transactions are
transactions with consistent with with TCWG
a) achieve a true the Engagement team. newly identified managment's The auditor shall
and fair 5. Identification and related parties. explanations. communicate with
presentation. assessment of the risk
4. Perform more c) whether such TCWG significant
b) are not of material substantive transactions have matters arising
misleading. misstatement procedures. been properly during the audit in
associated with related accounted for.
5. Reconsider connection with
To obtain audit party transactions and
risks with respect 2. Obtain audit the entity's
evidence as to relationships. to other related evidence that the related parties.
whether the 6. Responses to the parties. transactions have
related party Risks of Material been
5. If non Documentation:
transactions are Misstatement disclosure by the appropriately The auditor shall
properly associated with related management authorised and include in audit
identified, party relationships and appears approved.
documentation
accounted for, transactions. intentional,
names of the
and disclosed in evaluate the
implications for related parties
the financial and the nature of
statements. the audit.
the related party
transactions.
© The Institute of Chartered Accountants of India
5.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SA 550 deals with the auditor’s responsibilities regarding related party relationships and transactions
when performing an audit of financial statements. Specifically, it applies in relation to risks of material
misstatement associated with related party relationships and transactions.
TEST YOUR UNDERSTANDING 8
“Living Well Private Limited” is engaged in the manufacturing and export of floor coverings. Such
products are labour-intensive and do not require much of capital investment in machinery. The
company has no plans to diversify in other product lines. Its directors are also holding significant
interest in another company “My Living Private Limited” engaged in manufacturing of blankets using
capital intensive machinery.
During the course of the audit of “My Living Private Limited”, it was noticed by you that the company
has sold machinery of ` 1 crore to “Living Well Private Limited” during the year. The transaction has
been done at normal market rates applicable to such used machinery.
How do you view the above transaction as auditor of “My Living Private Limited”?
Case Study 1
Honest Speciality Chemicals Private Limited is a ` 1,000 crore turnover company having plants in
Khopoli, Mahad, and Ankleshwar for manufacturing various products for fertilizer units, cosmetics
and paint industry, etc. The company has built up a good reputation, and apart from the domestic
market, it exports to the European market and the Middle East. The company is a closely held
company owned by three friends and their family members. The types of materials handled and
produced are hazardous.
Following further latest information relating to the company is as under: -
• The company needs to import the key raw materials and is exposed to high risk of price
fluctuations and currency risks.
• The company carries high inventory due to the long import cycle and seasonal sales pattern.
• The working capital is almost 60% blocked in inventory and rest in receivables.
• The company has huge investments in plant and machinery financed through term loans from
financial institutions.
• Since the company has large imports, it buys import licenses from the open market.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.13
• The company has received customs notices about using fake licenses for importing materials
without paying duty. The company has filed an appeal against the said notice and the same
is pending with the Appellate Tribunal. The amount involved is material and, along with
interest and penalty, could be more than 10% of turnover.
• The company has liquid chemicals stored in huge tanks.
• The powdered form of chemicals is stored in standard-sized drums
• Few items of stocks like coal, sulphur are lying in the open area.
• The company has huge domestic sales on a consignment basis, and vast quantities of
finished inventories are lying with the consignees across India.
• The company has received an order from NGT to pay a fine of INR 1.5 crores for the emission
of toxic chemicals in the air and water. The company has filed an appeal against the said
order.
• The type of plant is such that it has to be a continuous process, and at any time, huge
quantities of materials are in process.
• Raw Materials are stored in huge tanks located 2 kilometres from the plant, and to transport
the chemicals (liquid), there is a network of pipes connecting them, and at any point in time,
there are huge quantities of materials lying in the pipeline.
• The company has prepared its inventory details by involving a management expert.
• During the year, the previous auditor resigned, and a new auditor got appointed.
Theoretical Questions
Based on the case study, please advise the auditor on the important aspects of carrying out
the audit procedures to obtain sufficient appropriate audit evidence in respect of the
following: -
1. Which audit procedures are required for verifying existence and condition of company’s
inventories with specific reference to its nature of operations?
2. The company has prepared inventory details by involving a management’s expert.
Elaborating upon its rationale, discuss responsibilities of auditor in regard to information
prepared by company involving such an expert.
3. What additional procedures does the auditor need to carry out in respect of stocks lying with
consignees all over the country?
4. What procedures should the auditor need to undertake for litigation matters?
© The Institute of Chartered Accountants of India
5.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Multiple Choice Questions
1. The objectivity of the management’s expert is likely to be lesser if:
(a) The expert is competent
(b) The expert is capable
(c) The expert has relevant experience
(d) The expert is employed by the entity
2. Which of the following matters is irrelevant for auditor in planning attendance at physical inventory
counts?
(a) Nature of inventory
(b) The timing of physical inventory counting
(c) The nature of the internal control related to inventory
(d) Whether 100% of inventory is covered in the count
3. External confirmations for receivables are not reliable in which of the following situations:
(a) The response directly received by the auditor
(b) The confirmation has come from the address of the confirming party
(c) The confirmation is signed by the plant manager
(d) The confirmation is positive confirmation
4. The new auditor planned certain procedures with respect to opening balances. Which of the
following procedures is not in accordance with SA 510?
(a) Reading the most recent financial statements and audit report
(b) Where the prior period report is modified, the impact on the current period
(c) Correctly bringing forward of prior period closing balances
(d) Ascertaining whether predecessor auditor had attended physical inventory count
Answers to Theoretical Questions
1. The auditor needs to obtain sufficient appropriate audit evidence regarding existence and
condition of inventory.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.15
For the above, the auditor needs to do all the following: -
(a) Attendance at physical inventory counting to:
(i) Evaluate management's instructions and procedures for recording and
controlling the results of the entity’s physical inventory counting like:
- The existence of appropriate control activities: collection of used
physical inventory count records, accounting for unused physical
inventory count records, count and recount procedures.
- The accurate identification of the stage of completion of work-in-
progress, of slow moving, obsolete, or damaged items and of inventory
lying in tanks, in pipes and in open areas.
- The procedures used to estimate physical quantities, for liquid chemicals
lying in process, tanks, pipelines, in open areas like coal pile, sulphur
pile, etc.
- Control over the moment of inventory between areas and the shipping
and receipt of inventory before and after the cut off date.
(b) Observe the performance of Management's count procedure by observing the control
over the movement of inventory before, during and after the count to determine
adequacy and effectiveness of count procedure.
(c) Inspect the inventory to assist in identifying obsolete, damaged or ageing of inventory.
(d) Perform the test counts to obtain the sufficient appropriate audit evidence
(i) By tracing items selected from the physical inventory to management's count
records,
(ii) By obtaining copies of Management's completed physical inventory count
records
(e) Cross matching the final inventory records with the actual inventory count results.
2. The company deals with speciality chemicals which are in liquid condition, powdered
condition, lying in the huge tanks or in plants under process, lying in pipelines or lying in open
areas like coal and sulphur. The unit of measurement for each of the above categories may
be different and could involve technical and mathematical principles involving technical and
© The Institute of Chartered Accountants of India
5.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
scientific expertise. Keeping these matters in view, inventory details have been prepared by
involving management’s expert.
When information to be used as audit evidence has been prepared using the work of a
management’s expert, the auditor shall, having regard to the significance of that expert’s work
for the auditor’s purposes:
(a) Evaluate the competence, capabilities and objectivity of that expert
(b) Obtain an understanding of the work of that expert and
(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevant
assertion.
3. Apart from obtaining the confirmation from the third party as to the quantities and condition
of the inventory held on behalf of the entity, the auditor may perform the following other audit
procedures:
- Attending, or arranging for another auditor to attend, the third party's physical counting
of inventory,
- Obtaining another auditor's report or a service auditor’s report on the adequacy of the
third party's internal control for ensuring that inventory is properly counted and
adequately safeguarded.
- Inspecting documentation regarding inventory held by third parties
4. The auditor shall design and perform audit procedures in order to identify litigation and claims
involving the entity by:-
- Inquiry of management and, where applicable, others within the entity including in-
house legal counsel.
- Reviewing minutes of meetings of those charged with governance and
correspondence between the entity and its external legal counsel.
- Reviewing legal expense account.
The legal claims involving customs and fine of NGT are material. In such circumstances if
auditor assesses risk of material misstatements regarding litigation, he can seek letter of
specific inquiry from the external legal counsel including: -
• A list of litigation and claims
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.17
• Where applicable, management's assessment of the outcome of each of the identified
litigation and claims and its estimate of the financial implications, including cost
involved and
• A request that the entity's external legal counsel confirm the reasonableness of
management's assessments and provide the auditor with further information if the list
is considered incomplete or incorrect.
• The auditor may seek meeting with the external legal counsel if the matter is having
significant risk, it is complex or there is disagreement between management assertion
and legal counsel's views.
• Obtaining written representation from the management and where appropriate those
charged with governance that all the known actual or possible litigation and claims
whose effects should be considered when preparing the financial statement have
been disclosed to the auditor and appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework.
Answers to Multiple Choice Questions
1. (d)
2. (d)
3. (c)
4. (d)
Case Study 2
“Trustworthy Real Estate Private Limited” with Mr. Bharose Lal as MD along with his wife, Maya,
owned the company.
The company had floated one SPV “Real Trust Developers Private Limited” in which a foreign entity
became a Joint Venture partner with a 50% stake.
The venture was formed with its Head Office in Mumbai to invest in SRA projects (Slum rehabilitation
authority) and develop them into commercial units for sale.
Mr. Bharose Lal was going through a rough patch in his life. He was in financial difficulty and had
mounting dues and huge outstanding exposure to banks and suppliers in his companies. Mrs. Maya
was from a very wealthy family and had fallen in love with Mr. Bharose Lal, who was from a middle-
class family. Mrs. Maya had an expensive lifestyle and was always short of funds to maintain her
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5.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
lifestyle. Mr. Bharose Lal sensed a golden opportunity in the new venture because the foreign partner
had no knowledge of Indian regulations and how the SRA projects worked and was solely dependent
on the local partner to get all the permissions, scouting for the projects, getting consents from the
slum dwellers for the project, giving contracts for the construction of projects and such matters.
M/S ABC and Company, Chartered Accountants were appointed as the auditor of the joint venture,
and the engagement team was headed by CA Sceptic, who had, in his stint with the firm, was
instrumental in unearthing two major frauds and had the ability to sniff out any such scenarios.
Mr. Bharose Lal has a dominant personality and a powerful influence on functioning, and everybody
looks to him for guidance. The governance structure was very poor in the organization, and Mr.
Bharose Lal used to dictate the decisions. Even though as part of the Joint Venture, there was a
detailed governance structure and policies and procedures in place for the decision-making process
at the joint venture. However, the representative on the board of the Joint Venture of the foreign
partner who had shifted to India to supervise the SRA project had grown friendly with Mr. Bharose
Lal, and Mr. Bharose Lal had even gone out of the way to help him get good accommodation and
second- hand Mercedes. Often, they both go to a club in the evening for a drink.
The dealings in the SRA project are not very transparent and above board but are very opaque.
Given the above situation, CA Sceptic wants to discuss with the audit team areas and situations
where risk of material misstatement is possible and there are chances of having an undisclosed
related party relationship to misappropriate the funds.
Theoretical Questions
1. Please guide the engagement team on the further course of action as per SA 550.
2. What are fraud risk factors in given case?
3. Given the situation that each partner in the joint venture has to bring into the entity a
contribution of 5 crores each and given the situation that Mr Bharose Lal had appointed one
agency, the name Useless & Sons Private Limited, to get consent from the slum dwellers, for
which the agency was paid 20 crores as Kitty to get the job done.
CA Sceptic inclines that there is some connection between the 20 crores paid and,
simultaneously, within a short span, the infusion of INR 5 crores as equity contribution by Mr.
Bharose Lal.
Please guide CA Sceptic in establishing this link based on the guidance available in SA 550
and SA 240.
What additional audit procedures does his team need to undertake for the conclusion?
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.19
4. If, based on additional audit procedures undertaken by CA Sceptic, it is established that there
is a likelihood of misappropriation of funds and the financial statements as a whole may be
materially misstated, how CA Sceptic needs to plan the future course of action?
Multiple Choice Questions
1. Which of the following best describes the method that Mr. Bharose Lal can indulge to commit
fraud?
(a) Concealing and not disclosing facts that could affect the amounts recorded in financial
statements.
(b) Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
(c) Causing an entity to pay for goods or services not received.
(d) Using undisclosed business partners to misappropriate funds in the garb of making a
business transaction and thus siphoning off the funds.
2. In the given case scenario, the main factor giving rise to risk of material misstatement is:
(a) The expensive lifestyle of owners.
(b) Appointment of an auditor having experience in unearthing of frauds
(c) The deteriorating financial condition of the owner’s business.
(d) The vulnerability and dependence of the foreign partner on the local partner.
3. In the given case scenario, which is the most important red flag for auditor:
(a) Expensive lifestyle
(b) Undisclosed related party relationships to siphon off the funds.
(c) Financial crunch
(d) The dominant influence of the owners
4. Which of the following is not a fraud risk factor?
(a) Dominant influence of the owners
(b) Expensive lifestyle
(c) Fraud risk due to the nature of the industry
(d) Floating of a new SPV itself
© The Institute of Chartered Accountants of India
5.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Theoretical Questions
1. The engagement team shall include specific consideration of the susceptibility of the financial
statements to material misstatement due to fraud or error that could result from the entity’s
related party relationships and transactions.
- The nature and extent of the entity’s relationships and transactions with related parties
as identified independently by the Auditor by verification of MBP-1 data and data
available on MCA website relating to directors and companies, etc.
- An emphasis on the importance of maintaining Professional Skepticism throughout the
audit regarding the potential for material misstatement associated with related party
relationships and transactions.
- The circumstances or conditions of the entity that may indicate the existence of related
party relationships or transactions that management has not identified or disclosed to
the auditor (e.g., a complex organisational structure, use of special purpose entities
off-balance sheet transactions, or an inadequate information system).
- The records or documents that may indicate the existence of related party
relationships or transactions.
- The importance of management and those charged with governance attached to the
identification, appropriate accounting for, and disclosure of related party relationships
and transactions (if the applicable financial reporting framework establishes related
party requirement), and the related risk of Management override of relevant controls.
- In addition, the discussion in the context of fraud may include specific consideration of how
related parties may be involved in fraud. For example:
(a) How special-purpose entities controlled by management might be used to
facilitate earnings management
(b) How transaction between the entity and known business partner of a key
member of management could be arranged to facilitate misappropriation of the
entity's assets.
- An exchange of ideas among engagement team members about how and
where they believe the entity's financial statements may be susceptible to
material misstatement due to fraud, how management could perpetrate
and conceal fraudulent financial reporting, and how assets of the entity
could be misappropriated.
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AUDIT EVIDENCE 5.21
- A consideration of circumstances that might be indicative of earnings
management and the practices that might be followed by management to
manage earnings that could lead to fraudulent financial reporting.
- A consideration of the known external and internal factors affecting the
entity that may create an incentive or pressure for management or others
to commit fraud, provide the opportunity for fraud to be perpetrated, and
indicate a culture or environment that enables management or others to
rationalize committing fraud.
- A consideration of management's involvement in overseeing employees
with access to cash or other assets susceptible to misappropriation.
- A consideration of any unusual or unexplained changes in behaviour or
lifestyle of management or employees which have come to the attention
of the engagement team.
- An emphasis on the importance of maintaining a proper state of mind
through out the audit regarding the potential for material misstatement due
to fraud.
- A consideration of the types of circumstances that, if encountered, might
indicate the possibility of fraud.
- A consideration of how an element of unpredictability will be incorporated
into the nature, timing and extent of the audit procedures to be performed.
- A consideration of the audit procedures that might be selected to respond
to the susceptibility of the entity's financial statement to material
misstatement due to fraud and whether certain types of audit procedures
are more effective than others.
- A consideration of any allegations of fraud that have come to the auditor's
attention.
- A consideration of the risk of management override of controls.
2. The fraud risk factors are the events or conditions that indicate an incentive or pressure to
commit fraud or provide an opportunity to commit fraud.
The fraud risk factors are classified based on the three conditions that are generally present
when fraud exists:
© The Institute of Chartered Accountants of India
5.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(i) An incentive or pressure to commit fraud
(ii) A perceived opportunity to commit fraud
(iii) An ability to rationalize the fraudulent action.
In the given case scenario following fraud risk factors can be segregated in the 2 conditions
of incentive or pressure to commit fraud in a perceived opportunity to commit fraud.
1) An incentive or pressure to commit fraud:
- Financial difficulty with huge outstanding dues towards vendors and Financial
Institutions.
- Expensive lifestyle.
- Requirement to fund ` 5 crore as equity contribution in the SPV.
2) A perceived opportunity to commit fraud:
- Dependency of the foreign partner and no knowledge of the foreign partner of local
laws and the SRA business model in India
- The risk is due to the way the real estate industry functions and particularly risk due
to the SRA business model.
- Dominant personality of MD, which can lead to management override of controls
for undisclosed business relationships with M/s. Useless and Sons (P) Ltd.
3. If the auditor identifies arrangements or information that suggests the existence of related
party relationships or transactions that management has not previously identified or disclosed
to the auditors, the auditor shall determine whether the underlying circumstances confirm the
existence of those relationships or transactions.
In such situations, the auditor shall:
- Promptly communicate the relevant information to the other members of the
engagement team in order to assist them in determining whether this information
affects the results of and conclusions drawn from risk assessment procedures already
performed, including whether the risk of material misstatement needs to be
reassessed.
- Where the applicable financial reporting framework establishes related party
requirements:
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AUDIT EVIDENCE 5.23
(i) Request management to identify all transactions with the newly identified related
parties for the auditor's further evaluation; and
(ii) Inquire as to why the entity's controls over related party relationships and
transactions failed to enable the identification or disclosure of the related party
relationships or transactions;
- Perform appropriate substantive audit procedures relating to such newly
identified related parties or significant related party transactions.
- Reconsider the risk that other related parties or significant related party
transactions may exist that management has not previously identified or
disclose to the auditor, and perform additional audit procedures as
necessary; and
- If the non-disclosure by management appears intentional (and therefore
indicative of a risk of material misstatement due to fraud), evaluate the
implications for the audit. In such cases, the requirements and guidance in
SA-240 regarding the auditor's responsibilities relating to fraud in an audit
of financial statements are relevant where management appears to have
intentionally failed to disclose related parties or significant related party
transactions to the auditor. The auditor may also consider whether it is
necessary to re-evaluate the reliability of management's responses to the
auditor's inquiries and management's representations to the auditor.
- The Auditor needs to carry out verification and inspection of the ownership
structure and the review of the financial statements of the M/s. Useless and
Sons (P) Ltd through the MCA website and establish the nexus between the
two.
- The Auditor needs to carry out an inspection of the data filed by Mr. Bharose
Lal for his group companies to establish any past transactions/relationships
between the two entities.
- The Auditor needs to ask for all the documents for the utilization of INR 20
crore and can investigate by visiting the parties involved and asking for
confirmation directly.
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5.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. The Auditor needs to reassess the reliability of evidence previously obtained as there are
doubts about the completeness and truthfulness of representations made and about the
genuineness of accounting records and documentation.
(a) Determine the professional and legal responsibilities applicable in the circumstances,
including whether there is the requirement for the auditor to report to the person or
persons who made the audit appointment or, in some cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal
from the engagement is legally permitted; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those charged with
governance the auditor’s withdrawal from the engagement and the reasons for the
withdrawal; and
(ii) Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to regulatory
authorities, the auditor’s withdrawal from the engagement and the reasons for the
withdrawal.
MCQ answers
1. (d) 2. (d) 3. (b) 4. (d)
Integrated Case Scenario
Black & White Ltd. is into the business of manufacturing readymade garments in Amritsar. It procures
all the raw material required for its production from Punjab, Himachal Pradesh & J&K. Its sales
market, however, covers almost all the northern parts of the country. CA Anu is the engagement
partner of Maheshwari & Co appointed as the statutory auditor of the company. She calls for a
meeting of the engagement team to delegate work and responsibilities. During the audit, the
engagement team comes across the following facts:-
• Woolen Private Limited is one of the vendors of the company from which the company has
been purchasing wool for many years on a current account basis, but no single purchase has
been made in the last nine months, and the outstanding balance stands as it is in the books
of accounts. CA Anu wants to confirm the balance and requests the CFO of the company for
sending a balance confirmation request to Woolen Private Ltd., to which he refuses and is
not willing.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.25
• The Fashion Jingo Ltd. is one of the customers of the company and hasn’t replied to CA Anu’s
positive balance confirmation request sent.
• Mr X, one of the fashion designers, had sold his designs to the company but owing to a
dispute, the contract got cancelled, and now both the parties are under litigation in the local
court of law. The engagement team is guided as to the procedures to be designed and
performed to identify this matter.
• CA Anu simultaneously seeks direct communication with the company’s external legal
counsel sensing the risk of material misstatement. However, it ends up in vain as the external
legal counsel, Mr Chadha, refuses to comment. She is unable to obtain sufficient appropriate
audit evidence in this regard through alternative audit procedures either.
The team documents all the relevant information w.r.t. the above facts, and CA Anu issues the audit
report accordingly.
Multiple Choice Questions
1. Fashion Jingo Ltd. has not responded to CA Anu’s request. What should be proper course of
action for her in such a situation?
(a) Perform alternative audit procedures
(b) Consider it as a negative confirmation
(c) Give a Qualified opinion
(d) Should visit the customer company premises herself and confirm the balance on the
spot.
2. With respect to advocate Chadha’s cold shoulder to CA Anu’s request , what she should do?
(a) Modify her audit opinion
(b) Give an unqualified opinion
(c) Give a disclaimer of opinion
(d) Withdraw from this engagement
3. What should be CA Anu’s first and foremost response in the case of request made relating to
balance confirmation from Woolen Pvt. Ltd.?
(a) Perform alternate audit procedures.
© The Institute of Chartered Accountants of India
5.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) Withdraw from the engagement.
(c) Communicate with Those charged with Governance telling the effects on his audit
opinion.
(d) Inquire as to the reasons behind the management’s response and seek audit evidence
as to its validity and reasonableness.
4. Which of the following procedures will not be performed by the engagement team as audit
procedures while dealing with the case of Mr. X?
(a) Inquiry of Management.
(b) Inquiry of Mr. X
(c) Reviewing Minutes of Meetings
(d) Reviewing Legal expenses account
Answer to MCQs of Integrated Case Scenario
1. (a) 2. (a) 3. (d) 4. (b)
Key Takeaways
SA 500 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.
The quality of all audit evidence is affected by the relevance and reliability of the information
upon which it is based.
Relevance deals with the logical connection with, or bearing upon, the purpose of the audit
procedure and, where appropriate, the assertion under consideration. The relevance of
information to be used as audit evidence may be affected by the direction of testing.
Reliability of information to be used as audit evidence, and therefore of the audit evidence
itself, is influenced by its source and its nature, and the circumstances under which it is
obtained, including the controls over its preparation and maintenance where relevant.
Therefore, generalisations about the reliability of various kinds of audit evidence are subject
to important exceptions. Even when information to be used as audit evidence is obtained from
sources external to the entity, circumstances may exist that could affect its reliability.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.27
When information to be used as audit evidence has been prepared using the work of a
management’s expert, the auditor shall, to the extent necessary, having regard to the
significance of that expert’s work for the auditor’s purposes, evaluate competence, capability
and objectivity of such an expert besides obtaining understanding of his work. Further,
appropriateness of management’s expert work as audit evidence for relevant assertion has
also to be evaluated.
SA 501 deals with specific considerations by the auditor in obtaining sufficient appropriate
audit evidence with respect to certain aspects of inventory, litigation and claims involving the
entity, and segment information in an audit of financial statements.
When inventory is material to the financial statements, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by attendance
at physical inventory counting, unless impracticable.
The auditor shall design and perform audit procedures in order to identify litigation and claims
involving the entity which may give rise to a risk of material misstatement. Litigation and
claims involving the entity may have a material effect on the financial statements and thus
may be required to be disclosed or accounted for in the financial statements.
Segment information refers to information about different types of products and services of
an enterprise and its operations in different geographical areas. In accordance with SA 501,
the auditor shall obtain sufficient appropriate audit evidence regarding the presentation and
disclosure of segment information in accordance with the applicable financial reporting
framework.
SA 505 deals with the auditor’s use of external confirmation procedures to obtain audit
evidence in accordance with the requirements of SA 500. It is intended to assist the auditor
in designing and performing external confirmations procedures to obtain relevant and reliable
audit evidence.
SA 510 deals with the auditor’s responsibilities relating to opening balances when conducting
an initial audit engagement. An initial audit engagement is an engagement in which either the
financial statements for prior period were not audited or were audited by a predecessor
auditor.
SA 530 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.
© The Institute of Chartered Accountants of India
5.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The objective of the auditor when using audit sampling is to provide a reasonable basis for
the auditor to draw conclusions about the population from which the sample is selected.
Sampling risk is the risk that the auditor’s conclusion based on a sample may be different
from the conclusion if the entire population were subjected to the same audit procedure.
Whatever may be the approach, statistical sampling or non-statistical sampling, the sample
must be representative. This means that it must be closely similar to the whole population
although not necessarily exactly the same. The sample must be large enough to provide
statistically meaningful results.
SA 550 deals with the auditor’s responsibilities regarding related party relationships and
transactions when performing an audit of financial statements.
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS WISDOM:
SCAN ME !
Note : Content of SA 500- Audit Evidence; SA 501-Audit Evidence - Specific Considerations
for Selected Items; SA 505-External Confirmations; SA 510- Initial Audit Engagements –
Opening Balances; SA 530 Audit Sampling & SA 550 - Related Parties is covered in depth at
Intermediate level. Thus, application part of above SAs may be discussed in the form of
Case Study at Final level.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.29
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Coccyx Ltd. supplies navy uniforms across the country. The company has 3 warehouses at
different locations throughout the India and 5 warehouses at the borders. The major stocks
are generally supplied from the borders. Coccyx Ltd. appointed M/s OPAQE & Co. to conduct
its audit for the financial year 2022-23. Mr. P, partner of M/s OPAQE & Co., attended all the
physical inventory counting conducted throughout the India but could not attend the same at
borders due to some unavoidable reason.
You are required to advise M/s OPAQE & Co.,
(I) How sufficient appropriate audit evidence regarding the existence and condition of
inventory may be obtained?
(II) How is an auditor supposed to deal when attendance at physical inventory counting is
impracticable?
2. GHK Associates, Chartered Accountants, conducting the audit of PBS Ltd., a listed company
for the year ended 31.03.2023 is concerned with the presentation and disclosure of segment
information included in Company's Annual Report. GHK Associates want to ensure that
methods adopted by management for determining segment information have resulted in
disclosure in accordance with the applicable financial reporting framework. Guide GHK
Associates with 'Examples of Matters' that may be relevant when obtaining an understanding
of the methods used by the management with reference to the relevant Standards on
Auditing.
3. Chintamani Ltd appoints Chintan & Mani as statutory auditors for the financial year 2022-
2023. Chintan & Mani seem to have different opinions on Audit approach to be adopted for
audit of Chintamani Ltd. Mani is of the opinion that 100% checking is not required and they
can rely on Audit Sampling techniques in order to provide them a reasonable basis on which
they can draw conclusions about the entire population.
Chintan is concerned that whether the use of audit sampling has provided a reasonable basis
for conclusions about the population that has been tested.
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5.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
You are required to guide Chintan about his role if audit sampling has not provided a
reasonable basis for conclusions about the population that has been tested in accordance
with SA 530.
4. During the audit of Star Ltd. a company engaged in the production of paper, the auditor
received certain confirmation for 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 small balances except one which is an old outstanding of
` 20 lakhs for which no confirmation was received. Comment with respect to Standards of
Auditing relating to the confirmation process and how to deal the non-receipt of confirmation.
Answers to Test your Understanding
1. She can obtain reliable audit evidence by going through GST returns filed by the company
on GST portal and correlating the same with e-way bills. She can obtain audit evidence about
how company has reflected its export sales in its GST returns and whether export sales
pertaining to three invoices having value of ` 75.00 lacs are reflected in such returns.
Further, e-way bills generated on the portal would provide evidence that goods have moved
out of the company’s premises. The export revenue should have been booked at the time the
goods moved out of the company’s premises. The company is claiming an IGST refund. The
refund is linked to the monthly sales return. This aspect can also be verified.
“Bill of Lading” is only a document issued by the carrier to the shipper of goods that goods
have been taken on board. She should challenge and counter management’s assertion on
the above grounds and point out violations of relevant accounting standards and principles.
In this way, she can obtain reliable audit evidence.
Highlighting such digital and other evidence, she can challenge management’s assertion
regarding the completeness of export revenues and point out that export revenues are
understated.
2. The above situation does not highlight the impracticability of attendance at inventory
counting. It only shows that the auditor is unable to attend physical inventory counting due to
unforeseen circumstances arising out of agitation by protestors. It has led to the
inaccessibility of the plant site for a month. The blockade is lifted after a month.
SA 501 states that if the auditor is unable to attend physical inventory counting due to
unforeseen circumstances, the auditor shall make or observe some physical counts on an
alternative date and perform audit procedures on intervening transactions. Therefore, the
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.31
audit should attend to the physical inventory count after the blockade is lifted and perform
audit procedures on intervening transactions.
3. SA 501 states that when audit procedures performed indicate that material litigation or claims
may exist, the auditor shall seek direct communication with the entity’s external legal counsel.
The auditor shall do so through a letter of inquiry prepared by management and sent by the
auditor, requesting the entity’s external legal counsel to communicate directly with the auditor.
Therefore, her approach in communicating with an external lawyer is wrong. She has to make
management aware of her intention to communicate directly with the lawyer. The letter of
enquiry has to be prepared by management and sent by her.
Her purpose in corresponding with the lawyer of the company is to identify litigation and
claims involving the entity which may give rise to a risk of material misstatement. It is due to
the reason that litigation and claims involving the entity may have a material effect on the
financial statements and thus may be required to be disclosed or accounted for in the financial
statements.
4. SA 501 states that when inventory under the custody and control of a third party is material
to the financial statements, the auditor shall obtain sufficient appropriate audit evidence
regarding the existence and condition of that inventory by performing one or both of the
following:
(a) Request confirmation from the third party as to the quantities and condition of inventory
held on behalf of the entity.
(b) Perform inspection or other audit procedures appropriate in the circumstances.
It further states that where information is obtained that raises doubt about the integrity and
objectivity of the third party, the auditor may consider it appropriate to perform other audit
procedures instead of, or in addition to, confirmation with the third party.
Examples of other audit procedures include:
• Attending, or arranging for another auditor to attend, the third party’s physical counting
of inventory, if practicable.
• Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of
the third party’s internal control for ensuring that inventory is properly counted and
adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties
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5.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In the given case, the integrity of the third party appears to be doubtful in view of DGGI raids
and his possible involvement in a fake billing scam. He has already been behind bars.
Keeping in view above, besides obtaining confirmation from such party, he may attend a third
party’s physical counting or ask some other auditor to attend physical counting as on reporting
date, depending upon practical considerations. He can also inspect the record of goods sent
and received back from such party by tracing it to challans, e-ways bills etc. and correlate the
above information.
5. SA 505 states that if the auditor determines that a response to a confirmation request is not
reliable, the auditor shall evaluate the implications on the assessment of the relevant risks of
material misstatement, including the risk of fraud, and on the related nature, timing and extent
of other audit procedures.
In the instant case, GST registrations of 25 concerns have been cancelled in the year 2022-
23. It indicates that businesses on those addresses were closed. Further, there are no fresh
registrations pertaining to the PANs of these parties. However, the auditor sent external
confirmation requests in March 2023, which were duly responded. It raises questions on the
reliability of responses received.
SA 500 indicates that even when audit evidence is obtained from sources external to the
entity, circumstances may exist that affect its reliability. All responses carry some risk of
interception, alteration or fraud. Such risk exists regardless of whether a response is obtained
in paper form or by electronic or other medium. Factors that may indicate doubts about the
reliability of a response include:
• Was received by the auditor indirectly or
• Appeared not to come from the originally intended confirming party.
Keeping in view the circumstances described in the case situation, there is a risk that the
response has not come from the originally intended confirming party.
Unreliable responses may indicate a fraud risk factor that requires evaluation.
6. SA 510 states that in conducting an initial audit engagement, one of the objectives of the
auditor with respect to opening balances is to obtain sufficient appropriate audit evidence
about whether opening balances contain misstatements that materially affect the current
period’s financial statements. The auditor has to evaluate whether audit procedures
performed in the current period provide evidence relevant to the opening balances or specific
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.33
audit procedures are required to be performed to obtain evidence regarding the opening
balances.
In the case of inventories, however, the current period’s audit procedures on the closing
inventory balance provide little audit evidence regarding inventory on hand at the beginning
of the period. Therefore, additional audit procedures may be necessary, and one or more of
the following may provide sufficient appropriate audit evidence:
• Observing a current physical inventory count and reconciling it to the opening
inventory quantities.
• Performing audit procedures on the valuation of the opening inventory items.
• Performing audit procedures on gross profit and cut-off.
7. The described risk is sampling risk. It is a risk that the auditor’s conclusion based on a sample
may be different from the conclusion if the entire population were subjected to the same audit
procedure.
In the given case, the auditor has arrived at erroneous conclusions on the basis of the
samples selected. In the case of a test of controls, he has concluded that access controls are
less effective than they actually are. In the case of a test of details, he has concluded
erroneously that a material misstatement exists when in fact, it does not. This type of
erroneous conclusion affects audit efficiency as it would usually lead to additional work to
establish that initial conclusions were incorrect.
8. In respect of significantly related party transactions outside the normal course of business of
an entity, it is the responsibility of the auditor, in accordance with SA 550, to evaluate the
business rationale or lack thereof of transactions that may have been entered to indulge in
fraudulent financial reporting or conceal misappropriation of assets.
The auditor has to seek to understand the business rationale of such a transaction from a
related party’s perspective. It would help him understand the economic reality of such a
transaction and why it was carried out.
In the given situation, there is no primary rationale for such a transaction. Living Well Private
Limited does not manufacture blankets, and the purchase of part of old machinery pertaining
to blanket manufacturing has no rationale for it primarily. A business rationale from the related
party’s perspective that appears inconsistent with the nature of its business may represent a
fraud risk factor.
© The Institute of Chartered Accountants of India
5.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Hints /Answers to Theoretical Questions
1. (I) Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence-
Specific Considerations for Selected Items”, when inventory is material to the financial
statements, the auditor shall obtain sufficient appropriate audit evidence regarding the
existence and condition of inventory by:
(1) Attendance at physical inventory counting, unless impracticable, to:
(i) Evaluate management’s instructions and procedures for recording and
controlling the results of the entity’s physical inventory counting;
(ii) Observe the performance of management’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts; and
(2) Performing audit procedures over the entity’s final inventory records to
determine whether they accurately reflect actual inventory count results.
(II) Attendance at Physical Inventory Counting Not Practicable: In some cases,
attendance at physical inventory counting may be impracticable. This may be due to
factors such as the nature and location of the inventory, for example, where inventory
is held in a location that may pose threats to the safety of the auditor. The matter of
general inconvenience to the auditor, however, is not sufficient to support a decision
by the auditor that attendance is impracticable. Further, as explained in SA 200
“Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, the matter of difficulty, time, or cost involved
is not in itself a valid basis for the auditor to omit an audit procedure for which there is
no alternative or to be satisfied with audit evidence that is less than persuasive.
Further, where attendance is impracticable, alternative audit procedures, for example,
inspection of documentation of the subsequent sale of specific inventory items acquired or
purchased prior to the physical inventory counting, may provide sufficient appropriate audit
evidence about the existence and condition of inventory.
In some cases, though, it may not be possible to obtain sufficient appropriate audit evidence
regarding the existence and condition of inventory by performing alternative audit procedures.
In such cases, SA 705 on Modifications to the Opinion in the Independent Auditor’s Report,
requires the auditor to modify the opinion in the auditor’s report as a result of the scope
limitation.
© The Institute of Chartered Accountants of India
AUDIT EVIDENCE 5.35
2. The auditors, GHK Associates wanted to ensure and obtain sufficient appropriate audit
evidence regarding the presentation and disclosure of segment information in accordance
with the applicable financial reporting framework by obtaining an understanding of the
methods used by management in determining segment information. SA 501 guides in this
regard. As per SA 501- “Audit Evidence—Specific Considerations for Selected Items”,
example of matters that may be relevant when obtaining an understanding of the methods
used by management in determining segment information and whether such methods are
likely to result in disclosure in accordance with the applicable financial reporting framework
include:
(i) Sales, transfers and charges between segments, and elimination of inter-segment
amounts.
(ii) Comparisons with budgets and other expected results, for example, operating profits
as a percentage of sales.
(iii) The allocation of assets and costs among segments.
(iv) Consistency with prior periods, and the adequacy of the disclosures with respect to
inconsistencies.
3. As per SA 530, “Audit Sampling”, the auditor shall evaluate:
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis for conclusions
about the population that has been tested.
If the auditor concludes that audit sampling has not provided a reasonable basis for
conclusions about the population that has been tested, the auditor may:
(I) Request management to investigate misstatements that have been identified and the
potential for further misstatements and to make any necessary adjustments; or
(II) Tailor the nature, timing and extent of those further audit procedures to best achieve
the required assurance. For example, in the case of tests of controls, the auditor might
extend the sample size, test an alternative control or modify related substantive
procedures.
4. External Confirmation: As per SA 505, “External Confirmation”, negative confirmation is a
request that the confirming party respond directly to the auditor only if the confirming party
disagrees with the information provided in the request. Negative confirmations provide less
persuasive audit evidence than positive confirmations.
© The Institute of Chartered Accountants of India
5.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The failure to receive a response to a negative confirmation request does not explicitly
indicate receipt by the intended confirming party of the confirmation request or 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 favour, 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 ` 20 lakh 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.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 6
7
COMPLETION AND
REVIEW
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Refreshen up your knowledge about procedures relating to completion
and review
Glance through relevant SAs-SA 560, SA 570 and SA 580 pictorially
Gain application-based knowledge of above SAs.
Understand the concepts through use of analytical examples and case
studies.
Gain knowledge about varied practical situations for an auditor while
performing such procedures
© The Institute of Chartered Accountants of India
6.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Completion and Review
SA 560 SA 570 SA 580
Subsequent Events Going Concern Written
(Revised) Representations
C.A. Sujatha M is an auditor of a company engaged in manufacturing energy-saving electric lights.
As an auditor of the company, she already knew that a devastating fire had taken place in the
plant of the company during the year gone by, and the entire plant building, machinery and
inventories were gutted. Estimate of loss to the company’s assets was to the tune of ` 50 crores.
The company had lodged a claim with insurers, but there was no progress on the claim settlement
front till the close of the year.
The company’s operations have been shut down since then. The company had little money to
reinvest in fresh assets on its own. The promoters had put certain personal properties for sale.
However, due to the sluggish real estate market, no deals could fructify. Meanwhile, customers
of the company had started procuring their requirements from other suppliers.
As an auditor of the company, she was in a predicament. The main question troubling her related
to the ability of the company to restart its operations in such circumstances and to continue as a
going concern. She had to complete the audit within the timelines. She was keeping her fingers
crossed and adopted a “Wait and watch” policy to consider the impact of any developments
regarding claim settlement. There were still four months left. She could wait.
Suddenly one day, she came to know that the forensic lab conducting the examination of samples
taken from the fire site had given an adverse report casting doubt upon the genuineness of the
claim itself. All hopes for the recovery of losses had dashed.
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.3
The management had provided her a future plan of action to restart the business. She was also
provided with a “cash flow forecast” for coming periods. However, she was not convinced
regarding expected cash flows. She was of the prima facie view that the company was not going
to withstand such a huge loss in the absence of claim money, and its plans were too rosy and
impracticable. The negative forensic lab report changed the whole situation.
However, on deeper scrutiny by management, the findings of the forensic lab appeared to be
contradictory. The management found gaping loopholes in the said report. The company was
earning good margins and was paying handsome taxes. It was in expansion mode. The demand
for its products was also growing rapidly. In such a situation, why would one take such a criminal
step? The management decided to take it heads on.
While performing her audit procedures, she checked for any updates on the claim. It became
known to her that the management of the company had challenged the forensic lab reports by
giving a point-wise rebuttal with the insurers. Even officers of the insurance company were not
able to digest forensic lab reports. As the management provided video graphics and other digital
evidence, the forensic lab was left red-faced. It seemed that extraneous considerations had
prevailed in the course of the submission of their report.
The insurance company asked the forensic lab to reconsider their findings in light of the
company’s submissions. A positive revised report was submitted by the lab to the insurance
company. Now, doors had opened for settlement of the claim and resolution of the claim was in
sight.
Performing audit procedures regarding subsequent events helped her to identify those conditions
that either mitigate or otherwise affect the company’s ability to continue as a going concern. Since
she was particular about performing procedures regarding subsequent events, she was able to
identify mitigating factors affecting uncertainty associated with the outcome of the claim. In light
of these developments, she could convince herself about the ability of the company to continue
as a going concern.
After performing substantive procedures, certain procedures are still to be performed by the auditor
before the audit report is issued. Some of such important procedures include dealing with the effect
of subsequent events, obtaining sufficient appropriate evidence regarding the use of going concern
assumption by management and obtaining written representations.
© The Institute of Chartered Accountants of India
6.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1. SA 560 SUBSEQUENT EVENTS
SA 560- " Subsequent Events"
Facts which become
Events occuring
known to the auditor Facts that become
between the date of
after the date of the known to the
Objectives of the the Financial
Scope of the SA Definitions auditor's report but auditor after the
auditor Statements and
before the date the financial statements
date of the auditor's
financial statements have been issued
report
are issued
This SA deals Subsequent
Events: 1. Discuss the matter
with auditor's Obtain sufficient 1. The auditor shall with management or
responsibilities Events occuring perform audit 1. Discuss the matter
appropriate audit TCWG. with management or
relating to between the date evidence about procedures to
subsequent of the financial ensure that all 2. Determine whether TCWG.
whether events the financial
events in an statements and the occuring between the such events have 2. Determine
audit of date of the been identified. statements need whether the financial
date of the financial amendment.
financial auditor's report, statements and the 2. The auditor shall statements need
statements. and facts that date of the auditor's consider the 3. Inquire how amendment.
become known to report that require auditor's risk management intends 3. Inquire how
the auditor after adjustment of, or assessment in to address the matter management intends
the date of the disclosure in, the determining the in the financial to address the matter
auditor's report. financial statements nature and extent statements. in the financial
are appropriately of such statements.
reflected in those procedures.
financial statements. If manangement Review if
3. If such event is amends the financial management has
identified, statements, auditor taken steps to
Respond appropriately determine whether should extend the inform about the
to the facts that such event is audit procedures and situation to
become known to the appropriately everyone in receipt
reflected in 1. Either amend the
auditor after the date of audit report to include of the previously
the auditor's report, financial issued financial
statements. an additional date
that, had they been restricted to the statements.
known to the auditor at 4. Obtain Written amendment . 1. If steps taken,
that date, may have Representation issue new/ amended
caused the auditor to that all such events 2.Or provide a new/
amended report report with EOM/ OM
amend the auditor's have been para.
report. adjusted or including a statement
disclosed. in EOM/ OM para. If steps not taken,
then take
appreopriate steps to
If managment prevent reliance on
doesn't amend the the auditor's report.
financial statements.
1. If audit report not yet
provided to the
managment, modify
the opinion.
2. If audit report has
already been provided
to the management,
notify TCWG not to
issue it to third parties.
If still issued then take
appropriate action to
prevent reliance on the
auditor's report.
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.5
SA 560 deals with the auditor’s responsibilities relating to subsequent events in an audit of financial
statements. The objectives of auditor in this regard are to obtain sufficient appropriate evidence
about whether such events are appropriately adjusted or disclosed in financial statements. Further,
in case some facts have come to his knowledge after date of auditor’s report, to respond to those
facts such that had they been known to him at the date of the report, they may have caused him to
amend the auditor’s report.
TEST YOUR UNDERSTANDING 1
“Move Fast Limited” is engaged in the manufacturing of shoes and slippers located in Bahadurgarh
in Haryana. Due to unprecedented rains in the area in the month of September 2022, many areas
of the town got inundated due to the choking of sewer systems. As a result of the above, the
company’s premises located in town were also affected, resulting in damage of stocks.
The company has lodged a claim with the insurance company for `1 crore, and the same is shown
as a claim receivable as of 31st March 2023, as the claim was not settled at year end.
The insurance surveyor appointed in the case submitted a report to the insurance company
recommending a claim of `45 lacs in the month of April 2023. The company has also given its
consent for the same, and the settled amount of `45 lacs was transferred to the bank account of the
company on 15th May 2023.
You have just finished performing substantive procedures of the company by the end of May 2023.
Is there any responsibility cast upon you as auditor of the company in the above situation?
TEST YOUR UNDERSTANDING 2
CA Anuj is the auditor of a listed company, and he is in the midst of conducting an audit of the said
company for the financial year ending 31St March 2023. At a meeting of the Board of Directors held
on 17th April 2023, a dividend of `1 crore is proposed to equity shareholders @ `10/- per share,
and such a proposal has a good chance of being approved in the AGM of the company to be held
after few months.
His audit procedures are near completion. He is contemplating finalizing the audit report by 31st July
2023. Is there any responsibility thrust upon him as auditor of the company?
© The Institute of Chartered Accountants of India
6.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. SA 570 GOING CONCERN
SA 570- " Going Concern"
When conditions or Implications on
Responsibilities of Responsibilities the auditor's Other Important
Scope of the SA events are identified Points to be
the management of the auditor report
considered
Use of Going Concern
Basis of Accounting
is appropriate- The
1. To make specific auditor shall express an The auditor shall
assessment of the adverse opinion. communicate with
1. To obtain sufficient TCWG, events or
This SA deals with entity's ability to and appropriate audit 1. Requesting managment to
continue as a going make its asessment relating conditions identified
the auditor's evidence and conclude
concern. to entity's ability to continue that may cast
responsibilities in the on the
2. To make as a going concern. significant doubt on
audit of financial appropriateness of the
appropriate 2. Evaluating management's the entity's ability to
statements relating management's use of
disclosures in plan of future actions. continue as a going
to going concern going concern.
connection with 3. Analysing the cash flow concern.
and the implications 2. To assess whether
on the auditor's going concern in a material uncertainty forecast of the entity.
the financial 4. Considering the additional If there is delay in the
report. exists about the entity's
statements. facts or information Use of Going Concern approval of the
ability to continue as a financial statements
going concern. available. basis of accounting is
5. Requesting Written appropriate but a and the auditor
3. However, auditor believes that such
cannot be expected to Representation from material uncertainty
management regarding the exists and: delay can be related
guarantee the entity's to events or
ability to continue as a plans of future actions and Adequate disclosure of
the feasibility of these plans. material uncertanity is conditions relating to
going concern. going concern
made in the financial
statements- Unmodified assessment, the
Opinion and a separate auditor shall perform
section "Material additional procedures
Uncertainty related to as well as consider
going concern". the effect on auditor's
conclusion.
Use of Going Concern
Management basis of accounting is
unwilling to make appropriate but a
or extend its material uncertainty
assessment- exists and:
Auditor shall Adequate disclosure
consider the of material uncertanity
implications for the is not made in the
auditor's report. financial statements-
Qualified/ adverse
opinion and mention in
the basis of opinion
paragraph.
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.7
SA 570 Going Concern deals with the auditor’s responsibilities in the audit of financial statements
relating to going concern and the implications for the auditor’s report.
The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding use of the going
concern basis of accounting in the preparation of the financial statements by the management. On the
basis of evidence obtained, it is concluded whether a material uncertainty exists relating to events or
conditions that may cast a significant doubt on the entity’s ability to continue as a going concern.
TEST YOUR UNDERSTANDING 3
CA. Somya is auditor of a company engaged in rearing of poultry birds and obtaining eggs therefrom.
The company has performed very well since its incorporation in 2013. Its sales had also grown and
the company had expanded its market from the native northern state of promoters to far-flung areas
in eastern parts of country.
However, since last two years, company’s fortunes have nosedived. First, due to the effects of the
pandemic and then due to recurrent outbreaks of bird flu thrice in a span of two years. The company’s
sales have dipped from around ` 50 crores to `10 crores. Further, a major part of its livestock was
also wiped off during bird flu. She is not optimistic about the going concern assumption followed by
management.
The management now wants to start with new batches of birds. The earlier working capital facilities
of the company granted by bank have also been restructured to support the business. She was
informed that the repayments of restructured working capital term loans are to begin from ensuing
year. No fresh credit facilities have been granted by the bank. The company also plans longer credits
from animal feed suppliers.
The company plans to take additional measures to prevent the safety of live stocks, including
aggressive vaccination, preventive health check-ups, and more frequent visits of veterinary staff.
The villagers in surrounding areas have accused the company of spreading air pollution.
The management has prepared a cash flow forecast for her examination. Discuss the approach to
be adopted by her in examining the “going concern” assumption keeping in view above with specific
reference to cash flow forecast.
© The Institute of Chartered Accountants of India
6.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 4
CA Sooraj finds that key financial ratios of a company, like current ratio, debt-service coverage ratio,
inventory turnover ratio, and trade receivables turnover ratio, are in red and have deteriorated
considerably as compared to last year. The company is also not able to pay to its creditors on time.
The company is requesting time and again to its bankers to grant additional credit facilities, but
bankers are not listening.
There have been significant losses to the company due to the lack of response of the company’s
products in the market. As a result of it, many products are sold at below cost price. There have
been situations where the company is not able to pay the salaries of staff on time.
All these negative findings have led him to conclude that the use of going concern as the basis of
accounting is not appropriate. He brings this matter to the knowledge of CFO of the company. What
is reporting duty cast upon him in such a scenario?
The CFO informs him that the management, in turn, is ready to include in the disclosures the
inappropriateness of its use of going concern assumption of accounting.
How should it impact the auditor’s opinion in case management itself discloses the inappropriateness
of its use of going concern assumption of accounting now?
3. SA 580 WRITTEN REPRESENTATIONS
SA 580 Written representations deals with the auditor’s responsibility to obtain written
representations from management and, where appropriate, those charged with governance.
Although written representations provide necessary audit evidence, they do not provide sufficient
appropriate audit evidence on their own about any of the matters with which they deal.
Furthermore, the fact that management has provided reliable written representations does not affect
the nature or extent of other audit evidence that the auditor obtains about the fulfilment of
management’s responsibilities or about specific assertions.
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.9
SA 580- " Written Representations"
Written Date & Periods
Objectives of the Important points to be
Scope of the SA Representation as covered by Written
auditor considered
Audit Evidence Representation
Doubts as to
1. To obtain written Although Written
reliability of Written
representation from the Representations
Representations:
management or TCWG provide necessary
If written
that they believe that audit evidence, they The date of Written
This SA deals with the representations are
they have fulfilled their do not provide Representation shall
auditor's responsibility inconsistent with other
responsibility for the sufficient appropriate be as near as
to obtain written audit evidence, auditor
preparation of the audit evidence on practicable to, but not
representation from shall perform audit
financial statements their own. after, the date of the
management and, procedures to resolve
and for the auditor's report on the the matter.
where appropriate,
completness of the financial statements. If the auditor concludes
those charged with
information provided to that the written
governance.
the auditor. Written Representation representation are not
2. To support other shall be for all financial reliable, the auditor
audit evidence relevant statements and shall take appropriate
to the financial periods referred to in action in accordance
statements or specific the auditor's report. with SA 705.
assertions in the Requested Written
financial statements by Representation not
means of written provided:
representations. Auditor shall discuss
3. To respond with the management,
appropriately to written re-evaluate the
representation integrity of
provided by management, take
managment/ TCWG. appropriate actions
including the impact on
audit report as per SA
705.
© The Institute of Chartered Accountants of India
6.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 5
Following is a written representation given by RES Limited to its statutory auditors i.e. M/s CTK &
Associates for audit of financial year 2022-23. The audit was completed and report dated 31.7.23
was issued.
Point out, if there is any, anomaly in written representation reproduced below.
15th April, 2023
To
CTK & Associates
Chartered Accountants
Dear Sir,
This representation letter is provided in connection with your audit of the financial statements of RES
Limited for the year ended March 31, 2023 for the purpose of expressing an opinion as to whether
the financial statements give a true and fair view in accordance with the applicable accounting
standards in India.
We confirm that (to the best of our knowledge and belief, having made such inquiries as we
considered necessary for the purpose of appropriately informing ourselves):
Financial Statements
• We have fulfilled our responsibilities, as set out in the terms of the audit engagement dated
17th August 2022 for the preparation of the financial statements in accordance with financial
reporting Standards, in particular, the financial statements give a true and fair view in
accordance with the applicable accounting standards in India.
• Significant assumptions used by us in making accounting estimates, including those
measured at fair value, are reasonable.
• Related party relationships and transactions have been appropriately accounted for and
disclosed in accordance with the requirements of applicable accounting standards in India.
(SA 550)
• All events subsequent to the date of the financial statements and for which applicable
accounting standards in India require adjustment or disclosure have been adjusted or
disclosed. (SA 560)
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.11
• The effects of uncorrected misstatements are immaterial, both individually and in the
aggregate, to the financial statements as a whole. A list of the uncorrected misstatements is
attached to the representation letter. (SA 450)
Information provided
• We have provided you with: -
- Access to all information of which we are aware that is relevant to the preparation of
the financial statements such as records, documentation and other matters;
- Additional information that you have requested from us for the purpose of the audit;
and
- Unrestricted access to persons within the entity from whom you determined it
necessary to obtain audit evidence.
• All transactions have been recorded in the accounting records and are reflected in the
financial statements.
• We have disclosed to you the results of our assessment of the risk that the financial
statements may be materially misstated as a result of fraud.
• We have disclosed to you all information in relation to fraud or suspected fraud that we are
aware of and that affects the entity and involves: -
- Management;
- Employees who have significant roles in internal control; or
- Others where the fraud could have a material effect on the financial statements.
• We have disclosed to you all information in relation to allegations of fraud, or suspected fraud,
affecting the entity’s financial statements communicated by employees, former employees,
analysts, regulators or others.
• We have disclosed to you all known instances of non-compliance or suspected non-
compliance with laws and regulations whose effects should be considered when preparing
financial statements.
• We have disclosed to you the identity of the entity’s related parties and all the related party
relationships and transactions of which we are aware. (SA 550)
Chief Financial Officer
© The Institute of Chartered Accountants of India
6.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Case Scenario 1
CA Sneha, a partner in M/s J & Associates, is carrying out a statutory audit of M/s ABC Stores Ltd.
for the Financial Year 2022-23, and she is ready to sign her audit report on 01.07.2023. There are
some written representations which are pending with the management of the company pertaining to
such an audit, and she sent Deepak (her articled trainee), who is also a member of the engagement
team, to the company’s office for collection of the same.
On returning back, Deepak tells CA Sneha that major stocks of the company got destroyed because
of a fire in their plant on 27.06.2023, and it has affected the company’s operations badly. However,
the business operations are likely to be resumed by management at an alternate place.
CA Sneha postponed the issuance of the audit report to consider the impact of such an event on the
financial state of affairs of the company. She wants the management to disclose the impact of this
unfortunate event in financial statements for the year 2022-23, to which management is disinclined.
After the management’s refusal, she issued her audit report on 15.07.2023.
The management of the company seeks an appointment from CA Sneha to discuss an important
matter on 20.07.2023. They informed her that the company had lost a lawsuit filed against it by one
of the creditors on 18.07.2023 in a fast-track court, and now the company has to pay the plaintiff a
huge amount of `2 crores. The events causing this lawsuit arose after 31.03.2023.
CA Sneha is a bit perplexed, and her first question to the people from management visiting her office
was whether audited financial statements have been made available to any third parties or filed with
the regulator. The management responded negatively.
Now, CA Sneha wants them to amend the financial statements to include the impact of this lawsuit
on the financial affairs of the company. This time, they agreed and amended the financial statements
accordingly to cover the impact of both the events – that of the fire in the plant and losing the lawsuit,
but they requested CA Sneha to issue a new audit report against the earlier one dated 15.7.2023.
The management amends the financial statements, which are finally approved on 25.7.2023. CA
Sneha issues a new audit report.
Considering the above situation, answer the following questions: -
1. What should be the appropriate date of signing of the new audit report?
(a) 20.07.2023
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COMPLETION AND REVIEW 6.13
(b) Anytime between 15.07.2023 & 18.07.2023
(c) On or after 25.07.2023
(d) Anytime between 15.07.2023 & 25.07.2023
2. CA Sneha would have taken into account a lot of procedures to get knowledge of the
events occurring after the balance sheet date up to the date of the audit report relating
to the company. Which of the following does not fall under such audit procedures as
per SA 560?
(a) Obtaining an understanding of the management’s procedures set up to identify
subsequent events.
(b) Inquiring of the management w.r.t the occurrence of any such subsequent events.
(c) Reading the minutes of the meetings of the board held after the balance sheet date
during this period.
(d) Getting the Interim financial statements prepared till the date of the audit report
mandatorily as a condition to issue the audit report
3. W.r.t the first audit report dated 15.07.2023, which type of opinion was most likely
provided by her?
(a) Modified opinion
(b) Unqualified opinion
(c) Disclaimer of opinion
(d) Including a statement in Emphasis of Matter/Other matters para
4. W.r.t the new audit report issued, which type of opinion is most appropriate?
(a) Disclaimer of opinion
(b) Unqualified opinion
(c) Adverse opinion
(d) Unqualified opinion and a statement in Emphasis of Matter/Other matters para.
5. The fire event occurring on 27.6.2023 in the company’s plant requires the following
action on part of management: -
(a) Disclosure in notes to accounts
(b) Adjustment in financial statements
(c) Waiting for the insurance company to settle the claim
(d) Preparing financial statements afresh
© The Institute of Chartered Accountants of India
6.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Integrated Case Scenario 1
1. (c) 2. (d) 3 (a) 4. (d) 5. (a)
Case Scenario 2
CA Namit, a partner in M/s J & Associates, is carrying out a statutory audit of M/s XYZ Gears Ltd.
for the Financial Year 2022-23 and is in the process of issuing an audit report. His articled trainee,
Manpreet, is very curious about knowing the various facts relating to the consideration of Standards
on Auditing while carrying out an audit and issuing the audit report.
She asks CA Namit about the relevance of the Going concern assumption in their audit and further
reporting to which CA Namit explains to her that both parties have got their own responsibilities w.r.t
this accounting assumption. The management of the company has its own set of responsibilities
while reporting upon the same is a very strict and sensitive matter for the auditor as per the
requirement of the relevant standard on auditing.
He tells Manpreet to prepare a list of procedures as she thinks that an auditor should carry out when
he identifies that the company is facing a downfall in business never seen before due to newer
technology in the market and other competitors having sprung up swiftly adopting new technology.
He finds that this condition may cast significant doubt on the company’s ability to continue as a going
concern.
Manpreet thinks and researches and hands over a list of audit procedures to CA Namit for a final
discussion. CA Namit clarifies accordingly. CA Namit concludes that the use of a going concern
basis of accounting is appropriate in this company’s case, but a material uncertainty exists as to the
future prospects of the current business. However, the management has made an appropriate
disclosure w.r.t such material uncertainty in the financial statements.
Manpreet’s list of audit procedures includes: -
(I) Requesting management to make its assessment relating to the company's ability to continue
as a going concern.
(II) Evaluating management's plan of future actions.
(III) Make a specific assessment of the company’s ability to continue as a going concern.
(IV) Analysing the cashflow forecast of the company.
(V) Considering the additional facts or information available since the date of management’s
assessment
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(VI) Make appropriate disclosures in the financial statements in connection with going concerns.
(VII) Requesting Written Representation from management regarding the plans of future actions
and the feasibility of these plans.
(VIII) Writing a para addressed to the stakeholders in the audit report citing the results of
procedures adhered to relating to the going concern assumption.
Keeping in view above, answer the following questions: -
1. CA Namit tells Manpreet about the auditor’s responsibilities in the above case on the
matter under discussion. Which of the following doesn’t fall under the auditor’s
responsibilities?
(a) Obtaining sufficient and appropriate audit evidence on the matter under discussion.
(b) Conclude on the appropriateness of the management’s use of going concern.
(c) Assessing whether a material uncertainty exists about the company’s ability to
continue as a going concern.
(d) Guarantee the company’s ability to continue as a going concern based upon his audit
procedures.
2. Identify which set of audit procedures are relevant in the above case scenario as per
the list prepared by Manpreet.
(a) (I), (II), (IV), (V) & (VII)
(b) (I), (III) & (V)
(c) (II), (IV), (VI), (VII) & (VIII).
(d) (I), (II), (III), (IV) & (V).
3. CA Namit’s conclusion in the above case will lead him to give which type of audit
opinion from the following?
(I) Modified opinion
(II) Unmodified opinion.
(III) A separate section “Material uncertainty wrt Going concern” in his audit report.
(a) (I) only
(b) (II) only
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6.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) (I) & (III)
(d) (II) & (III)
4. Consider the following statements: -
Statement I: - The Management is under a responsibility to make specific assessment
of the company's ability to continue as a going concern.
Statement II: -. The Management is under a responsibility to make appropriate
disclosures in connection with going concern in the financial statements.
(a) Statement I is correct only.
(b) Statement II is correct only as Statement I falls under the auditor’s responsibilities.
(c) Both statements are correct.
(d) Both statements are incorrect.
5. Which of the following is most appropriate regarding “going concern” assumption?
(a) It signifies that company is reflecting net losses in its financial statements.
(b) It signifies that company is not modernising its plant and machinery.
(c) It signifies that company has no intention of curtailing materially the scale of its
operations in foreseeable future.
(d) It signifies that assets are likely to be recorded at the prices they would fetch.
Answers to Integrated Case Scenario 2
1. (d) 2. (a) 3. (d) 4. (c) 5. (c)
Case Study
Infinity Hospitality Private Limited was established in 1996 and was in the business of running hotels
in tourist destinations in state of Kerala. It took leased properties on long-term leases ranging from
10 to 12 years, most with a lock-in of a whole term. The terms did not cover the force majeure clause.
The company was family-owned business and had created a good reputation as value for a money-
budget hotel. Most of the time, hotels clocked 60 to 75% occupancy rate, and during the festive
season/ vacations, hotel business clocked 100% Occupancy.
The capital structure of the company was debt oriented and over-leveraged.
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COMPLETION AND REVIEW 6.17
Primary working capital was blocked in maintaining and upkeeping the leased properties, running
the restaurant, leases, food and beverages, salary, Director's remuneration etc.
The owners looked at the business as a cash cow and did not plough back the funds to expand the
business but were content with the decent profits the hotels were generating.
As the properties were leased and not owned, most of the cash flow generated from operations was
used in servicing the property and huge loans from financial institutions. What was left was
withdrawn as Directors' remuneration and dividend.
Everything was going on smoothly. However, there were flash floods in Kerala due to unprecedented
rains. There were landslides and roads were blocked. The entire tourist season was washed away
due to infrastructural challenges. Accessibility to resorts and hotels was badly hindered. Logistics
support took time to reach in far flung areas. Visit to the “The God’s own country” was last on the
mind of tourists. The company was hardly trying to get back to some semblance of normalcy when
pandemic struck. It was double whammy for the company.
The impact on travel, tourism and hospitality business was very severe. The management of Infinity
Hospitality Private Limited believed that bad days would end soon and the business would be back
to normal. They also were optimistic about the government coming up with support for the industry
and were hopeful of negotiating with lessors and Financial Institutions for relief. They decided on
humanitarian grounds not to terminate the employees and continued paying them a regular salary,
maybe deferring 25% to be paid after one year. The immediate fallout was on the top line as
suddenly, the business stopped.
The auditors, M/s XYZ and Associates, were conducting the audit of the company and were grappling
with the situation and are seeking your guidance for the course of action they need to follow.
Theoretical Questions
Based on the case scenario, you are required to provide your answers to the following:-
1. What additional audit procedures must the auditor undertake as per requirements of SA 570
based on the facts given in the case?
2. According to your judgment, what risk assessment procedures should the auditor consider
for arriving at a conclusion based on the management assertion of the entity being Going
Concern?
3. What should be approach of the auditor if the management agrees that the material
uncertainly exists, but the entity is a Going Concern? Also discuss reporting requirements.
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6.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. What if the auditor believes, on the basis of his additional audit procedures conducted to
conclude that the entity is not a Going Concern, but the management is not accepting the
same? What course of action the auditor needs to undertake?
5. What kind of written representation does the auditor need to obtain in case of the scenario
covered in Q3 above?
Multiple Choice Questions
1. Which of the following is not a financial event/ condition that may cast significant doubt on
companies ability to continue as a going concern as per SA 570?
(a) Change from credit to cash on delivery model with suppliers
(b) Arrears or discontinuance of dividend
(c) Opening of a new chain of hotels by renowned competitor near the entity's area
(d) Adverse key financial ratios
2. Please choose the mitigating measure as the management is unable to pay lease rentals.
(a) Cancel the lease
(b) Restructure the lease agreement and negotiate for deferment and relief
(c) Terminate the employees and pay the lessor
(d) All the above
3. Which one of the following is not a responsibility of the auditor relating to communicating
events or conditions identified that may cast significant doubt on the entity’s Going Concern
assertion?
(a) Perform additional audit procedures to identify events/ conditions beyond 12 months
from the date of financial statements
(b) Whether the events constitute a material uncertainty
(c) The adequacy of related discloses in the financial statements
(d) The implications for the auditor's report
4. Written Representation need to be mandatorily obtained from:
(a) Audit Committee
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COMPLETION AND REVIEW 6.19
(b) Client relationship Managers
(c) Company Secretary
(d) CFO
5. Which of the following is not main pillar of written representations?
(a) The management responsibility for preparation of financial statement
(b) Assertion related to completeness
(c) Assertion related to access to data and information
(d) Written representation provides sufficient appropriate audit evidence
Answers to Theoretical Questions
1. In the given case scenario the events and conditions have been identified which cast
significant doubt on the entity's ability to continue as a Going Concern, the auditor needs to
obtain sufficient appropriate audit evidence to determine whether or not material uncertainty
and gather evidence including of mitigating factors. It can be done by performing following
additional procedures: -
• Analysing and discussing cash flow, profit and other relevant forecast with
management.
• Analysing and discussing the entity's latest available interim financial statement.
• Reading the terms of loan agreements and determining whether any have been
breached.
• Reading minutes of the meetings of shareholders, those charged with governance and
relevant committees for reference to financing difficulties.
• Inquiring of the entity's legal counsel regarding the existence of litigation and claims
and the reasonableness of management's assessments of their out come and the
estimate of their financial implications.
• Confirming the existence, legality and enforceability of arrangements to provide or
maintain financial support with related and third party and assessing the financial
ability of such parties to provide additional funds.
• Performing audit procedures regarding subsequent events to identify those that either
mitigate or otherwise affect the entity's ability to continue as a going concern.
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6.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Confirming the existence, terms and adequacy of borrowing facilities.
• Where management has not yet performed an assessment of the entity's ability to
continue as a going concern, requesting management to make its assessment.
• Evaluating management's plans for further actions in relation to its going concern
assessment, whether the outcome of these plan is likely to improve the situation and
whether the management's plans are feasible in the circumstances.
• Evaluating management's plans for future actions may include inquiries of
management as to its plan for future action, including, for example, its plan to liquidate
assets, borrow money or restructure debt, reduce or delay expenditures, or increase
capital.
• Considering whether any additional facts or information have become available since
the date on which management made it assessment.
• Requesting written representation from management and, where appropriate, those
charged with governance, regarding their plans for future actions and the feasibility of
these plans.
2. When performing risk assessment procedures as required by SA-315, the auditor shall
consider whether events or conditions exist that may cast significant doubt on the entity's
ability to continue the going concern. In so doing, the auditor shall consider whether
management has already performed a preliminary assessment of the entity's ability to
continue as a going concern.
• The auditor shall discuss the assessment with management and determine whether
management has identified events and conditions that, individually or collectively, cast
significant doubt on the entity's ability to continue as a going concern and if so,
management's plan to address them.
• The auditor shall specifically draw attention of Management on following events or
condition and get the response on how they plan to address them:
The company is debt heavy and over leveraged. The leased properties are having
considerable lock-in period with absence of force majeure clause. There are no contingency
reserves available with company. All these factors shall be taken into account while
performing risk assessment procedures.
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COMPLETION AND REVIEW 6.21
3. If the auditor concludes that the management's use of going concern basis of accounting is
appropriate in the circumstances but a material uncertainty exists, the auditors shall
determine whether the financial statements:
(a) Adequately disclose the principal events or conditions that make a significant doubt
on the entity's ability to continue as a going concern and management's plan to deal
with these events or conditions, and
(b) Disclose clearly that there is a material uncertainty related to events or conditions that
may cast significant doubt on 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.
(c) The disclosures may include:
i. Management's evaluation of the significance of the events or conditions relating
to the entity's ability to meet its obligations; or
ii. Significant judgements made by management as a part of its assessment of the
entity's ability to continue as a going concern
iii. Disclosures about the magnitude of the potential impact of the principal events
or conditions, and the likelihood and timing of the occurrence.
iv. The auditor shall express and unmodified opinion and the auditor’s reports shall
include a separate section under the heading "Material Uncertainty Related to
Going Concern" to:
• Draw attention to the note in the financial statement that discloses the
events or conditions and
• State that these events are conditions indicate that a material
uncertainty exists that may cast significant doubt on the entity's ability to
continue as a going concern and the auditor's opinion is not modified in
respect of the matter and how the matter was addressed in the audit.
4. If management has prepared financial statements using the Going Concern assertion to which
auditor differs as according to his judgement, the Going Concern assertion by the
management is not appropriate, then the auditor is required to express an adverse opinion.
5. The auditor needs to obtain written representation from management and where appropriate,
those charged with governance, regarding their plans for future action and the feasibility of
these plans.
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6.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Multiple Choice Questions
1. (c) 2 (b) 3 (a) 4 (d) 5 (d)
Key Takeaways
Events occurring between the date of the financial statements and the date of the auditor’s
report and facts that become known to the auditor after the date of the auditor’s report are
known as subsequent events.
Such events may be those that provide evidence of conditions that existed at the date of the
financial statements and those that provide evidence of conditions that arose after the date
of the financial statements.
SA 560 deals with the auditor’s responsibilities relating to subsequent events in an audit of
financial statements.
The auditor shall perform audit procedures designed to obtain sufficient appropriate audit
evidence that all events occurring between the date of the financial statements and the date of
the auditor’s report that require adjustment of, or disclosure in, the financial statements have been
identified.
Going concern is one of the fundamental accounting assumptions. The enterprise is normally
viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is
assumed that the enterprise has neither the intention nor the necessity of liquidation or of
curtailing materially the scale of the operations.
SA 570 Going Concern deals with the auditor’s responsibilities in the audit of financial
statements relating to going concern and the implications for the auditor’s report.
The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going
concern. Management’s assessment of the entity’s ability to continue as a going concern is a key
part of the auditor’s consideration of management’s use of the going concern basis of accounting.
If events or conditions have been identified that may cast significant doubt on the entity’s ability to
continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to
determine whether or not 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 through performing
additional audit procedures, including consideration of mitigating factors.
A written representation is a written statement by management provided to the auditor to
confirm certain matters or to support other audit evidence. Written representations in this
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COMPLETION AND REVIEW 6.23
context do not include financial statements, the assertions therein, or supporting books and
records.
Although written representations provide necessary audit evidence, they do not provide
sufficient appropriate audit evidence on their own about any of the matters with which they
deal.
SA 580 Written representations deals with the auditor’s responsibility to obtain written
representations from management and, where appropriate, those charged with governance.
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS WISDOM:
SCAN ME !
Note: Content of SA 560 -Subsequent Event; SA 570- Going Concern and
SA 580- Written Representation is covered in depth at Intermediate level. Thus, application
part of above SAs may be discussed in the form of Case Study at Final level
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Ramadhan & Co., are the Auditors of XYZ Company Ltd., for the year ended on 31/03/2023.
The Audit Report for that year was signed by the Auditors on 04/05/2023. The Annual General
Meeting was decided to be held during the month of August 2023. On 06/05/2023, the
Company had received a communication from the Central Government that an amount of
` 5800 crore kept pending on account of incentives pertaining to Financial Year
2022-23 had been approved and the amount would be paid to the Company before the end
of May 2023. To a query to Chief Financial officer of the Company by the Board, it was
informed that this amount had not been recognised in the Audited Financial Statements in
view of the same not being released before the close of the Financial Year and due to
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6.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
uncertainty of receipt. Now, having received the amount, the Board of Directors wished to
include this amount in the Financial Statements of the Company for the Financial Year ended
on 31/03/2023. On 08/05/2023, the Board amended the accounts, approved the same and
requested the Auditor to consider this event and issue a fresh Audit Report on the Financial
Statements for the year ended on 31/03/2023. Analyse the issues involved and give your
views as to whether or not the Auditors could accede to the request of the Board of Directors.
2. M/s Airlift Ltd., carrying on the business of Passenger Transportation by air is running into
continuous financial losses as well as reduction in Sales due to stiff competition and frequent
break down of its own aircrafts. The Financial Statements for the Year ended on 31/03/2023
are to be now finalized. The Management is quite uncertain as to its ability to continue in near
future and has informed the Auditors that having seized of this matter, it had constituted a
committee to study this aspect and to give suggestions for recovery, if any, from this bad
situation. Till the study is completed, according to the Management, the issue involves
uncertainty as to its ability to continue its business and it informs the Auditor that the fact of
uncertainty clamping on the "Going Concern" would suitably be disclosed in notes to
accounts. State the reporting requirement if any, in the Independent Auditor's Report in
respect of this matter.
3. PRSH & Co is the statutory auditor of Make My Journey Ltd. The company is in the business
of tours and travels. Annual turnover of the company is INR 2000 crores and profits are INR
190 crores. During the planning meeting of the management and the auditors, it was
discussed that the management needs to provide written representation letter to the auditors
for the preparation of the financial statements and for the completeness of the information
provided to the auditor. At the time of closure of the audit, there has been some confusion
about the requirements of the written representation letter. Management argued that
representation need not be written, it can also be verbal which has been provided to the audit
team during the course of their audit. Auditors have completed their documentation and hence
in a way, representation based on verbal discussions with the auditors has also got
documented. Auditors explained that this is mandatory to obtain written representation in
accordance with the requirements of SA 580. However, still some confusion remains
regarding the date and period covered by the written representation. You are required to
advise about the date of and period covered by written representation in view of SA 580.
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COMPLETION AND REVIEW 6.25
Answers to Test your Understanding
1. The given situation provides evidence of conditions that existed at the date of financial
statements. Initially, the company had lodged claim of `1 crore and the same is reflected as
claim receivable in financial statements as on 31st March, 2023.
However, subsequent events occurring have provided evidence that claim was settled for
` 45 lacs only. Such settled amount has already been accepted by the company by providing
its consent. Therefore, such events have provided fresh information about items included in
financial statements.
Further, performance of substantive procedures has been finished implying that audit report
is not yet issued.
Therefore, financial statements as on 31 st March, 2023 should be adjusted to reflect fresh
information emanating from described events and management should be asked to take
appropriate action in this regard so that adjustment pertaining to above is properly reflected
in financial statements in accordance with applicable financial reporting framework.
2. In the given situation, dividend has been proposed by Board of Directors on 17th April, 2023.
It is an example of condition that arose after the reporting period. No liability exists for the
company on reporting date because there is no obligation to pay at the reporting date in
accordance with Ind AS 1.
Therefore, above situation does not require recognition of above proposed dividend in
financial statements. It is an example of events which does not require adjustments. However,
it should be disclosed in financial statements in notes to accounts. Therefore, it should be
ensured that it is disclosed in notes to accounts in financial statements. He should verify in
accordance with SA 560 that it is so disclosed in notes to accounts.
3. In accordance with SA 570,"Going Concern”, if events or conditions have been identified that
may cast significant doubt on the entity’s ability to continue as a going concern, the auditor
shall obtain sufficient appropriate audit evidence to determine whether or not 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 by performing additional audit procedures, including
consideration of mitigating factors.
Where the entity has prepared a cash flow forecast, and analysis of forecast is a significant
factor in considering the future outcome of events or conditions in the evaluation of
management’s plans for future actions, it includes
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6.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(i) Evaluating the reliability of the underlying data generated to prepare the forecast and
(ii) Determining whether there is adequate support for the assumptions underlying the
forecast.
In the above situation, cash flow forecast has been prepared by management. Therefore, she
should carefully evaluate assumptions underlying forecast and also reliability of data to
prepare the forecast. For example: -
• She should verify assumption regarding fresh batch of livestock. The bankers have
not provided fresh credit facilities. How funds from the same would be arranged? The
reasonability of assumption in cash flow forecast needs to be looked into.
• She needs to check loan sanction letters/agreement to verify when repayments are
beginning to see their accuracy in cash flow forecasts.
• The company plans to avail longer credits from animal feed suppliers. In the downturn
situation of the company, how would suppliers extend longer credits? This is going to
have effect on the cash flow forecast.
• Whether company has accounted for increased expenditure on preventive health
check-up, vaccination and more frequent visits of veterinary staff in cash flow forecast.
• Since villagers have accused the company of spreading air pollution, how does the
company plan to deal with the same? Whether any proposed expenditure in this regard
is accounted for in the cash flow statement. She may also consider other implications
of this issue and possible effect on cash flows.
4. If the financial statements have been prepared using the going concern basis of accounting
but, in the auditor’s judgment, management’s use of the going concern basis of accounting
in the financial statements is inappropriate, the auditor shall express adverse opinion.
The requirement for an auditor to express an adverse opinion applies regardless of whether
or not the financial statements include disclosure of the inappropriateness of management’s
use of the going concern basis of accounting.
Therefore, even if management discloses that its use of going concern assumption of
accounting is inappropriate, it would have no impact on auditor’s opinion. He would need to
express adverse opinion.
5. The date of the written representations shall be as near as practicable to, but not after, the
date of the auditor’s report on the financial statements. As the auditor is concerned with
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COMPLETION AND REVIEW 6.27
events occurring up to the date of the auditor’s report that may require adjustment to or
disclosure in the financial statements, the written representations are dated as near as
practicable to, but not after, the date of the auditor’s report on the financial statements.
In the given situation, written representation is dated 15 th April 2023. The audit report is dated
31st July 2023. There is a considerable lag between date of written representations and date
of audit report.
It could signify that all subsequent events after date of financial statements requiring
adjustments or disclosure may not have been adjusted or disclosed in the financial
statements by management.
As audit report is dated 31St July, 2023, it reflects that auditor has considered subsequent
events occurring between date of financial statements and date of auditor’s report. However,
written representations pertain to 15th April 2023.
Hints /Answers to Theoretical Questions
1. Facts Which Become Known to the Auditor After the Date of the Auditor’s Report but
Before the Date the Financial Statements are Issued: As per SA 560, “Subsequent
Events”, the auditor has no obligation to perform any audit procedures regarding the financial
statements after the date of the auditor’s report. However, when, after the date of the auditor’s
report but before the date the financial statements are issued, a fact becomes known to the
auditor that, had it been known to the auditor at the date of the auditor’s report, may have
caused the auditor to amend the auditor’s report, the auditor shall
(i) Discuss the matter with management and, where appropriate, those charged with
governance.
(ii) Determine whether the financial statements need amendment and, if so,
(iii) Inquire how management intends to address the matter in the financial statements.
If management amends the financial statements, the auditor shall carry out the audit
procedures necessary in the circumstances on the amendment. Further, the auditor shall
extend the audit procedures and provide a new auditor’s report on the amended financial
statements. However, the new auditor’s report shall not be dated earlier than the date of
approval of the amended financial statements.
In the instant case, XYZ Company Ltd. received an amount of rupees 5800 crore on account
of incentives pertaining to year 2022-23 in the month of May 2023 i.e. after finalisation of
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6.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
financial statements and signing of audit report. Board of Directors of XYZ Ltd. amended the
accounts, approved the same and requested the Ramadhan & Co. (auditor) to consider this
event and issue a fresh audit report on the financial statements for the year ended on
31.03.2023.
After applying the conditions given in SA 560, Ramadhan & Co. can issue new audit report
subject to date of audit report which should not be earlier than the date of approval of the
amended financial statements.
2. Reporting requirements in case of Uncertainty clamping on the Going Concern: As per
SA 570 “Going Concern”, if the auditor concludes that management’s use of the going
concern basis of accounting is appropriate in the circumstances but a material uncertainty
exists, the auditor shall determine whether the financial statements : (i)adequately disclose
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 (ii) 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.
If adequate disclosure about the material uncertainty is made in the financial statements, the
auditor shall express an unmodified opinion and the auditor’s report shall include a separate
section under the heading “Material Uncertainty Related to Going Concern” to:
(i) Draw attention to the note in the financial statements that discloses the matters set
out above; and
(ii) State that these events or conditions indicate that a material uncertainty exists that
may cast significant doubt on the entity’s ability to continue as a going concern and
that the auditor’s opinion is not modified in respect of the matter.
In the instant case, M/s Aircraft Ltd. is running into continuous financial losses as well as
reduction in sales due to stiff competition and frequent break down of its own aircrafts and
management of Aircraft Ltd. is uncertain as of its ability to continue in near future. Therefore,
a committee has been constituted to study this aspect and till the time study is completed
management accordingly decided to suitable disclose this aspect in notes to accounts.
Therefore, the auditor should disclose about the material uncertainty and express an
unmodified opinion and in his audit report shall include a separate section under the heading
“Material Uncertainty Related to Going Concern” to draw attention to the note in the financial
© The Institute of Chartered Accountants of India
COMPLETION AND REVIEW 6.29
statements that discloses the matters set out above; and state that these events or conditions
indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability
to continue as a going concern and that the auditor’s opinion is not modified in respect of the
matter.
3. As per SA 580, “Written Representations”, as written representations are necessary audit
evidence, the auditor’s opinion cannot be expressed, and the auditor’s report cannot be
dated, before the date of the written representations. Furthermore, because the auditor is
concerned with events occurring up to the date of the auditor’s report that may require
adjustment to or disclosure in the financial statements, the written representations are dated
as near as practicable to, but not after, the date of the auditor’s report on the financial
statements.
In some circumstances it may be appropriate for the auditor to obtain a written representation
about a specific assertion in the financial statements during the course of the audit. Where
this is the case, it may be necessary to request an updated written representation.
The written representations are for all periods referred to in the auditor’s report because
management needs to reaffirm that the written representations it previously made with
respect to the prior periods remain appropriate. The auditor and management may agree to
a form of written representation that updates written representations relating to the prior
periods by addressing whether there are any changes to such written representations and, if
so, what they are.
Situations may arise where current management were not present during all periods referred
to in the auditor’s report. Such persons may assert that they are not in a position to provide
some or all of the written representations because they were not in place during the period.
This fact, however, does not diminish such persons’ responsibilities for the financial
statements as a whole. Accordingly, the requirement for the auditor to request from them
written representations that cover the whole of the relevant period(s) still applies.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 7
7
REPORTING
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the Reporting requirements and Different types of Un-
Modified and Modified 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.
© The Institute of Chartered Accountants of India
7.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Audit Report
Types of Elements of Audit Report
Meaning
Audit Report Audit Reports formats
CA. A got an invitation to attend a seminar on “Audit Conclusions and Reporting-Responsibilities
of auditors” in context of SA 700 series organized by local branch of WIRC of ICAI. Realizing
importance of topic in context of heightened regulatory glare being continuously highlighted in
media, he made it sure to attend the seminar. Eminent speakers brought out how significant it is
to prepare an audit report in accordance with Standards on Auditing. Audit report is the document
by means of which an auditor expresses opinion. Its significance, in context of an audit, is
paramount.
Discussing threadbare such issues, one learned speaker underlined need for ‘expression of
appropriate opinion” by auditors in view of rapid changes in business environment. If modified
opinion is warranted in accordance with SA 705, such an opinion must be expressed by auditors
clearly explaining basis for such opinion. In case evidence points to misstatements impact of
which is both material and pervasive, auditors should not hesitate to express adverse opinion in
audit reports.
It was also made loud and clear that auditors should try to challenge matters such as key
underlying assumptions. These should not be meekly accepted by the auditors as these have
significant implications for audit report.
It was tried to be explained in context of “Going concern” assumption. Auditors should go all out
to see that its use is appropriate in preparation of financial statements by the client by going
through client’s assessment. If client has not made its assessment, auditor should quiz
management regarding justification of it following such an assumption.
© The Institute of Chartered Accountants of India
REPORTING 7.3
Such matters have immediate and direct implications for auditor’s report. Like, if in auditor’s
judgment, use of going concern basis of accounting is inappropriate, adverse opinion needs to
be expressed. Raising an alarm, it was clearly transmitted that such matters were too crucial to
be taken lightly.
Accentuating value of Emphasis of Matter paragraphs, it was shared by another speaker how to
use such paragraphs in audit reports. One fundamental requirement of using such a para in
accordance with SA 706 is that such paragraph cannot be used in respect of matters for which
modification of opinion is required. These paras are no substitute for modified opinion.
Underscoring increase in communicative value of audit reports by highlighting key audit matters
identified during the course of audit, it was hammered that not only such matters are stated in
accordance with SA 701, manner of addressing such matters by performing audit procedures is
also stated in audit reports.
1. INTRODUCTION
Assuming you are an auditor and have
concluded the audit field work, your next step
will be issuance of the audit report. Issuance
of Audit report is the culmination of the Audit
Work. It is the most important deliverable for
a Statutory Auditor. 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 the Financial Statements.
By expressing an opinion in the audit report,
the auditor takes upon himself a great
responsibility because a large number of
stakeholders are likely to place reliance on
the financial statements and are dependent
on the Auditors Opinion 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 in accordance with the
reporting requirements mandated by the
Standards on Auditing to bring about uniformity in the issuance of Audit Opinion.
© The Institute of Chartered Accountants of India
7.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS
The SA 700 series is purely dedicated to the auditor’s report to be issued by the auditor. There are
following SAs which you need to be aware of:
Particulars Head Purpose
SA-700 Forming an Opinion • Forming an opinion on the financial statements.
and Reporting on
• Form and content of the auditor’s report.
Financial Statements
• Deals with Un-Modified (Clean) opinion of the
Auditor.
SA-701 Communicating Key • To enhance the communicative value of the
Audit Matters in the auditor’s report by providing greater transparency
Independent Auditor’s about the audit that was performed.
Report • To assist the user 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.
SA-705 Modifications to the • To issue an appropriate auditor’s report when the
Opinion in the auditor considers the modification of the audit
Independent Auditor’s opinion in the report is necessary.
Report • To deal with the revised form and content when the
modification of the opinion takes place.
SA-706 Emphasis of Matter To draw user’s attention to a matter or matters:-
Paragraphs and • Presented or disclosed in the financial statements
Other Matter and which is fundamental for the understanding of
Paragraphs in the the user, or
Independent Auditor’s
Report • Not presented or disclosed in the financial
statement and which is relevant for the
understanding of the user.
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.
© The Institute of Chartered Accountants of India
REPORTING 7.5
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
SA 700 applies to an audit of a complete set of general-purpose financial statements and is written
in that context. 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 ∗
Forming an opinion on the Financial Statements
The auditor shall form an opinion on whether the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework. In order to form that
opinion, the auditor shall obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement whether due to fraud or error. Further, when the financial
∗ Source : accountlearning.com
© The Institute of Chartered Accountants of India
7.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
statements are prepared in accordance with a fair presentation framework, the auditor shall also
evaluate as to whether the financial statements achieve fair presentation by considering:
1. The overall presentation, structure and content of the financial statements; and
2. Whether the financial statements, including the related notes, represent the underlying
transactions and events in a manner that achieves fair presentation.
In other words, the auditor shall express an unmodified opinion when the auditor concludes that the
financial statements are prepared, in all material respects, in accordance with the applicable
financial reporting framework.
In order to form that opinion, the auditor shall conclude whether he has obtained reasonable
assurance that the financial statements as a whole are free from material misstatement whether due
to fraud or error.
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 shall
be in writing and shall include the following basic elements, which ordinarily includes in case of
Auditors’ Report for Audits Conducted in Accordance with Standards on Auditing:
Title
Addressee
Auditor's Opinion
Basis for opinion
Going Concern
Key Audit Matters
Other Information
Responsibility for Financial Statement
Auditor’s Responsibilities for the Audit of the Financial Statements
Location of the description of the auditor’s responsibilities for the Audit of the F.S
Other Reporting Responsibilities
Signature of the Auditor
Place of Signature
Date of the Auditor's Report
© The Institute of Chartered Accountants of India
REPORTING 7.7
1. Title: The auditor’s report shall have a title that clearly indicates that it is the report of an
independent auditor.
1. “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.
2. 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.
© The Institute of Chartered Accountants of India
7.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Extract of Independent Auditor’s Report - Unmodified Opinion Paragraph
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.
© The Institute of Chartered Accountants of India
REPORTING 7.9
Extract of Independent Auditor’s Report – Basis for Unmodified Opinion
Paragraph
5. Going Concern: Where applicable, the auditor shall report in accordance with SA 570. SA
570 deals with the auditor’s responsibilities in the audit of financial statements relating to
going concern and the implications for the auditor’s report. The auditor’s responsibilities are
to obtain sufficient appropriate audit evidence regarding, and conclude on, the
appropriateness of management’s use of the going concern basis of accounting in the
preparation of the financial statements, and to conclude, based on the audit evidence
obtained, whether a material uncertainty exists about the entity’s ability to continue as a going
concern.
Implications for the Auditor’s Report:
Implications on
Auditor's Report
Use of Going Concern Basis Management
Use of Going Concern Basis
of Accounting Is Appropriate Unwilling to Make or
of Accounting Is
but a Material Uncertainty Extend Its
Inappropriate
Exists and Assessment
Adequate Disclosure of a
Adequate Disclosure of a Consider the
An adverse Material Uncertainty Is Not
Material Uncertainty Is Made implications on
opinion Made in the Financial
in the Financial Statements Audit report
Statements
Unmodified opinion and Qualified/ adverse
separate section "Material opinion and mention in
Uncertainity related to going the basis of opinion
concern" paragraph
© The Institute of Chartered Accountants of India
7.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
I. Use of Going Concern Basis of Accounting Is Inappropriate: If the financial
statements have been prepared using the going concern basis of accounting but, in the
auditor’s judgment, management’s use of the going concern basis of accounting in the
preparation of the financial statements is inappropriate, the auditor shall express an adverse
opinion.
II. Use of Going Concern Basis of Accounting Is Appropriate but a Material
Uncertainty Exists and:
(A) Adequate Disclosure of a Material Uncertainty Is Made in the Financial
Statements: If adequate disclosure about the material uncertainty is made in the
financial statements, the auditor shall express an unmodified opinion and the auditor’s
report shall include a separate section under the heading “Material Uncertainty
Related to Going Concern” to:
(i) Draw attention to the note in the financial statements that discloses the matters
(ii) State that these events or conditions indicate that a material uncertainty exists
that may cast significant doubt on the entity’s ability to continue as a going
concern and that the auditor’s opinion is not modified in respect of the matter.
Extract of Independent Auditor’s Report – Material Uncertainty related to Going
Concern
(B) Adequate Disclosure of a Material Uncertainty Is Not Made in the Financial
Statements: If adequate disclosure about the material uncertainty is not made in the
financial statements, the auditor shall:
© The Institute of Chartered Accountants of India
REPORTING 7.11
(i) Express a qualified opinion or adverse opinion, as appropriate, in accordance
with SA 705 (Revised); and
(ii) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state
that a material uncertainty exists that may cast significant doubt on the entity’s
ability to continue as a going concern and that the financial statements do not
adequately disclose this matter.
(C) Management Unwilling to Make or Extend Its Assessment: If management is
unwilling to make or extend its assessment when requested to do so by the auditor,
the auditor shall consider the implications for the auditor’s report.
Note: Where the use of Going Concern Basis is appropriate then no special paragraph
is required in the Auditors Report mentioning the fact.
ILLUSTRATION 1
CA Sameer is the statutory auditor of Tram Fram Ltd. for the FY 2022-23. While
concluding the audit CA Sameer decided to issue an unmodified opinion, though he
also concluded that a material uncertainity exists with respect to the company’s ability
to continue as a going concern on account of a pending litigation related to labour
laws. He is of the view that the company has made appropriate disclosures with respect
to such pending litigation in the notes to accounts annexed to the financial statements
of Tram Fram Ltd. for the FY 2022-23. Explain how CA Sameer will deal with the above
situation in his auditor’s report (draft the relevant portion of the auditor’s report.)
SOLUTION
Material Uncertainty Related to Going Concern
We draw attention to Note 10 in the financial statements, which indicates that the outcome of
a litigation on account of labour laws is pending in case of the company during the year 31
March, 2023. As stated in Note 11, this event or condition, indicate that a material uncertainty
exists that may cast significant doubt on the Company’s ability to continue as a going concern.
Our opinion is not modified in respect of this matter.
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.
© The Institute of Chartered Accountants of India
7.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Definition of Key Key Audit matter are those matters that, in the auditor’s
Audit Matters 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.
7. Other Information: Where applicable, the auditor shall report in accordance with
SA 720 (Revised).
8. 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 describe management’s responsibility for:
(b) Assessing the entity’s ability to continue as a
(a) Preparing the financial statements in going concern and whether the use of the going
accordance with the applicable financial concern basis of accounting is appropriate as
reporting framework, and for such internal well as disclosing, if applicable, matters relating
control as management determines is necessary to going concern. The explanation of
to enable the preparation of financial statements management’s responsibility for this assessment
that are free from material misstatement, shall include a description of when the use of the
whether due to fraud or error; and going concern basis of accounting is
appropriate.
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 “the preparation of
financial statements that give a true and fair view,” as appropriate in the circumstances.
9. 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.”
© The Institute of Chartered Accountants of India
REPORTING 7.13
(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:
To exercises professional judgment and maintains professional
skepticism throughout the audit as per SAs;
Auditor’s Responsibilities in Audit of FS
To identify and assess the risks of
material misstatement of the FS
To obtain an understanding of internal accounting policies used
control relevant for audit to design audit
To describe an audit procedures
by stating that the reasonableness of
auditor’s To evaluate the appropriateness of: accounting estimates
responsibilities are:
To conclude on the appropriateness of related disclosures
management’s use of the going made by management.
concern basis
To describe the
auditor’s
responsibilities in a to evaluate the overall presentation,
group audit structure and content of the financial
engagement as per statements
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
© The Institute of Chartered Accountants of India
7.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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
disclosures, and whether the financial statements represent the
underlying transactions and events in a manner that achieves fair
presentation.
© The Institute of Chartered Accountants of India
REPORTING 7.15
(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.
10. 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:
© The Institute of Chartered Accountants of India
7.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) By a specific reference
within the auditor’s report
(b) Within an appendix to
to the location of such a
the auditor’s report, in
description on a website of
(a) Within the body of the which case the auditor’s
an appropriate authority,
auditor’s report; report shall include a
where law, regulation or
reference to the location of
the auditing standards
the appendix; or
expressly permit the
auditor to do so.
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.
11. 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.”
12. 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
© The Institute of Chartered Accountants of India
REPORTING 7.17
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 practice 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.
3. For ABC and Co.
Chartered Accountants
Firm Registration Number
Signature
(Name of the Member Signing the Audit Report)
(Designation {Partner/Proprietor})
© The Institute of Chartered Accountants of India
7.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
13. Place of Signature: The auditor’s report shall name specific location, which is ordinarily the
city where the audit report is signed.
14. 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:
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.
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.
© The Institute of Chartered Accountants of India
REPORTING 7.19
(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.
(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.
Students may note that the Chartered Accountants need to ensure compliance with all the
requirements relating to signature prescribed in the relevant law or regulation, SAs and relevant
announcements/ clarifications issued by ICAI on the matter including the requirement to mention
UDIN (mandatory from 1st July 2019) (UDIN – UNIQUE DOCUMENT IDENTIFICATION
NUMBER). The requirement to mention UDIN is applicable both for manually and digitally signed
reports/certificates including certificates uploaded online.
For detailed understanding, students may refer the following link:
https://resource.cdn.icai.org/59024aasb48128.pdf
© The Institute of Chartered Accountants of India
7.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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.
3.5 Supplementary Information Presented with the Financial Statements
If supplementary information that is not required by the applicable financial reporting framework is:
presented with the audited financial not considered an integral part of the audited financial
statements, the auditor shall evaluate statements, the auditor shall evaluate whether such
whether, in the auditor’s professional supplementary information is presented in a way that
sufficiently and clearly differentiates it from the audited
judgment, supplementary information is financial statements. If this is not the case, then the auditor
nevertheless an integral part of the shall ask management to change how the unaudited
financial statements due to its nature or supplementary information is presented. If management
how it is presented. When it is an integral refuses to do so, the auditor shall identify the unaudited
part of the financial statements, the supplementary information and explain in the auditor’s
supplementary information shall be report that such supplementary information has not been
covered by the auditor’s opinion. audited.
© The Institute of Chartered Accountants of India
REPORTING 7.21
For example:
4. When the notes to the financial statements include an explanation or the reconciliation of the
extent to which the financial statements comply with another financial reporting framework, the
auditor may consider this to be supplementary information that cannot be clearly differentiated from
the financial statements. the auditor’s opinion would also cover notes or supplementary schedules
that are cross referenced from the financial statements.
5. When an additional profit and loss account that discloses specific items of expenditure is
disclosed as a separate schedule included as an appendix to the financial statements, the auditor
may consider this to be supplementary information that can be clearly differentiated from the
financial statements.
TEST YOUR UNDERSTANDING 1
The auditors of a listed company have affirmed in their audit report communication of significant
audit findings including significant deficiencies in internal control of the company identified to those
charged with governance. Where are such matters included in audit report of a listed company? Also
dwell upon importance of such communication.
4. SA 701 COMMUNICATING KEY AUDIT MATTERS IN THE
INDEPENDENT AUDITOR’S REPORT
SA 701 provides guidance regarding communication of Key Audit Matters. This 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.
Key Audit matter are those
matters that, in the auditor’s Key audit matters are selected
professional judgment, were of from matters communicated
most significance in the audit of with those charged with
the financial statements of the governance.
current period.
© The Institute of Chartered Accountants of India
7.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
Objective • 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 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.
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 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
© The Institute of Chartered Accountants of India
REPORTING 7.23
(d) A separate opinion on individual matters.
a substitute for disclosures in the financial statements;
a substitute for the auditor expressing a modified opinion in case of circumstances
of a specific audit engagement as per SA 705;
a substitute for reporting in accordance with SA 570 or
a separate opinion on individual matters.
Applicability of This SA applies to audits of complete sets of general purpose
SA 701 financial statements of :
listed entities and
circumstances when the auditor otherwise decides to
communicate key audit matters in the auditor’s report
and
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 (b) Significant auditor judgments
assessed risk of relating to areas in the financial (c) The effect on the
material misstatement, statements that involved audit of significant
or significant risks significant management events or transactions
identified in judgment, including accounting that occurred during
accordance with SA estimates that have been the period.
315 identified as having high
estimation uncertainty.
© The Institute of Chartered Accountants of India
7.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
6-10 Examples of Key Audit Matters:
Assessment of Impairment,
Provision for losses and contingencies,
Valuation of financial instruments,
Matters relating to Revenue recognition,
Taxation matters (multiple tax jurisdictions, uncertain tax position, deferred tax assets).
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.
In case there are no Key Audit Matter to communicate, the auditors’ report must specifically
mention that by carrying a Key Audit Matter Paragraph and under which they shall mention
that there are no Key Audit matter to communicate.
Extract of Independent Auditor’s Report – Key Audit Matter
© The Institute of Chartered Accountants of India
REPORTING 7.25
ILLUSTRATION 2
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.] 1
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.
5.1 Types of Modified Opinions:
Types of Modified (i) Qualified Opinion
Opinions as per SA 705:
(ii) Adverse Opinion
(iii) Disclaimer of Opinion
© The Institute of Chartered Accountants of India
7.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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
(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 The auditor is unable to obtain sufficient
evidence obtained, the financial statements as appropriate audit evidence to conclude that
a whole are not free from material
the financial statements as a whole are free
misstatement; or
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.
© The Institute of Chartered Accountants of India
REPORTING 7.27
Illustrative Audit Opinion:
ILLUSTRATION 3
XYZ Ltd. is a company engaged in the manufacture of cranes. CA Sudhir is the statutory
auditor of the company for the FY 2022-23. The company has taken long term funding for
fixed capital requirements and short-term funding for its working capital requirements.
During the course of audit, CA Sudhir found that the company’s financing arrangements are
about to expire and the company is unable to re- negotiate or obtain the replacement
financing. As such the company may be unable to realize its assets and discharge its
liabilities in the normal course of business. Notes to accounts annexed to the financial
statements discuss the magnitude of financing arrangements, the expiration and the total
financing arrangements; however, the financial statements do not include discussion on the
impact or the availability of refinancing. Thus, the financial statements (and notes thereto) do
not fully disclose this fact. What kind of opinion should CA Sudhir issue in case of XYZ Ltd.?
SOLUTION
In the present case, XYZ Ltd. is unable to re- negotiate or obtain the replacement financing for its
long term and short-term funding requirements. 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, XYZ Ltd. may be unable to realize its assets and discharge its liabilities in the normal
course of business. Further, the financial statements of XYZ Ltd. do not disclose this fact adequately.
Thus, the financial statements of XYZ Ltd. are materially misstated due to the inadequate disclosure
of the material uncertainty. CA Sudhir will express a qualified opinion as the effects on the financial
statements of this inadequate disclosure are material but not pervasive to the financial statements.
The relevant extract of the Qualified Opinion Paragraph and Basis for Qualified Opinion
paragraph is as under:
Qualified Opinion
In our opinion and to the best of our information and according to the explanations given to us,
except for the incomplete disclosure of the information referred to in the Basis for Qualified Opinion
section of our report, the aforesaid standalone financial statements give the information required by
the Act in the manner so required and give a true and fair view in conformity with the accounting
principles generally accepted in India, of the state of affairs of XYZ Ltd. as at March 31, 2023, and
profit/loss, for the year ended on that date.
Basis for Qualified Opinion
As discussed in Note 6, the Company’s financing arrangements are about to expire and the
Company has been unable to conclude renegotiations or obtain replacement financing. This situation
indicates that a material uncertainty exists that may cast significant doubt on the Company’s ability
to continue as a going concern. The financial statements do not adequately disclose this matter.
© The Institute of Chartered Accountants of India
7.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
ILLUSTRATION 4
ABC Ltd. is a company engaged in the manufacture of iron and steel bars. PP & Associates
are the statutory auditors of ABC Ltd. for the FY 2022-23. During the course of audit, CA
Prakash, the engagement partner, found that the Company’s financing arrangements have
expired and the amount outstanding was payable on March 31, 2023. 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. What opinion should CA
Prakash express in case of ABC Ltd.?
SOLUTION
In the present case based on the audit evidence obtained, CA Prakash has concluded that 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, and the entity is considering bankruptcy. The
financial statements of ABC Ltd. omit the required disclosures relating to the material uncertainty.
In such circumstances, CA Prakash should express an adverse opinion because the effects on
the financial statements of such omission are material and pervasive.
The relevant extract of the Adverse Opinion Paragraph and Basis for Adverse Opinion
paragraph is as under:
Adverse Opinion
In our opinion, because of the omission of the information mentioned in the Basis for Adverse
Opinion section of our report, the accompanying financial statements do not present fairly, the
financial position of the entity as at March 31, 2023, and of its financial performance and its
cash flows for the year then ended in accordance with the Accounting Standards issued by the
Institute of Chartered Accountants of India.
Basis for Adverse Opinion
The financing arrangements of ABC Ltd. has expired and the amount outstanding was payable
on March 31, 2023. The entity has been unable to conclude re-negotiations or obtain replacement
financing and is considering filing for bankruptcy. This situation indicates that a material
uncertainty exists that may cast significant doubt on the Company’s ability to continue as a going
concern. The financial statements do not adequately disclose this fact.
© The Institute of Chartered Accountants of India
REPORTING 7.29
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.
11. 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 (where applicable)] 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.
ILLUSTRATION 5
MNO Ltd. is a power generating company having its plants in the north eastern states of the country.
For the FY 2022-23, M/s PRT & Associates are the statutory auditors of the company. During the
course of audit, the audit team was unable to obtain sufficient appropriate audit evidence about a
single element of the consolidated financial statements. That is, the auditor was also unable to obtain
audit evidence about the financial information of a joint venture investment (in XYZ Ltd.) that
represents over 90% of the entity’s net assets. What kind of opinion should the statutory auditors
issue in such case?
SOLUTION
M/s PRT & Associates are unable to obtain sufficient appropriate audit evidence about the financial
information of a joint venture investment that represents over 90% of the entity’s net assets. The
possible effects of this inability to obtain sufficient appropriate audit evidence are both material and
pervasive to the consolidated financial statements.
Therefore, the statutory auditor should issue a disclaimer of opinion.
© The Institute of Chartered Accountants of India
7.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The relevant extract of the Disclaimer of Opinion Paragraph and Basis for Disclaimer of
Opinion paragraph is as under:
Disclaimer of Opinion
We do not express an opinion on the accompanying financial statements of MNO Ltd. 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
The Group’s investment in its joint venture XYZ Company is carried at ` 95 crores on the Group’s
consolidated balance sheet, which represents over 90% of the Group’s net assets as at March 31,
2023. We were not allowed access to the management and the auditors of XYZ Company, including
XYZ Company’s auditors’ audit documentation. As a result, we were unable to determine whether
any adjustments were necessary in respect of the Group’s proportional share of XYZ Company’s
assets that it controls jointly, its proportional share of XYZ Company’s liabilities for which it is jointly
responsible, its proportional share of XYZ’s income and expenses for the year, (and the elements
making up the consolidated statement of changes in equity) and the consolidated cash flow
statement.
What is Pervasive: Pervasive is a term used in the context of misstatements, to describe the effects
on the financial statements of misstatements or the possible effects on the financial statements of
misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit
evidence.
Pervasive effects on the financial statements are those that in the auditor’s judgment:
— Are not confined to specific elements, accounts or items of the financial statements;
— If so confined, represent or could represent a substantial proportion of the financial statements; or
— In relation to disclosures, are fundamental to users’ understanding of the financial statements.
Pervasive, therefore, is that which is not localised to any one or two elements of a financial
statements, but the impact is across various elements of the financial statements.
For example, if sufficient appropriate audit evidence is not available for say Inventory but the other
elements are properly supported by documentary evidence then the non-availability of information
on Inventory is localized to possible misstatement of inventory but has no impact on the other
elements like trade receivables, PPE, loans, Trade payables etc.
Therefore, it is necessary to ascertain whether the impact of misstatement is pervasive or not pervasive.
© The Institute of Chartered Accountants of India
REPORTING 7.31
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.
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.
5.6.1 Where Auditors’ withdrawal is not permitted: The listing agreement and the Securities and
Exchange Board of India’s directive on the resignation of auditor does not permit withdrawing from
the engagement without issuing the audit / review report. The said directive contained in circular no.
CIR/CFD/CMD1/114/2019 dated October 18, 2019 issued by the Securities and Exchange Board of
India inter-alia provides that
© The Institute of Chartered Accountants of India
7.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
If the auditor proposes to resign:
a) within 45 days from the end of any of the quarters of a period covered under the appointment,
then the auditor shall, before such resignation, issue the audit / limited review report for such
quarter.
b) after 45 days from the end any of the quarters of a period covered under the appointment,
then we shall, before such resignation, issue the audit / Limited review report for such quarter
as well as the next quarter.
c) If the Limited review report has been issued for all the three quarters, then the auditor shall
issue the audit report for the full year before resigning from the engagement.
ICAI announcement on the Resignation of Auditor: The ICAI has made an announcement that
the auditor of an unlisted company shall not mention “professional pre-occupation” as a reason for
the resignation. The auditor shall mention the reasons clearly for the resignation in the resignation
letter issued to the Company.
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:
© The Institute of Chartered Accountants of India
REPORTING 7.33
(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.
ILLUSTRATION 6
CA Yash is the statutory auditor of Laksmi Vardhan Limited for the FY 2022-23. In respect of loans
and advances of ` 55,00,000/- given to Sarvagya Private Limited, the Company has not furnished
any agreement to CA Yash and in absence of the same, he is unable to verify the terms of repayment,
chargeability of interest and other terms.
What kind of opinion should CA Yash give in such situation?
SOLUTION
In the present case, with respect to loans and advances of ` 55,00,000/- given to Sarvagya
Private Limited, the Company has not furnished any agreement to CA Yash. In absence of such
agreement, CA Yash is unable to verify the terms of repayment, chargeability of interest and other
terms. For an auditor, while verifying any loans and advances, one of the most important audit
evidences is the loan agreement. Therefore, the absence of such document in the present case,
tantamount to a material misstatement in the financial statements of the company. However, the
inability of CA Yash to obtain such audit evidence is though material but not pervasive so as to
require him to give a disclaimer of opinion.
Thus, in the present case, CA Yash should give a qualified opinion
The relevant extract of the Qualified Opinion Paragraph and Basis for Qualified Opinion
paragraph is as under:
Qualified Opinion
In our opinion and to the best of our information and according to the explanations given to us,
except for the possible effects of the matter described in the Basis for Qualified Opinion section
of our report, the financial statements of Laksmi Vardhan Limited 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 on 31.03.2023 and profit/ loss for the year ended on that date.
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7.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Basis for Qualified Opinion
The Company is unable to furnish the loan agreement with respect to loans and advances of `
55,00,000/- given to Sarvagya Private Limited. Consequently, in absence of such agreement, we
are unable to verify the terms of repayment, chargeability of interest and other terms.
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:
(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].
ILLUSTRATION 7
In the financial year 2022-23, MSD Ltd. faced an extraordinary event (earthquake), which
destroyed a lot of business activity of the company. These circumstances indicate material
uncertainty on the company’s ability to continue as going concern. Due to such event it
may not be possible for the company to realize its assets or pay off the liabilities during
the regular course of its business. The financial statement and notes to the financial
statements of the company do not disclose this fact. What kind of opinion should the
statutory auditor of MSD Ltd. issue in such circumstances?
SOLUTION
In the present case, there exists a material uncertainty that cast a significant doubt on the
company’s ability to continue as going concern and the same is not disclosed in the financial
statements of MSD Ltd.
As such, the financial statements of MSD Ltd. for the FY 2022-23 are materially misstated and
the effect of the misstatement is so material and pervasive on the financial statements that giving
only a qualified opinion will be insufficient and therefore the statutory auditor of MSD Ltd. should
issue an adverse opinion.
The relevant extract of the Adverse Opinion Paragraph and Basis for Adverse Opinion
paragraph is as under:
© The Institute of Chartered Accountants of India
REPORTING 7.35
Adverse Opinion
In our opinion, because of the omission of the information mentioned in the Basis for Adverse
Opinion section of our report, the accompanying financial statements do not present fairly, the
financial position of MSD Ltd. as at March 31, 2023, and of its financial performance and its cash
flows for the year then ended in accordance with the Accounting Standards issued by the Institute
of Chartered Accountants of India.
Basis for Adverse Opinion
MSD Ltd. has faced an extraordinary event (earthquake), which destroyed a lot of business
activity of the company. Due to such event it may not be possible for the company to realize its
assets or pay off the liabilities during the regular course of its business. This situation indicates
that a material uncertainty exists that may cast significant doubt on the Company’s ability to
continue as a going concern. The financial statement and notes to the financial statements of the
company do not disclose this fact.
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.
ILLUSTRATION 8
CA Abhimanyu is the statutory auditor of PQR Ltd. for the FY 2022-23. During the course
of audit CA Abhimanyu noticed the following:
1. With respect to the debtors amounting to ` 150 crores, no balance confirmation was
received by the audit team. Further, there have been defaults on the payment obligations
by debtors on the due dates during the year under audit. The Company has created a
provision for doubtful debts to the tune of `25 Cr. during the year under audit. The
Company has stated that the provision is based on receivables which are older than 36
months, which according to the audit team is inadequate and as such the audit team is
unable to ascertain the carrying value of trade receivables.
2. Further, in respect of Inventories (which constitutes 40% of the total assets of the
company), during the reporting period, the management has not undertaken
physical verification of inventories at periodic intervals. Also, the Company has not
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7.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
maintained adequate inventory records at the factory. The audit team was unable to
undertake the physical inventory count as such the value of inventory could not be
verified.
Under the above circumstances what kind of opinion should CA Abhimanyu give?
SOLUTION
In the present case, CA Abhimanyu is unable to obtain sufficient and appropriate audit evidence
with respect to the following:
1. The balance confirmation with respect to debtors amounting to ` 150 crores is not
available. Further there has been default in payment by the debtors and the provision so
made is not adequate. The audit team is also unable ascertain the carrying value of trade
receivables.
2. With respect to 40% of the company’s inventory, neither the physical verification has been
done by the management nor are adequate inventory records maintained. The audit team
is also unable to undertake the physical inventory count as such the value of inventory
could not be verified.
In the above two circumstances the auditor is unable to obtain sufficient appropriate audit
evidence on which to base the opinion, and the possible effects on the financial statements of
undetected misstatements, if any, could be both material and pervasive.
Thus, CA Abhimanyu should give a Disclaimer of Opinion.
The relevant extract of the Disclaimer of Opinion Paragraph and Basis for Disclaimer of
Opinion paragraph is as under:
Disclaimer of Opinion
We do not express an opinion on the accompanying financial statements of PQR Ltd. 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 are unable to obtain balance confirmation with respect to the debtors amounting to ` 150
crores. Further, there have been defaults on the payment obligations by debtors on the due dates
during the year under audit. The Company has created a provision for doubtful debts to the tune
of `25 Cr. during the year under audit which is inadequate in the circumstances of the company.
The carrying value of trade receivables could not be ascertained.
© The Institute of Chartered Accountants of India
REPORTING 7.37
Further, in respect of Inventories (which constitutes 40% of the total assets of the company),
during the reporting period, the management has not undertaken physical verification of
inventories at periodic intervals. Also, the Company has not maintained adequate inventory
records at the factory. We were unable to undertake the physical inventory count and as such the
value of inventory could not be verified.
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.
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.
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7.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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;
(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.
Matrix to be considered to determine what type of modified opinion should be used by the
Auditor: When the auditor concludes that there exists a material misstatement which precludes the
auditor from issuing an un-modified opinion, the auditor must determine which type of modified
opinion is to be issued by the auditor as per SA 705 – Modifications to the Opinion in the Independent
Auditors Report. The following matrix assists the auditor in determining the type of modified opinion.
© The Institute of Chartered Accountants of India
REPORTING 7.39
Nature of Matter Giving Rise to Auditor’s judgment about the Pervasiveness of the
the Modification: Effects or Possible Effects on the Financial
Statements
Material but not pervasive Material and pervasive
Financial Statements are Qualified Opinion Adverse Opinion
materially misstated
Inability to obtain Sufficient Qualified Opinion Disclaimer of Opinion
appropriate audit evidence
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. The Auditor is required to discuss and deliberate with those charged
with governance the audit findings and the type of misstatements.
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 judgment, is of
such importance that it is fundamental to users’ understanding of the financial statements.
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7.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
12. 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.
© The Institute of Chartered Accountants of India
REPORTING 7.41
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 other appropriate
heading.
13. 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 financial
statements and the date of the auditor’s report.
• Early application (where permitted) of a new accounting standard that has a material
effect on the financial statements.
• A major catastrophe that has had, or continues to have, a significant effect on the
entity’s financial position.
ILLUSTRATION 9
In respect of the audit of BDS Ltd., the statutory auditor of the company noticed some
matters. The statutory auditor wants to draw the user’s attention towards such matters,
though his opinion is not modified in respect of such matters. Draft the relevant paragraphs
of the audit report for the following matters:
i. The company has a plan to resume its construction activities with respect to one
of its thermal power project, The activity of such power plant was suspended in the
© The Institute of Chartered Accountants of India
7.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
FY 2020-21. The thermal power project comprises of the plant and equipment
amounting to ` 5.95 crore and capital work in progress of ` 147.50 crore.
ii. The financial statements of 5 branches are included in the Standalone Financial
Statements of BDS Ltd. whose financial statements reflect total assets of ` 90
crores as at 31.03.2023 and total revenue from operations of ` 40 crores for the
year ended on that date. The financial statements of these branches have been
audited by the branch auditors.
SOLUTION
Emphasis of Matter
We draw attention to the following note of the standalone financial statements:
Note 27 regarding the plans of the Company to resume construction/developmental activities of
a thermal power project. The carrying amounts related to the project as at 31st March, 2023
comprise of plant and equipment of ` 5.95 crore and capital work in progress of ` 147.50 crore.
Our opinion is not modified in respect of this matter.
Other Matter
We did not audit the financial statements of 5 branches included in the Standalone Financial
Statements of the company whose financial statements reflect total assets of ` 90 crores as at
31.03.2023 and total revenue from operations of ` 40 crores for the year ended on that date. The
financial statements of these branches have been audited by the branch auditors whose reports
have been furnished to us, and our opinion in so far as it relates to the amounts and disclosures
included in respect of these branches, is based solely on the report of the branch auditors.
Our opinion is not modified in respect of this matter.
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.
© The Institute of Chartered Accountants of India
REPORTING 7.43
Extract of Independent Auditor’s Report – Emphasis of Matter Para & Other Matter
Note: Students are advised to refer Illustration of Emphasis of Matter Para as given in
appendix at the end of the Chapter.
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7.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Relationship between Emphasis of Matter Paragraphs and Key Audit Matters in the
Auditor’s Report
Key audit matters— Those matters that, in the Emphasis of Matter paragraph – A paragraph
auditor’s professional judgment, were of most included in the auditor’s report that refers to a
significance in the audit of the financial matter appropriately presented or disclosed in
statements of the current period. Key audit the financial statements that, in the auditor’s
matters are selected from matters judgment, is of such importance that it is
communicated with those charged with fundamental to users’ understanding of the
governance. [SA 701] financial statements. [SA 706]
Matters that are determined to be key audit A widespread use of Emphasis of Matter
matters in accordance with SA 701 may also be, paragraphs may diminish the effectiveness of
in the auditor’s judgment, fundamental to users’ the auditor’s communication about such
understanding of the financial statements. In matters.
such cases, in communicating the matter as a Use of Emphasis of Matter paragraphs is not a
key audit matter in accordance with SA 701, the substitute for a description of individual key
auditor may wish to highlight or draw further audit matters where SA 701 is applicable.
attention to its relative importance.
There may be a matter that is not determined
Communicating key audit matters provides to be a key audit matter in accordance with SA
additional information to intended users of the 701 (i.e., because it did not require significant
financial statements to assist them in auditor attention), but which, in the auditor’s
understanding those matters that, in the judgment, is fundamental to users’
auditor’s professional judgment, were of most understanding of the financial statements (e.g.,
significance in the audit and may also assist a subsequent event). If the auditor considers it
them in understanding the entity and areas of necessary to draw users’ attention to such a
significant management judgment in the audited matter, the matter is included in an Emphasis
financial statements. of Matter paragraph in the auditor’s report in
accordance with this SA.
The communication of key audit matters in the The auditor may do so by presenting the matter
auditor’s report may also provide intended more prominently than other matters in the Key
users a basis to further engage with Audit Matters section (e.g., as the first matter)
management and those charged with or by including additional information in the
governance about certain matters relating to the description of the key audit matter to indicate
entity, the audited financial statements, or the the importance of the matter to users’
audit that was performed. understanding of the financial statements.
© The Institute of Chartered Accountants of India
REPORTING 7.45
SA-706
Emphasis of Matter Paragraphs and Other Matter Paragraphs in
the Independent Auditor’s Report
Scope
• This 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
• (a) presented or disclosed in the financial statements that are of such importance that they are fundamental to users’
understanding of the financial statements; or
• (b) 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.
Objectives
• 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.
Definitions
• 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 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.
Requirements
• Emphasis of Matter Paragraphs in the Auditor’s Report
• 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.
• 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.
The auditor shall include the paragraph within a separate section with the heading “Other Matter,” or other appropriate
heading.
• Communication 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.
© The Institute of Chartered Accountants of India
7.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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. {it is clarified that emphasis of
matter is not a substitute for modification of opinion}.
The Emphasis of Matter is to be made in respect of something which is appropriately presented and
for which the auditor has obtained sufficient appropriate audit evidence.
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 the 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
© The Institute of Chartered Accountants of India
REPORTING 7.47
not automatically become a qualification. The report must categorically state the matter from the
auditor’s standpoint and not from the management stand point.
Note : Students are advised to refer examples/illustrative formats given at the end of the
Chapter for better understanding of the differences.
Test your Understanding 2
Below is draft extract of audit report of a listed company. Para (A) below reflects certain matter
stated in audit report communicated with CFO of company and Para (B) is in nature of auditor’s
response to said matter.
(A) The Company recognizes revenues when the control of goods is transferred to the customer at
the net consideration which the Company expects to receive for those goods from customers in
accordance with contracts terms and conditions.
The terms of sales arrangements based on the terms and conditions of relevant contract and nature of
discount and rebates create complexities that require judgment in determining revenues.
(B) We read the Company’s revenue recognition policy and assessed its compliance in terms of Ind
AS 115 “Revenue from contracts with customers”.
We assessed design and tested the operating effectiveness of internal controls related to sales and
rebates/discounts.
We tested on a sample basis that revenue has been recognized in the proper period with reference to
the supporting documents including confirmations from customers.
From description given above, identify what auditors are trying to report and under what heading such
matter should be reflected in audit report of the company?
TEST YOUR UNDERSTANDING 3
PTD Limited is engaged in business of executing construction contracts for its clients. There are
non-current receivables outstanding in financial statements of the company as on 31st March, 2023
for `500 crore. Such amounts represent claims raised by the company on its clients relating to cost
overruns necessitated due to delays caused by clients, change in work specifications and related
matters. Besides negotiations, the company has also gone for arbitration in some of the said cases.
The management of company has considered above amounts to be fully recoverable as stated in
notes to accounts.
© The Institute of Chartered Accountants of India
7.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CA. Piyush, auditor of the company, has relied only upon management representation in this regard.
Besides, he has decided to include the said matter in “Emphasis of Matter” Paragraph in audit report.
How do you view decision to include above matter in “Emphasis of Matter” Paragraph by auditor of
the company?
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.
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 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
© The Institute of Chartered Accountants of India
REPORTING 7.49
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.
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.
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.
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7.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
10. 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
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.
10.1 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.
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REPORTING 7.51
(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.
10.2 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.
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7.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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.
SA 710 : Comparative Information-
Corresponding Figures and Comparative
Financial Statements
Audit Procedure Audit Reporting
1. With Reference to
Assess the consistency of corresponding figures, auditor 2. With Reference to
accounting policies used opinion should refer in his opinion comparative figures
only when
Check Comparative figures with a) the auditor's opinion shall
a) if previous AR is other refer to each period for which
amount and disclosure in prior
than unqualified FS are presented and on
period
which audit opinion is
expressed
Determine that FS Contains
b) Prior period misstatement
appropriately classified b) Difference in opinion on
not addressed
comparative information previously issued FS
Evaluate the impact of possible
c) if prior period FS c) if previous FS audited by
misstatement in comparative
unaudited some other auditor, mention
information on FS
the same in AR
Obtain Written representation d) If prior period FS unaudited,
mention the same in the AR
11. SA 720 THE AUDITOR’S RESPONSIBILITIES 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
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REPORTING 7.53
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.
This SA does not apply to preliminary announcements of financial information; or securities offering
documents, including prospectuses.
Important Definition :
(a) Annual report – A document, or combination of documents, prepared typically on an annual
basis by management or those charged with governance in accordance with law, regulation or
custom, the purpose of which is to provide owners (or similar stakeholders) with information
on the entity’s operations and the entity’s financial results and financial position as set out in
the financial statements. An annual report contains or accompanies the financial statements
and the auditor’s report thereon and usually includes information about the entity’s
developments, its future outlook and risks and uncertainties, a statement by the entity’s
governing body, and reports covering governance matters.
(c) Other information – Financial or non-financial information (other than financial statements and
the auditor’s report thereon) included in an entity’s annual report.
11.1 Objective
The objectives of the auditor, having read the other information, are:
(a) To consider whether there is a material inconsistency between the other information and the
financial statements;
(b) To consider whether there is a material inconsistency between the other information and the
auditor’s knowledge obtained in the audit;
(c) To respond appropriately when the auditor identifies that such material inconsistencies
appear to exist, or when the auditor otherwise becomes aware that other information appears
to be materially misstated; and
(d) To report in accordance with this SA.
© The Institute of Chartered Accountants of India
7.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Other information may include amounts or other items that are intended to be the same as, to
summarize, or to provide greater detail, about amounts or other items in the financial statements,
and other amounts or other items about which the auditor has obtained knowledge in the audit. Other
information may also include other matters.
11.2 Obtaining the Other Information
The auditor shall:
(a) Determine, through discussion with management, which document(s) comprises the annual
report, and the entity’s planned manner and timing of the issuance of such document(s);
(b) Make appropriate arrangements with management to obtain in a timely manner and, if possible,
prior to the date of the auditor’s report, the final version of the document(s) comprising the
annual report; and
(c) When some or all of the document(s) determined in (a) will not be available until after the date
of the auditor’s report, request management to provide a written representation that the final
version of the document(s) will be provided to the auditor when available, and prior to its
issuance by the entity, such that the auditor can complete the procedures required by this SA.
Reading and Considering the Other Information
The auditor shall read the other information and, in doing so shall:
(a) Consider whether there is a material inconsistency between the other information and the
financial statements. As the basis for this consideration, the auditor shall, to evaluate their
consistency, compare selected amounts or other items in the other information (that are
intended to be the same as, to summarize, or to provide greater detail about, the amounts or
other items in the financial statements) with such amounts or other items in the financial
statements; and (Ref: Para. A25–A29)
(b) Consider whether there is a material inconsistency between the other information and the
auditor’s knowledge obtained in the audit, in the context of audit evidence obtained and
conclusions reached in the audit. (Ref: Para. A30–A36)
While reading the other information in accordance with above, the auditor shall remain alert for
indications that the other information not related to the financial statements or the auditor’s
knowledge obtained in the audit appears to be materially misstated.
© The Institute of Chartered Accountants of India
REPORTING 7.55
11.3 Responding When a Material Inconsistency Appears to Exist or Other
Information Appears to Be Materially Misstated
If the auditor identifies that a material inconsistency appears to exist (or becomes aware that the
other information appears to be materially misstated), the auditor shall discuss the matter with
management and, if necessary, perform other procedures to conclude whether:
(a) A material misstatement of the other information exists;
(b) A material misstatement of the financial statements exists; or
(c) The auditor’s understanding of the entity and its environment needs to be updated.
11.4 Responding When the Auditor Concludes That a Material
Misstatement of the Other Information Exists
11.4.1 If the auditor concludes that a material misstatement of the other information exists, the
auditor shall request management to correct the other information. If management:
(a) Agrees to make the correction, the auditor shall determine that the correction has been made;
or
(b) Refuses to make the correction, the auditor shall communicate the matter with those charged
with governance and request that the correction be made.
11.4.2 If the auditor concludes that a material misstatement exists in other information obtained prior
to the date of the auditor’s report, and the other information is not corrected after communicating
with those charged with governance, the auditor shall take appropriate action, including:
(a) Considering the implications for the auditor’s report and communicating with those charged
with governance about how the auditor plans to address the material misstatement in the
auditor’s report.
(b) Withdrawing from the engagement, where withdrawal is possible under applicable law or
regulation.
11.4.3 If the auditor concludes that a material misstatement exists in other information obtained after
the date of the auditor’s report, the auditor shall:
(a) If the other information is corrected, perform the procedures necessary in the circumstances;
or
(b) If the other information is not corrected after communicating with those charged with
governance, take appropriate action considering the auditor’s legal rights and obligations, to
seek to have the uncorrected material misstatement appropriately brought to the attention of
users for whom the auditor’s report is prepared.
© The Institute of Chartered Accountants of India
7.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
11.5 Responding When a Material Misstatement in the Financial
Statements Exists or the Auditor’s Understanding of the Entity and
Its Environment Needs to Be Updated
If, as a result of performing the procedures discussed in 11.2, the auditor concludes that a material
misstatement in the financial statements exists or the auditor’s understanding of the entity and its
environment needs to be updated, the auditor shall respond appropriately in accordance with the
other SAs.
11.6 Reporting
The auditor’s report shall include a separate section with a heading “Other Information”, or other
appropriate heading, when, at the date of the auditor’s report:
(a) For an audit of financial statements of a listed entity, the auditor has obtained, or expects to
obtain, the other information; or
(b) For an audit of financial statements of an unlisted corporate entity, the auditor has obtained
some or all of the other information. (Ref: Para. A52)
When the auditor’s report is required to include an Other Information section, this section shall
include:
(a) A statement that management is responsible for the other information;
(b) An identification of:
(i) Other information, if any, obtained by the auditor prior to the date of the auditor’s report; and
(ii) For an audit of financial statements of a listed entity, other information, if any, expected to be
obtained after the date of the auditor’s report;
(c) A statement that the auditor’s opinion does not cover the other information and, accordingly,
that the auditor does not express (or will not express) an audit opinion or any form of assurance
conclusion thereon;
(d) A description of the auditor’s responsibilities relating to reading, considering and reporting on
other information as required by this SA; and
(e) When other information has been obtained prior to the date of the auditor’s report, either:
(i) A statement that the auditor has nothing to report; or
(ii) If the auditor has concluded that there is an uncorrected material misstatement of the other
information, a statement that describes the uncorrected material misstatement of the other information.
When the auditor expresses a qualified or adverse opinion in accordance with SA 705 (Revised),
Modifications to the Opinion in the Independent Auditor’s Report the auditor shall consider the
implications of the matter giving rise to the modification of opinion for the statement required.
© The Institute of Chartered Accountants of India
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11.7 Reporting Prescribed by Law or Regulation
If the auditor is required by a relevant law or regulation to refer to the other information in the
auditor’s report using a specific layout or wording, the auditor’s report shall refer to Standards on
Auditing only if the auditor’s report includes, at a minimum:
(a) Identification of the other information obtained by the auditor prior to the date of the auditor’s
report;
(b) A description of the auditor’s responsibilities with respect to the other information; and
(c) An explicit statement addressing the outcome of the auditor’s work for this purpose.
(Note: Students are advised to refer Series of SA 700 on Audit Reporting and Conclusion for
better understanding)
SA 720- " The Auditor's Responsibilities Relating to Other Information"
Objectives Requireme
Scope of
of the Definitions nts of the
the SA
Auditor SA
Deals with This SA does To consider whether Obtaining the
auditor's not apply to : there is material Other
responsibilities inconsistency between Other Information.
relating to other information and Information:
other financial statements. Financial or
Preliminary Reading and
information, non Financial considering the
whether announcements information
of financial To consider whether there other
financial or (other than information.
non financial, information or is material inconsistency financial
included in between other information statements
entity's annual and auditor's knowledge and the Responding when a
report. Securities obtained in the audit auditor's material Inconsistency
offering report appears to exist or other
documents, thereon) information appears to
including To respond appropriately included in be materially misstated.
prospectuses. when auditor identifies an entity's
material inconsistencies or annual report.
other information appears to 4. Responding when the
be materially misstated. auditor concludes that a
material misstatement of the
To report in other information exists.
accordance
with this SA.
5. Responding when a material
misstatement in the financial statements
exists or auditor's understanding of the
entity and its environment needs to be
updated.
6. Reporting and
Documentation
© The Institute of Chartered Accountants of India
7.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
12. 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).”
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.
© The Institute of Chartered Accountants of India
REPORTING 7.59
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;
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7.60 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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:-
(1) whether the company has disclosed the impact, if any, of pending litigations on its
financial position in its financial statement;
(2) 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;
(3) whether there has been any delay in transferring amounts, required to be transferred,
to the Investor Education and Protection Fund by the company.
(4) (i) Whether the management has represented that, to the best of it’s knowledge
and belief, other than as disclosed in the notes to the accounts, no funds have
been advanced or loaned or invested (either from borrowed funds or share
premium or any other sources or kind of funds) by the company to or in any
other person(s) or entity(ies), including foreign entities (“Intermediaries”), with
the understanding, whether recorded in writing or otherwise, that the
Intermediary shall, whether, directly or indirectly lend or invest in other persons
or entities identified in any manner whatsoever by or on behalf of the company
(“Ultimate Beneficiaries”) or provide any guarantee, security or the like on
behalf of the Ultimate Beneficiaries;
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REPORTING 7.61
(ii) Whether the management has represented, that, to the best of it’s knowledge
and belief, other than as disclosed in the notes to the accounts, no funds have
been received by the company from any person(s) or entity(ies), including
foreign entities (“Funding Parties”), with the understanding, whether recorded
in writing or otherwise, that the company shall, whether, directly or indirectly,
lend or invest in other persons or entities identified in any manner whatsoever
by or on behalf of the Funding Party (“Ultimate Beneficiaries”) or provide any
guarantee, security or the like on behalf of the Ultimate Beneficiaries; and
(iii) Based on such audit procedures that the auditor has considered reasonable
and appropriate in the circumstances, nothing has come to their notice that has
caused them to believe that the representations under sub-clause (i) and (ii)
contain any material mis-statement.
(5) Whether the dividend declared or paid during the year by the company is in compliance
with section 123 of the Companies Act, 2013.
(6) Whether the company has used such accounting software for maintaining its books
of account which has a feature of recording audit trail (edit log) facility and the same
has been operated throughout the year for all transactions recorded in the software
and the audit trail feature has not been tampered with and the audit trail has been
preserved by the company as per the statutory requirements for record retention.]
Audit Trail means, a step-by-step sequential record which provides evidence of the
documented history of financial transactions to its source. An auditor can trace every step
of, the financial data of a particular transaction right from the general ledger to its source
document with the help of the audit trail.
Note: Students may refer Guidance note on Reporting under section 143(3)(f) and (h) of the
Companies Act, 2013 for better understanding.]
The Companies (Amendment) Act, 2017 effective 12-09-2018 inserted Section 197(16) of the
Companies Act, 2013 that requires as under:
“The auditor of the company shall, in his report under section 143, make a statement as to whether
the remuneration paid by the company to its directors is in accordance with the provisions of this
section, whether remuneration paid to any director is in excess of the limit laid down under this
section and give such other details as may be prescribed”.
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7.62 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
As per Advisory issued by ICAI on 09-09-2019, the aforesaid reporting requirement for auditors of
public companies needs to be covered in auditor’s report under the Section “Report on Other Legal
and Regulatory Requirements”. Accordingly, auditors of public companies are advised to comply
with the aforesaid reporting requirements in their auditor’s reports.
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.
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;
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REPORTING 7.63
(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 (b) Approximate amount (c) Parties involved.
description; involved; and
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.
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; (d) Remedial actions taken.
and
© The Institute of Chartered Accountants of India
7.64 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Fraud Reporting
[Section 143(12) of Companies Act, 2013 & Rule 13 of CAAR, 2014]
Fraud involving amount of Fraud involving amount of
less than ` 1 crore ` 1 crore or above
Auditor to Report to Company bound to Auditor to Report to Central Government
Board/ disclose certain in following manner:
Audit Committee specified details in
Board's Report such
as: Within 2 days of
Within 2 days of (a) Nature of Fraud knowledge of fraud,
knowledge of fraud, with description;
(b) Approximate Report to Board/
Report the following amount involved; Audit Committee
matters: (c) Parties involved, if
(a) Nature of Fraud remedial action not
with description; taken; and Seek reply
(b) Approximate (d) Remedial actions within 45 days
amount involved; and taken.
(c) Parties involved.
Reply/observations Reply/observations not
received within received within stipulated
stipulated time time
Forward Forward
Report+Reply/ Report+Note
observations+Comments containing details of
to CG report for which
within 15 days of receipt of failed to receive any
such reply/observations reply/observations
to CG
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
practice does not comply with the provisions of sub-section (12) of section 143, he shall be liable to
a penalty of five lakh rupees in case of a listed company and a penalty of one lakh rupees in case
of any other company.
The auditor is also required to report under clause (xi) of paragraph 3 of Companies (Auditor’s
Report) Order, 2020 [CARO, 2020] on whether any fraud by the company or any fraud on the
Company has been noticed or reported during the year. If yes, the nature and the amount involved
is to be indicated.
© The Institute of Chartered Accountants of India
REPORTING 7.65
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 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.]
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)
© The Institute of Chartered Accountants of India
7.66 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
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.
12.1 Reporting Under CARO, 2020
In exercise of the powers conferred by section 143(11) of the Companies Act, 2013, the Central
Government, after consultation with the National Financial Reporting Authority constituted under
section 132 of the Companies Act, 2013, has issued the Companies (Auditor’s Report) Order, 2020,
(CARO, 20) dated 25th February, 2020.
1. Applicability of the Order: The CARO, 2020 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, 2013. However, the Order specifically exempts the
following classes of companies:
Private limited
company
subject to Banking
fulfilment of company
specified
conditions
Exempted
Small company
as per the Classes of Insurance
company
Companies Act Companies
Company
licensed to
One Person
operate under
Company
section 8 of the
Companies Act
© The Institute of Chartered Accountants of India
REPORTING 7.67
(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.
It may be noted that the Order shall not apply to the auditor’s report on consolidated financial
statements except clause (xxi) of paragraph 3.
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) (A) whether the company is maintaining proper records showing full
particulars, including quantitative details and situation of Property, Plant
and Equipment;
(B) whether the company is maintaining proper records showing full
particulars of intangible assets;
(b) whether these Property, Plant and Equipment 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 all the immovable properties (other than
properties where the company is the lessee and the lease agreements
are duly executed in favour of the lessee) disclosed in the financial
© The Institute of Chartered Accountants of India
7.68 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
statements are held in the name of the company, if not, provide the
details thereof in the format below:-
Description Gross Held in name Whether Period held – Reason for
of property carrying of promoter, indicate not being
value director or range, where held in name
their appropriate of company*
relative or
employee
- - - - - *also
indicate if
in dispute
(d) whether the company has revalued its Property, Plant and Equipment
(including Right of Use assets) or intangible assets or both during the
year and, if so, whether the revaluation is based on the valuation by a
Registered Valuer; specify the amount of change, if change is 10% or
more in the aggregate of the net carrying value of each class of Property,
Plant and Equipment or intangible assets;
(e) whether any proceedings have been initiated or are pending against the
company for holding any benami property under the Benami
Transactions (Prohibition) Act, 1988 (45 of 1988) and rules made
thereunder, if so, whether the company has appropriately disclosed the
details in its financial statements;
(ii) (a) whether physical verification of inventory has been conducted at reasonable
intervals by the management and whether, in the opinion of the auditor, the
coverage and procedure of such verification by the management is appropriate;
whether any discrepancies of 10% or more in the aggregate for each class of
inventory were noticed and if so, whether they have been properly dealt with in
the books of account;
(b) whether during any point of time of the year, the company has been sanctioned
working capital limits in excess of five crore rupees, in aggregate, from banks
or financial institutions on the basis of security of current assets; whether the
quarterly returns or statements filed by the company with such banks or
financial institutions are in agreement with the books of account of the
Company, if not, give details;
(iii) whether during the year the company has made investments in, provided any
guarantee or security or granted any loans or advances in the nature of loans, secured
or unsecured, to companies, firms, Limited Liability Partnerships or any other parties,
if so,-
© The Institute of Chartered Accountants of India
REPORTING 7.69
(a) whether during the year the company has provided loans or provided advances
in the nature of loans, or stood guarantee, or provided security to any other
entity [not applicable to companies whose principal business is to give loans],
if so, indicate-
(A) the aggregate amount during the year, and balance outstanding at the
balance sheet date with respect to such loans or advances and
guarantees or security to subsidiaries, joint ventures and associates;
(B) the aggregate amount during the year, and balance outstanding at the
balance sheet date with respect to such loans or advances and
guarantees or security to parties other than subsidiaries, joint ventures
and associates;
(b) whether the investments made, guarantees provided, security given and
the terms and conditions of the grant of all loans and advances in the
nature of loans and guarantees provided are not prejudicial to the
company’s interest;
(c) in respect of loans and advances in the nature of loans, whether the
schedule of repayment of principal and payment of interest has been
stipulated and whether the repayments or receipts are regular;
(d) 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;
(e) whether any loan or advance in the nature of loan granted which has
fallen due during the year, has been renewed or extended or fresh loans
granted to settle the overdues of existing loans given to the same
parties, if so, specify the aggregate amount of such dues renewed or
extended or settled by fresh loans and the percentage of the aggregate
to the total loans or advances in the nature of loans granted during the
year [not applicable to companies whose principal business is to give
loans];
(f) whether the company has granted any loans or advances in the nature
of loans either repayable on demand or without specifying any terms or
period of repayment, if so, specify the aggregate amount, percentage
thereof to the total loans granted, aggregate amount of loans granted to
Promoters, related parties as defined in clause (76) of section 2 of the
Companies Act, 2013;
(iv) in respect of loans, investments, guarantees, and security, whether provisions of
sections 185 and 186 of the Companies Act have been complied with, if not, provide
the details thereof;
© The Institute of Chartered Accountants of India
7.70 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(v) in respect of deposits accepted by the company or amounts which are deemed to be
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
and the rules made thereunder, 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 sub-section (1) of section 148 of the Companies Act 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 Goods and Services Tax, provident fund, employees' state insurance,
income-tax, sales-tax, 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 statutory dues referred to in sub-clause (a) 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 any transactions not recorded in the books of account have been surrendered
or disclosed as income during the year in the tax assessments under the Income Tax
Act, 1961 (43 of 1961), if so, whether the previously unrecorded income has been
properly recorded in the books of account during the year;
(ix) (a) whether the company has defaulted in repayment of loans or other borrowings
or in the payment of interest thereon to any lender, if yes, the period and the
amount of default to be reported as per the format below:-
Nature of Name of Amount Whether No. of Remarks,
borrowing, lender* not principal days if any
including paid on or delay
debt due interest or
securities date unpaid
*lender wise
details to be
provided in
case of
defaults to
banks,
© The Institute of Chartered Accountants of India
REPORTING 7.71
financial
institutions
and
Government.
(b) whether the company is a declared wilful defaulter by any bank or financial
institution or other lender;
(c) whether term loans were applied for the purpose for which the loans were
obtained; if not, the amount of loan so diverted and the purpose for which it is
used may be reported;
(d) whether funds raised on short term basis have been utilised for long term
purposes, if yes, the nature and amount to be indicated;
(e) whether the company has taken any funds from any entity or person on account
of or to meet the obligations of its subsidiaries, associates or joint ventures, if
so, details thereof with nature of such transactions and the amount in each
case;
(f) whether the company has raised loans during the year on the pledge of
securities held in its subsidiaries, joint ventures or associate companies, if so,
give details thereof and also report if the company has defaulted in repayment
of such loans raised;
(x) (a) whether moneys raised by way of initial public offer or further public offer
(including debt instruments) during the year 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;
(b) whether the company has made any preferential allotment or private placement
of shares or convertible debentures (fully, partially or optionally convertible)
during the year and if so, whether the requirements of section 42 and section
62 of the Companies Act, 2013 have been complied with and the funds raised
have been used for the purposes for which the funds were raised, if not, provide
details in respect of amount involved and nature of non-compliance;
(xi) (a) whether any fraud by the company or any fraud on the company has been
noticed or reported during the year, if yes, the nature and the amount involved
is to be indicated;
(b) whether any report under sub-section (12) of section 143 of the Companies Act
has been filed by the auditors in Form ADT-4 as prescribed under rule 13 of
Companies (Audit and Auditors) Rules, 2014 with the Central Government;
(c) whether the auditor has considered whistle-blower complaints, if any, received
during the year by the company;
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7.72 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(xii) (a) whether the Nidhi Company has complied with the Net Owned Funds to
Deposits in the ratio of 1:20 to meet out the liability;
(b) whether the Nidhi Company is maintaining ten per cent. unencumbered term
deposits as specified in the Nidhi Rules, 2014 to meet out the liability;
(c) whether there has been any default in payment of interest on deposits or
repayment thereof for any period and if so, the details thereof;
(xiii) whether all transactions with the related parties are in compliance with sections 177
and 188 of Companies Act where applicable and the details have been disclosed in
the financial statements, etc., as required by the applicable accounting standards;
(xiv) (a) whether the company has an internal audit system commensurate with the size
and nature of its business;
(b) whether the reports of the Internal Auditors for the period under audit were
considered by the statutory auditor;
(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 have been complied with;
(xvi) (a) whether the company is required to be registered under section 45-IA of the
Reserve Bank of India Act, 1934 (2 of 1934) and if so, whether the registration
has been obtained;
(b) whether the company has conducted any Non-Banking Financial or Housing
Finance activities without a valid Certificate of Registration (CoR) from the
Reserve Bank of India as per the Reserve Bank of India Act, 1934;
(c) whether the company is a Core Investment Company (CIC) as defined in the
regulations made by the Reserve Bank of India, if so, whether it continues to
fulfil the criteria of a CIC, and in case the company is an exempted or
unregistered CIC, whether it continues to fulfil such criteria;
(d) whether the Group has more than one CIC as part of the Group, if yes, indicate
the number of CICs which are part of the Group;
(xvii) whether the company has incurred cash losses in the financial year and in the
immediately preceding financial year, if so, state the amount of cash losses;
(xviii) whether there has been any resignation of the statutory auditors during the year, if so,
whether the auditor has taken into consideration the issues, objections or concerns
raised by the outgoing auditors;
(xix) on the basis of the financial ratios, ageing and expected dates of realisation of financial
assets and payment of financial liabilities, other information accompanying the
© The Institute of Chartered Accountants of India
REPORTING 7.73
financial statements, the auditor’s knowledge of the Board of Directors and
management plans, whether the auditor is of the opinion that no material uncertainty
exists as on the date of the audit report that company is capable of meeting its liabilities
existing at the date of balance sheet as and when they fall due within a period of one
year from the balance sheet date;
(xx) (a) whether, in respect of other than ongoing projects, the company has transferred
unspent amount to a Fund specified in Schedule VII to the Companies Act
within a period of six months of the expiry of the financial year in compliance
with second proviso to sub-section (5) of section 135 of the said Act;
(b) whether any amount remaining unspent under sub-section (5) of section 135 of
the Companies Act, pursuant to any ongoing project, has been transferred to
special account in compliance with the provision of sub-section (6) of section
135 of the said Act;
(xxi) whether there have been any qualifications or adverse remarks by the respective
auditors in the Companies (Auditor's Report) Order (CARO) reports of the companies
included in the consolidated financial statements, if yes, indicate the details of the
companies and the paragraph numbers of the CARO report containing the
qualifications or adverse remarks.
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.
13. 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,
© The Institute of Chartered Accountants of India
7.74 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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
st
generally accepted in India, of the state of affairs of the Company as at March 31 , 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.]
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.
© The Institute of Chartered Accountants of India
REPORTING 7.75
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.
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 Institute of Chartered Accountants of India
7.76 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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
st
31 , 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.
© The Institute of Chartered Accountants of India
REPORTING 7.77
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
st
of the Company as at March 31 , 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 Institute of Chartered Accountants of India
7.78 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
(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
© The Institute of Chartered Accountants of India
REPORTING 7.79
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).
• 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)1 for the year then ended, and notes to the financial statements, including a summary
of significant accounting policies.
1
Where applicable.
© The Institute of Chartered Accountants of India
7.80 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
Responsibilities of Management and Those Charged with Governance for the Financial
Statements2
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.
Auditor’s Responsibilities for the Audit of the Financial Statements
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.
2
Or other terms that are appropriate in the context of the legal framework of the particular entity.
© The Institute of Chartered Accountants of India
REPORTING 7.81
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
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.3
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
For purposes of this illustrative auditor’s report, the following circumstances are assumed:
• 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. 4
3 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.
4 SA 210, Agreeing the Terms of Audit Engagements
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7.82 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• 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.
• 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).
• Key audit matters have been communicated in accordance with SA 701.
• Those responsible for oversight of the financial statements differ from those responsible
for the preparation of the financial statements.
• 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 Statements 5
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) 6 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)) 7.
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 31 st, 2XXX
and profit/loss, (changes in equity) and its cash flows for the year ended on that date.
Basis for Qualified Opinion
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
5 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.
6 As may be applicable.
7 As may be applicable.
© The Institute of Chartered Accountants of India
REPORTING 7.83
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
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 terms of the audit engagement reflect the description of management’s responsibility
for the financial statements in SA 210.
• The auditor was unable to obtain sufficient appropriate audit evidence about multiple
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7.84 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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
• Those responsible for oversight of the financial statements differ from those responsible
for the preparation of the financial statements.
• 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.
Report on the Audit of the Financial Statements 8
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) 9 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
8 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.
9 Where applicable.
© The Institute of Chartered Accountants of India
REPORTING 7.85
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) 10.
Auditor’s Responsibilities for the Audit of the Financial Statements
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.
Illustration of an Auditor’s Report that Includes a Key Audit Matters Section, an Emphasis
of Matter Paragraph, and an Other Matter Paragraph
For purposes of this illustrative auditor’s report, the following circumstances are assumed:
• 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.
• 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.
• 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).
• Between the date of the financial statements and the date of the auditor’s report, there was
10
Where applicable.
© The Institute of Chartered Accountants of India
7.86 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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.
• Those responsible for oversight of the financial statements differ from those responsible
for the preparation of the financial statements.
• 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 Statements 11
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)) 12.
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
11 1The 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.
12 As may be applicable
© The Institute of Chartered Accountants of India
REPORTING 7.87
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 13
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
For purposes of this illustrative auditor’s report, the following circumstances are assumed:
• 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..
• 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.
• 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.
• 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).
• 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.
As noted in paragraph A16, an Emphasis of Matter paragraph may be presented either directly before or after the Key Audit
13
Matters section based on the auditor’s judgment as to the relative significance of the information included in the Emphasis of
Matter paragraph.
© The Institute of Chartered Accountants of India
7.88 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• 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.
• 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 Statements 14
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.
Basis for Qualified Opinion
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.
14The 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 Institute of Chartered Accountants of India
REPORTING 7.89
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.
Integrated Case Scenario
CA. Raghav is in midst of finalizing audit reports of five clients. On reviewing each file, it is noticed
as under: -
[A] In case of a company engaged in business of selling of agricultural products which are outside
ambit of GST, engagement team has found that substantial part of revenues of the company (about
80%) is generated through cash sales. However, there is no proper system and internal control to
verify accuracy of revenues generated through cash sales. Therefore, team has been unable to
verify such revenues generated through cash sales.
[B] TS Limited has been dragged to court by BS Limited for stealing its trade secrets using cyber
theft and filed a claim for `50 crore. On reviewing audit file of TS Limited, CA Raghav finds that legal
opinion of company’s standing counsel is ambiguous. There are precedent case laws both in favour
and against on such issue. The financial statements of TS Limited are silent on this litigation matter.
[C] It is noticed on review of audit file of a client that net profit before tax was `2 crore on a
turnover of `100 crore. There is an export receivable from a chain of stores outstanding in financial
statements of `3 crore for which there is no chance of recovery. The said chain of stores has gone
bankrupt. There is also no hope of recovering money through ECGC (Export credit Guarantee
Corporation) due to certain technical issues. Debt has not been written off by the client despite being
communicated to client.
[D] On reviewing file of a small finance bank, it was noticed that team has drafted following para
proposed to be included under Emphasis of Matter paragraph: -
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7.90 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
“Concerns are raised regarding “Going Concern” status of the Bank. However, the Bank feels that it
continues to remain a “Going Concern” in view of reasons stated in note 10.
Our opinion is not modified in respect of this matter.”
[E] On reviewing file of a client, it is noticed that team was not informed about finished goods of
`1 crore lying at a location taken on rent in February 2023. The said issue was flagged at time of
reconciling inventories by the team. Hence, team could not attend physical inventory counting. The
alternative procedures cannot be performed in absence of adequate records pertaining to above
location. Total inventories reflected in financial statements is ` 8 crores. PBT of client is `10 crores.
Based upon above, answer the following questions: -
1. As regards description regarding revenues generated through cash sales of a
company, which of the following statements is most appropriate in terms of SA 705?
(a) Qualified opinion will be issued and basis for qualified opinion will also be provided.
(b) Adverse opinion will be issued and basis for adverse opinion will also be provided.
(c) A disclaimer of opinion will be issued and basis for disclaimer of opinion will also be provided.
Besides, statement in audit report will be changed from “financial statements have been audited” to
“auditor was engaged to audit financial statements.”
(d) A disclaimer of opinion will be issued and basis for disclaimer of opinion will also be provided.
Besides, statement in audit report will be changed from “financial statements have been audited” to
“financial statements have not been audited.”
2. Considering litigation matter of TS Limited, which of the following statements is most
appropriate in this regard?
(a) Unmodified opinion needs to be expressed by auditor.
(b) It amounts to non-disclosure of a material contingent liability by the company. Adverse
opinion needs to be expressed by auditor.
(c) It amounts to non-disclosure of a material contingent liability by the company. Qualified
opinion needs to be expressed by auditor.
(d) The company has not made a material provision resulting in material misstatement. Adverse
opinion needs to be expressed by auditor.
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REPORTING 7.91
3. Considering description of issue regarding non-recoverability of export receivable of
`3 crore from a chain of stores, which type of opinion is appropriate to be issued in audit
report?
(a) Disclaimer of opinion
(b) Unmodified opinion
(c) Qualified opinion
(d) Adverse opinion
4. As regards matter of going concern in respect of a small finance Bank, which of the
following statements is most appropriate?
(a) The para drafted by team is proper and in accordance with SA 570 since auditor has decided
to give unmodified opinion.
(b) The para drafted by team is proper and in accordance with SA 570 since matter has been
disclosed in notes to accounts by bank management.
(c) Instead of giving emphasis of matter paragraph, separate paragraph on ‘Material Uncertainty
Related to Going Concern’ in report should be given in accordance with SA 570.
(d) Separate paragraph on ‘Material Uncertainty Related to Going Concern’ under the heading
“Emphasis of matter” paragraph in report should be given in accordance with SA 570.
5. Regarding issue of not informing team regarding inventory of finished goods lying at
a location taken on rent in February 2023, which type of opinion is appropriate to be issued
in case of this client?
(a) Modified opinion
(b) Qualified opinion
(c) Unmodified opinion
(d) Either Modified or Qualified opinion
Key Takeaways
SA 700 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.
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7.92 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The objectives of the auditor in accordance with SA 700 are to form an opinion on the financial
statements based on an evaluation of the conclusions drawn from the audit evidence obtained
and to express clearly that opinion through a written report.
As per SA 700, the auditor’s report shall be in writing and shall include the basic elements
which ordinarily includes in case of auditors’ Report for audits conducted in accordance with
Standards on Auditing
SA 701 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 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.
It is mandatory to communicate key audit matters in audits of complete sets of general
purpose financial statements of listed entities in accordance with SA 701.
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, the auditor concludes that a
modification to the auditor’s opinion on the financial statements is necessary.
The auditor shall express a qualified opinion when 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 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.
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.
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 Institute of Chartered Accountants of India
REPORTING 7.93
SA 706 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.
“Emphasis of Matter” paragraph is 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
judgment, is of such importance that it is fundamental to users’ understanding of the financial
statements.
“Other Matter Paragraph” is 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.
SA 710 deals with the auditor’s responsibilities regarding comparative information in an audit
of financial statements.
Comparative information refers to the amounts and disclosures included in the financial
statements in respect of one or more prior periods in accordance with the applicable financial
reporting framework.
SA 720 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.
SA 720 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.
© The Institute of Chartered Accountants of India
7.94 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
FOR SHORTCUT TO ENGAGEMENT & QUALITY CONTROLS STANDARDS
WISDOM: SCAN ME !
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.
5. “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.” As an expert you are required to brief the special considerations required for
expressing:
(a) Qualified Opinion;
(b) Adverse Opinion and
(c) Disclaimer of Opinion.
© The Institute of Chartered Accountants of India
REPORTING 7.95
6. ADKS & Co LLP are the newly appointed statutory auditors of PKK Ltd. During the course of
audit, the statutory auditors have come across certain significant observations which they
believe could lead to material misstatement of financial statements. Management has a
different view and does not concur with the view of the statutory auditors. Considering this
the statutory auditors are determining as to how to address these observations in terms of
their reporting requirement. Please advise.
7. 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 2023 after doing all appointment formalities wherein auditors are required to
ensure compliance with Standards on Auditing and Internal Standards on Auditing.
As an expert you are required to advise the auditor about the requirements regarding auditor’s
report for audits conducted in accordance with both Standards on Auditing issued by ICAI
and International Standards on Auditing.
8. TUV Ltd. is a company engaged in the business of manufacture of spare parts. Saroj &
Associates are the statutory auditors of the company for the FY 2022-23. During the course
of audit, CA Saroj noticed that the company had a major customer, namely, Korean Mart from
South Korea. Owing to an outbreak of war and subsequent destruction leading to government
ban on import and export in South Korea, the demand from Korean Mart for the products of
TUV Ltd. ended for an unforeseeable time period. When discussed with the management, CA
Saroj was told that the company is in the process of identifying new customers for their
products. CA Saroj understands that though the use of going concern assumption is
appropriate but a material uncertainty exists with respect to the identification of new
customers. This fact is duly reflected in the financial statements of TUV Ltd. for the FY 2022-
23. How should CA Saroj deal with this matter in the auditor’s report for the FY 2022-23?
9. Sun Moon Ltd. is a power generating company which uses coal as raw material for its power
generating plant. The company has been allotted coal blocks in the state of Jharkhand and
Odisha. During the FY 2022-23, a scam regarding allotment of coal blocks was unveiled
leading to a ban on the allotment of coal blocks to various companies including Sun Moon
Ltd. This happened in the month of December 2023 and as such entire power generation
© The Institute of Chartered Accountants of India
7.96 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
process of Sun Moon Ltd, came to a halt in that month. As a result of such ban, and the
resultant stoppage of the production process, many key managerial personnel of the company
left the company. There were delays in the of payment of wages and salaries and the banks
from whom the company had taken funds for project financing also decided not to extend
further finance or to fund further working capital requirements of the company.
Further, when discussed with the management, the statutory auditor understood that the
company had no action plan to mitigate such circumstances. Further, all such circumstances
were not reflected the financial statements of Sun Moon Ltd. What course of action should
the statutory auditor of the company consider in such situation?
10. CA Omkar is the statutory auditor of Sabhyata Ltd. for the FY 2022-23. The company is
engaged in the business of manufacture of floor tiles. During the course of audit, CA Omkar
obtained certain audit evidence which were not consistent with the affirmation made in the
financial statements. Discuss as to how CA Omkar should deal with the situation in the
auditor’s report.
Answers to Test your Understanding
1. Such matters are in nature of auditor’s responsibilities and are stated in “The Auditor’s
Responsibilities for the Audit of the Financial Statements” section of the auditor’s report in
accordance with SA 700. Communication of significant audit findings and deficiencies
identified in internal control to those charged with governance is one of important
responsibilities of auditor.
Such communication assists those charged with governance in fulfilling their responsibility to
oversee the financial reporting process and in fulfilling their oversight responsibilities.
2. The above matter is in nature of Key audit matter and should be stated under heading “Key
audit matters” in audit report. 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. Key audit matters are selected from matters communicated with those
charged with governance.
SA 701 states that 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, significant auditor judgments relating to
areas in the financial statements that involved significant management judgment including
© The Institute of Chartered Accountants of India
REPORTING 7.97
accounting estimates that have been identified as having high estimation uncertainty be taken
into account.
The above described matter relates to revenue recognition and creation of complexities
requiring judgment in revenues. Further, the description also describes how the matter was
addressed by auditors by performing various audit procedures in accordance with SA 701.
3. In accordance with SA 706, Emphasis of Matter Paragraph is 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 judgment, is of such importance that it is fundamental to
users’ understanding of the financial statements.
As per SA 706, 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.
Further, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report
provided the auditor would not be required to modify the opinion in accordance with SA 705
as a result of the matter.
In the given situation, auditor has relied upon management representation letter only. He has
not performed any other audit procedures like verifying contracts with customers, status of
arbitration proceedings etc. Since management representations by themselves do not
constitute sufficient appropriate evidence, performing necessary audit procedures may lead
auditor to conclude that modification in opinion is necessary. In such circumstances, matter
cannot be included in Emphasis of matter Paragraph.
Therefore, auditor should form his opinion by performing necessary audit procedures and
obtaining sufficient appropriate evidence. It is only when he concludes that modification of
opinion is not required as a result of said matter in terms of SA 705, the said matter may be
included in Emphasis of Matter paragraph.
© The Institute of Chartered Accountants of India
7.98 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Case Study
1. (c)
2. (c)
3. (d)
4. (c)
5. (b)
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 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 • Standard on Auditing 260 deals
Act, 2013 deals with the with the provisions relating to
provisions relating to reporting reporting to those Charged with
to Shareholders. Thus, it is a Governance.
© The Institute of Chartered Accountants of India
REPORTING 7.99
Statutory Audit Report which is
addressed to the members.
• Statutory Audit Report is on true • It is a reporting on matters those
and fair view and as per charged with governance like
prescribed Format. scope of audit, audit procedures,
audit modifications, etc.
• Statutory Audit Reports are in • Reporting to those Charged with
public domain. 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 • Standard on Auditing 706
“Modifications to the Opinion in “Emphasis of Matter Paragraphs
the Independent Auditor’s and Other Matter Paragraphs in
Report”, deals with the the Independent Auditor’s Report”
provisions relating to Audit deals with the provisions relating
Qualification. to Emphasis of Matter.
• Audit Qualifications are • Emphasis of Matter is a paragraph
modifications to the opinion of which is included in auditor’s
the Auditors opinion where the report to draw users’ attention to
auditor concludes that there is a important matter(s) which are
material misstatement in the already disclosed in Financial
financial statement due to which Statements and are fundamental
the modification to the opinion of to users’ for understanding of
the auditor is necessary. Financial Statements.
• The Emphasis of matter pre-
supposes that there is Sufficient
Appropriate audit evidence and
the matter has been correctly
disclosed.
• Audit Qualifications are given • Emphasis of Matter is a paragraph
when auditor has concluded that which is issued when the auditor
the financial statements are feels that it is necessary to invite
materially misstated or do not attention to a particular mater
confirm to the financial reporting which has been appropriately
framework. Depending upon the disclosed in the financial
© The Institute of Chartered Accountants of India
7.100 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
nature of material misstatement statements which in the opinion of
being pervasive or otherwise the the auditor is necessary for better
appropriate type of modified understanding of the financial
opinion is issued. statement.
5. Refer Para 5.8
6. As per SA 705 (Revised), if 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, the auditor shall modify the
opinion in his report.
The auditor in such a case needs to determine the modification as follows:
(i) 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.
(ii) 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
(iii) 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.
© The Institute of Chartered Accountants of India
REPORTING 7.101
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.
7. Refer Para 3.4
8. As per SA 570, “Going Concern”, loss of a major market or a key customer is one of the
operating indicators that may cast significant doubt on the company’s ability to continue as a
going concern.
In the present case, TUV Ltd. has a key customer in South Korea from which the demand for
its products has ended on account of outbreak of war, subsequent destruction and
government ban on import and export in South Korea. Further, the company has not yet
identified new customers and is in the process of doing the same. As such, the identification
of new customer is a material uncertainty that cast a significant doubt on the company’s ability
to continue as a going concern.
However, this matter is duly disclosed by the management of TUV Ltd. in the financial
statements for the year ended 31.03.2023.
As such, considering that the going concern assumption is appropriate but a material
uncertainty exists with respect to identification of new customer, CA Saroj should:
(1) Express an unmodified opinion and
(2) Include in his audit report, a separate section under the heading “Material Uncertainty
Related to Going Concern” to:
(i) Draw attention to the note in the financial statements that discloses the matters
and
(ii) State that these events or conditions indicate that a material uncertainty exists
that may cast significant doubt on the entity’s ability to continue as a going
concern and that the auditor’s opinion is not modified in respect of the matter.
© The Institute of Chartered Accountants of India
7.102 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Thus, CA Saroj should deal with this matter in his auditor’s report in the above mentioned
manner.
9. SA 570 - “Going Concern” deals with the auditor’s responsibilities in the audit of financial
statements relating to going concern and the implications for the auditor’s report.
The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding,
and conclude on, the appropriateness of management’s use of the going concern basis of
accounting in the preparation of the financial statements, and to conclude, based on the audit
evidence obtained, whether a material uncertainty exists about the entity’s ability to continue
as a going concern.
When the use of Going Concern Basis of Accounting Is Inappropriate i.e. if the financial
statements have been prepared using the going concern basis of accounting but, in the
auditor’s judgment, management’s use of the going concern basis of accounting in the
preparation of the financial statements is inappropriate, the auditor shall express an adverse
opinion.
Also when adequate Disclosure of a Material Uncertainty Is Not Made in the Financial
Statements the auditor shall:
(i) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA
705 (Revised); and
(ii) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that
a material uncertainty exists that may cast significant doubt on the entity’s ability to
continue as a going concern and that the financial statements do not adequately
disclose this matter.
In the present case, the following circumstances indicate the inability of Sun Moon Ltd. to
continue as a going concern:
• Ban on the allotment of coal blocks
• Halt in power generation
• Key Managerial Personnel leaving the company.
• Banks decided not to extend further finance and not to fund the working capital
requirements of the company.
• Non availability of sound action plan to mitigate such circumstances.
© The Institute of Chartered Accountants of India
REPORTING 7.103
Therefore, considering the above factors it is clear that the going concern basis is
inappropriate for the company. Further, such circumstances are not reflected in the financial
statements of the company. As such, the statutory auditor of Sun Moon Ltd. should:
(1). Express an adverse opinion in accordance with SA 705 (Revised) and
(2). In the Basis of Opinion paragraph of the auditor’s report, the statutory auditor should
state that a material uncertainty exists that may cast significant doubt on the entity’s
ability to continue as a going concern and that the financial statements do not
adequately disclose this matter.
The auditor is also required to report as per clause (xix) of CARO 2020 that on the basis of
the financial ratios, ageing and expected dates of realisation of financial assets and payment
of financial liabilities, other information accompanying the financial statements, the auditor’s
knowledge of the Board of Directors and management plans, whether the auditor is of the
opinion that no material uncertainty exists as on the date of the audit report that company is
capable of meeting its liabilities existing at the date of balance sheet as and when they fall
due within a period of one year from the balance sheet date.
10. SA 705 (Revised) deals with the auditor’s responsibility to issue an appropriate report in
circumstances when, in forming an opinion in accordance with SA 700, the auditor concludes
that a modification to the auditor’s opinion on the financial statements is necessary.
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.
Further, 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.
In the present case, during the course of audit, CA Omkar obtained certain audit evidence
which were not consistent with the affirmation made in the financial statements. Therefore,
CA Omkar should modify his report in accordance with SA 705- “Modifications to The Opinion
In The Independent Auditor’s Report.
© The Institute of Chartered Accountants of India
7.104 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CA Omkar should issue either a qualified opinion or an adverse opinion depending upon the
circumstances of the case:
(a) CA Omkar shall express a qualified opinion when, having obtained sufficient
appropriate audit evidence, he concludes that misstatements, individually or in the
aggregate, are material, but not pervasive, to the financial statements
(b) CA Omkar 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.
Thus, since CA Omkar has obtained audit evidence which are inconsistent with the
affirmations made in the financial statement, CA Omkar should modify his opinion as per the
circumstances of the case.
© 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 (Academic). 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 clarification or have any suggestion
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.
© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
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.
Basic draft of this publication was prepared by CA. Vandana D Nagpal.
Edition : April, 2023
Committee/Department : Board of Studies (Academic)
E-mail : bosnoida@icai.in
Website : www.icai.org
Price : ` /- (For All Modules)
ISBN No. : 978-81-19472-09-3
Published by : The Publication & CDS Directorate on behalf of
The Institute of Chartered Accountants of India,
ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi 110 002 (India)
Printed by :
© The Institute of Chartered Accountants of India
ii
This Study Material has been prepared by the faculty of the Board of Studies (Academic). 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 clarification or have any suggestion
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.
© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
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.
Basic draft of this publication was prepared by CA. Vandana D Nagpal.
Edition : April, 2023
Committee/Department : Board of Studies (Academic)
E-mail : bosnoida@icai.in
Website : www.icai.org
Price : ` /- (For All Modules)
ISBN No. : 978-81-19472-09-3
Published by : The Publication & CDS Directorate on behalf of
The Institute of Chartered Accountants of India,
ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi 110 002 (India)
Printed by :
© The Institute of Chartered Accountants of India
iii
iii
CONTENTS
MODULE – 1
Chapter 1: Quality Control
Chapter 2: General Auditing Principles and Auditors Responsibilities
Chapter 3: Audit Planning, Strategy and Execution
Chapter 4: Materiality, Risk Assessment and Internal Control
Chapter 5: Audit Evidence
Chapter 6: Completion and Review
Chapter 7: Reporting
MODULE – 2
Chapter 8: Specialised Areas
Chapter 9: Related Services
Chapter 10: Review of Financial Information
Chapter 11: Prospective Financial Information and Other Assurance Services
Chapter 12: Digital Auditing & Assurance
Chapter 13: Group Audits
Chapter 14: Special Features of Audit of Banks & Non-Banking Financial Companies
MODULE – 3
Chapter 15: Overview of Audit of Public Sector Undertakings
Chapter 16: Internal Audit
Chapter 17: Due Diligence, Investigation & Forensic Accounting
Chapter 18 : Emerging Areas: Sustainable Development Goals (SDG) & Environment, Social
And Governance (ESG) Assurance
Chapter 19: Professional Ethics & Liabilities of Auditors
© The Institute of Chartered Accountants of India
iv
DETAILED CONTENTS MODULE - 2
CHAPTER 8: SPECIALISED AREAS
LEARNING OUTCOMES .......................................................................................................... 8.1
CHAPTER OVERVIEW ............................................................................................................. 8.2
Contents:
1. Introduction ................................................................................................................. 8.3
2. SA 800- Special Considerations - Audits of Financial Statements
Prepared in Accordance with Special Purpose Frameworks .......................................... 8.4
2.1 What is Special Purpose framework? .............................................................. 8.4
2.2 Considerations When Accepting Such Engagement ......................................... 8.5
2.3 Considerations When Planning and Performing such Audit ............................. 8.6
2.4 Description of the Applicable Financial Reporting Framework .......................... 8.7
2.5 Alerting Readers that the Financial Statements Are Prepared in
Accordance with a Special Purpose Framework ............................................... 8.7
2.6 Restriction on Distribution or Use .................................................................... 8.8
3. SA 805-Special Considerations—Audits of Single Financial Statements
and Specific Elements, Accounts or Items of a Financial Statement .............................. 8.8
3.1 What is a Single Financial Statement? ............................................................ 8.9
3.2 What is Element of a Financial Statement?...................................................... 8.9
3.3 Considerations When Accepting Such Engagement ........................................ 8.9
3.4 Considerations When planning and performing the Audit ............................... 8.11
3.5 Form of Opinion ............................................................................................ 8.11
3.6 Forming an Opinion and Reporting Considerations ........................................ 8.13
4. SA 810- Engagements to Report on Summary Financial Statements ........................... 8.16
4.1 What do Summary Financial Statements Reflect? .......................................... 8.16
© The Institute of Chartered Accountants of India
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4.2 Engagement Acceptance .............................................................................. 8.16
4.3 Nature of Procedures to be Performed by Auditor .......................................... 8.19
4.4 Form of Opinion ............................................................................................ 8.20
4.5 Auditor’s Report on Summary Financial Statements....................................... 8.21
4.6 Modifications to the Opinion, Emphasis of Matter Paragraph or other Matter
Paragraph in the Auditor’s Report on the Audited Financial Statements ......... 8.22
4.7 Restriction on Distribution or Use or Alerting Readers to
the Basis of Accounting................................................................................. 8.23
4.8 Comparatives ............................................................................................... 8.24
4.9 Unaudited Supplementary Information Presented with Summary
Financial Statements .................................................................................... 8.24
4.10 Other Information in Documents Containing Summary
Financial Statements ................................................................................... 8.24
4.11 Auditor Association ....................................................................................... 8.25
4.12 Timing of Work and Events Subsequent to the Date of the Auditor’s
Report on the Audited Financial Statements .................................................. 8.25
KEY TAKEAWAYS ................................................................................................................. 8.29
TEST YOUR KNOWLEDGE .................................................................................................... 8.31
CHAPTER 9: RELATED SERVICES
LEARNING OUTCOMES .......................................................................................................... 9.1
CHAPTER OVERVIEW ............................................................................................................. 9.2
Contents:
1. Introduction ................................................................................................................. 9.3
2. SRS 4400 Engagements to Perform Agreed-upon
Procedures regarding Financial Information .................................................................. 9.4
2.1 Objective in Accordance with SRS 4400 .......................................................... 9.4
2.2 Audit vs. Agreed-upon Procedures .................................................................. 9.5
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2.3 General Principles of an Agreed-upon Procedures Engagement ...................... 9.6
2.4 Reporting........................................................................................................ 9.8
2.5 Documentation ............................................................................................... 9.9
3. SRS 4410 Compilation Engagements ........................................................................... 9.9
3.1 Objectives in accordance with SRS 4410....................................................... 9.11
3.2 Scope of Compilation Engagements .............................................................. 9.11
3.3 Ethical Requirements .................................................................................... 9.11
3.4 Engagement Acceptance and Continuance.................................................... 9.12
3.5 Performing the Engagement .......................................................................... 9.13
3.6 Communication with Management and Those Charged with Governance ....... 9.14
3.7 The Practitioner’s Report .............................................................................. 9.14
3.8 Engagement Level Quality Control ................................................................ 9.16
3.9 Documentation ............................................................................................. 9.16
KEY TAKEAWAYS ................................................................................................................. 9.19
TEST YOUR KNOWLEDGE .................................................................................................... 9.20
CHAPTER 10- REVIEW OF FINANCIAL INFORMATION
LEARNING OUTCOMES ........................................................................................................ 10.1
CHAPTER OVERVIEW ........................................................................................................... 10.2
Contents:
1. Introduction ............................................................................................................... 10.3
1.1 Standards on Review Engagements .............................................................. 10.3
2. SRE 2400 Engagements to Review Historical Financial Statements ............................ 10.4
2.1 Objectives in a review of financial statements in accordance
with SRE 2400 .............................................................................................. 10.5
2.2 Compliance with Ethical Requirements and Engagement
Level Quality Control .................................................................................... 10.5
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2.3 Preconditions for Accepting a Review Engagement ....................................... 10.6
2.4 Agreeing to the Terms of Engagement .......................................................... 10.8
2.5 Emphasis of Matter and Other Matter Paragraphs in the
Practitioner’s Report ................................................................................... 10.25
2.6 Other Reporting Responsibilities ................................................................ 10.25
2.7 Documentation ........................................................................................... 10.26
2.8 Audit Vs. Review ........................................................................................ 10.27
3. SRE 2410 Review of Interim Financial Information Performed
by the Independent Auditor of the Entity ................................................................... 10.28
3.1 Objective of an Engagement to Review Interim Financial Information in
Accordance with SRE 2410 ......................................................................... 10.28
3.2 Agreeing the Terms of the Engagement....................................................... 10.29
3.3 Understanding the Entity and its Environment
including its Internal Control ........................................................................ 10.29
3.4 Inquiries, Analytical and other Review procedures ....................................... 10.31
3.5 Evaluation of Misstatements........................................................................ 10.35
3.6 Management representations ...................................................................... 10.35
3.7 Auditor’s Responsibility for Accompanying Information ................................ 10.36
3.8 Communication ........................................................................................... 10.37
3.9 Reporting the Nature, Extent and Results of the Review of Interim
Financial Information .................................................................................. 10.38
3.10 Departure from the Applicable Financial Reporting Framework .................... 10.39
3.11 Limitation on Scope .................................................................................... 10.40
3.12 Going Concern and Significant Uncertainties ............................................... 10.41
3.13 Other Considerations .................................................................................. 10.41
3.14 Documentation ........................................................................................... 10.42
KEY TAKEAWAYS ............................................................................................................... 10.46
TEST YOUR KNOWLEDGE .................................................................................................. 10.47
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CHAPTER 11: PROSPECTIVE FINANCIAL INFORMATION AND OTHER ASSURANCE
SERVICES
LEARNING OUTCOMES ........................................................................................................ 11.1
CHAPTER OVERVIEW ........................................................................................................... 11.2
Contents:
1. Introduction .............................................................................................................. 11.3
1.1 Standards on Assurance Engagements ......................................................... 11.4
2. SAE 3400 The Examination of Prospective Financial Information ................................ 11.4
2.1 Scope of SAE-3400 ...................................................................................... 11.6
2.2 Nature of Assurance Regarding Prospective Financial Information ................. 11.6
2.3 Responsibility of Preparation and Presentation of Prospective
Financial Information .................................................................................... 11.6
2.4 Duties of Member who is Examining the Prospective
Financial Information .................................................................................... 11.7
2.5 Nature of Assurance regarding Prospective Financial Information .................. 11.8
2.6 Acceptance of Engagement: Precautions to be taken by Auditor
Before Accepting such an Engagement: ........................................................ 11.8
2.7 Examination Procedures ............................................................................... 11.9
2.8 Presentation and Disclosure.......................................................................... 11.9
2.9 Report on Examination of Prospective Financial Information ........................ 11.10
2.10 Documentation ........................................................................................... 11.12
3. SAE 3402 Assurance Reports on Controls at a Service Organisation ........................ 11.13
3.1 Scope of SAE 3402..................................................................................... 11.13
3.2 Objectives of Service Auditor in Accordance with SAE 3402 ........................ 11.15
3.3 Type 1 Report & Type 2 Report ................................................................... 11.15
3.4 How such an Engagement is Proceeded with?............................................. 11.16
3.5 Reporting.................................................................................................... 11.18
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3.6 Documentation ........................................................................................... 11.21
4. SAE 3420 Assurance Engagements to Report on the Compilation of Pro
Forma Financial Information Included in a Prospectus .............................................. 11.22
4.1 Objectives in Accordance with SA 3420 ....................................................... 11.23
4.2 Compilation of Pro forma financial information ............................................. 11.23
4.3 Nature of the Practitioner’s Responsibility ................................................... 11.23
4.4 Steps involved in such an engagement........................................................ 11.24
4.5 Documentation ........................................................................................... 11.30
KEY TAKEAWAYS .............................................................................................................. 11.33
TEST YOUR KNOWLEDGE .................................................................................................. 11.34
CHAPTER 12: DIGITAL AUDITING AND ASSURANCE
LEARNING OUTCOMES ........................................................................................................ 12.1
CHAPTER OVERVIEW ........................................................................................................... 12.2
Contents:
1. Digital Audit .............................................................................................................. 12.4
1.1 What is a Digital Audit? ................................................................................. 12.4
1.2 Key Features of a Digital Audit ..................................................................... 12.4
1.3 Advantages of Digital Audit .......................................................................... 12.5
1.4 Consideration and Challenges of Digital Audit: .............................................. 12.6
2. Auditing Digitally ....................................................................................................... 12.7
2.1 What is the concept of auditing digitally? ....................................................... 12.7
2.2 Key Features or Advantages of Auditing Digitally: .......................................... 12.8
2.3 Considerations in Auditing Digitally ............................................................... 12.9
3. Understand The IT Environment .............................................................................. 12.10
3.1 Key Areas for an Auditor to Understand IT Environment ............................. 12.11
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4. Identifying the Risks Arising from Usage of IT ........................................................... 12.12
4.1 How to identify the IT Risks? ....................................................................... 12.12
4.2 Risks arising from use of IT: ........................................................................ 12.13
4.3 Know how to identify the IT dependencies impacting the Audit .................... 12.14
5. Assessing Cyber Risks (Including Remote Audit) ..................................................... 12.16
5.1 What is Cyber Risk ..................................................................................... 12.16
5.2 Stages of Cyber Risks ................................................................................ 12.18
5.3 Cyber Security Framework .......................................................................... 12.20
5.4 Control considerations for Cyber Risks ........................................................ 12.23
5.5 Remote Audit ............................................................................................. 12.25
6. Emerging Technologies in Audit .............................................................................. 12.27
7. Automated Tools in Audit ........................................................................................ 12.30
7.1 Internet of Things ........................................................................................ 12.31
7.2 AI (Artificial intelligence) ............................................................................. 12.32
7.3 Blockchain .................................................................................................. 12.33
7.4 Robotic Process Automation ....................................................................... 12.36
8. Control Considerations or Objectives of Auditing Digitally ......................................... 12.44
8.1 Key Steps for Auditors in a Changing Technology Environment .................. 12.45
9. Next Generation Audit ............................................................................................. 12.46
10. Conclusion .............................................................................................................. 12.50
KEY TAKEAWAYS ............................................................................................................... 12.52
TEST YOUR KNOWLEDGE .................................................................................................. 12.53
CHAPTER 13: GROUP AUDITS
Learning Outcomes............................................................................................................... 13.1
Chapter Overview ................................................................................................................. 13.2
1. Introduction ............................................................................................................... 13.3
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1.1 Consolidation of Financial Statements - Mandatory under
Companies Act, 2013. ................................................................................... 13.5
2. Responsibility of Parent ............................................................................................. 13.7
3. Responsibility of the Auditor of the Consolidated Financial Statements ....................... 13.8
4. Audit Considerations .................................................................................................. 13.9
5. Auditing the Consolidation........................................................................................ 13.12
6. Special Considerations ............................................................................................ 13.16
6.1 Permanent Consolidation Adjustments ........................................................ 13.16
6.2 Current Period Consolidation Adjustments................................................... 13.17
7. Management Representations .................................................................................. 13.24
8. Reporting................................................................................................................. 13.24
8.1 When the Parent’s Auditor is also the Auditor of all its Components ............. 13.25
8.2 When the Parent’s Auditor is not the Auditor of all its Components ............... 13.25
8.3 When the Component(s) Auditor Reports on Financial Statements
under an Accounting Framework Different than that of the Parent ................ 13.26
8.4 When the Component(s) Auditor Reports under an Auditing
Framework Different than that of the Parent ................................................ 13.27
8.5 Components Not Audited ............................................................................ 13.27
KEY TAKEAWAYS .............................................................................................................. 13.32
TEST YOUR KNOWLEDGE .................................................................................................. 13.34
CHAPTER 14: SPECIAL FEATURES OF AUDIT OF BANKS & NON-BANKING FINANCIAL
COMPANIES
UNIT 1 – SPECIAL FEATURES OF AUDIT OF BANKS .......................................................... 14.1
LEARNING OUTCOMES ........................................................................................................ 14.1
UNIT OVERVIEW ................................................................................................................... 14.2
1. Introduction ............................................................................................................... 14.4
2. Legal Framework ....................................................................................................... 14.6
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3. Form and Content of Financial Statements ................................................................. 14.7
3.1 Audit of Accounts & Appointment of Auditor .................................................. 14.7
4. Conducting an Audit................................................................................................... 14.9
4.1 Special Considerations in IT Environment.................................................... 14.13
4.2 Internal Audit and Inspection ....................................................................... 14.15
5. Internal Control in Certain Selected Areas ................................................................ 14.16
6. Compliance with CRR and SLR requirements ........................................................... 14.20
7. Verification of Assets ............................................................................................... 14.23
8. Verification of Capital & Liabilities ............................................................................ 14.44
8.1 Stress Testing ............................................................................................ 14.45
8.2 BASEL III framework ................................................................................... 14.45
9. Auditor's Report ....................................................................................................... 14.57
9.1 Format of Audit Report ................................................................................ 14.57
9.2 Long Form Audit Report .............................................................................. 14.59
9.3 Other Reporting Requirements .................................................................... 14.60
9.4 Reports and certificates .............................................................................. 14.60
10. Concurrent Audit ...................................................................................................... 14.61
10.1 Scope of Concurrent Audit .......................................................................... 14.62
10.2 Concurrent Audit System in Commercial Banks ........................................... 14.62
10.3 Coverage of Business/Branches.................................................................. 14.63
10.4 Types of Activities to be Covered ................................................................ 14.63
10.5 Appointment of Concurrent Auditors and Accountability ............................... 14.66
10.6 Remuneration of Concurrent Auditor ........................................................... 14.66
10.7 Reporting Systems...................................................................................... 14.66
11 Audit Committee ...................................................................................................... 14.67
KEY TAKEAWAYS .............................................................................................................. 14.71
TEST YOUR KNOWLEDGE .................................................................................................. 14.72
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CHAPTER 8
7
SPECIALISED AREAS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Know about special considerations applicable in respect of the audit of financial statements
prepared in accordance with the special purpose framework in accordance with SA 800.
Understand the meaning of special purpose framework.
Know about special considerations applicable in acceptance, planning and performance and
forming an opinion and reporting in such types of engagements.
Gain knowledge about special considerations applicable to an audit of a single financial
statement or of a specific element, account or item of a financial statement in accordance
with SA 805.
Understand the meaning of a single financial statement and elements of a financial statement.
Know about special considerations applicable in acceptance, planning and performance and
forming an opinion and reporting in such types of engagements in accordance with
requirements of SA 805.
Understand the responsibilities of an auditor when undertaking an engagement to report on
summary financial statements derived from financial statements audited in accordance with
SAs by the same auditor in accordance with SA 810.
Know about special considerations applicable in acceptance, planning and performance and
forming an opinion and reporting in such type of engagements in accordance with
requirements of SA 810.
Understand elements of audit report issued on summary financial statements in accordance
with SA 810.
© The Institute of Chartered Accountants of India
8.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
SA 800 dealing with audit of FS
prepared in accordance with special
purpose framework
Specialised areas
SA 805 dealing with audit of a single
FS or of a specific element, account
or item of a FS
SA 810 dealing with engagement to
report on summary FS derived from
FS audited by that same auditor
CA. Julie has joined an audit firm based in Mumbai. On her very first day in office, she was
handed over an assignment pertaining to the audit of a client whose financial statements had
been prepared in pursuance to the financial reporting provisions of a contract. The said client
had entered into a contract with various entities stipulating payments to be made to these
entities on the basis of certain parameters in lieu of services rendered by these entities to
the auditee client.
The contract, inter alia, contained a provision that financial statements shall be specifically
prepared considering the requirements of the contract. She was in a dilemma. Do Standards
on auditing apply to such types of engagements? Are there any special considerations to be
borne in mind by the auditor before accepting such an engagement? Most importantly, she
was worried about reporting aspects. The report in such a case was not going to be issued
under the Companies Act 2013. What factors would come into play in such a case? She was
also turning sceptical towards the possible use of the report.
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SPECIALISED AREAS 8.3
She was wondering whether there was any authoritative pronouncement on the issue.
Cursing herself for passing in auditing in CA final exams with bare minimum marks, she
turned to the ICAI website and found that SA 800 served her purpose. She also turned to
recorded webinars on the issue to gain better clarity.
While turning to webinars, she found that SA 800-899 series dealt with specialised areas.
Whereas SA 800 dealt with special considerations in the audit of financial statements
prepared in accordance with special purpose framework, SA 805 dealt with special
considerations to an audit of a single financial statement or of a specific element, account or
item of a financial statement. Although she had read about elements of financial statements,
“single financial statement” was a new term to her.
She found the whole topic of specialised areas quite interesting and delved deeper into the
requirements of SA 810. She was astonished at the detailing made in SA 810 regarding
summary financial statements, the nature of procedures, forming opinions and reporting
considerations. All this was like a whiff of fresh breeze- She had imbibed many new things
and was raring to apply these practically.
1. INTRODUCTION
Special considerations apply in respect of the audit of financial statements prepared in accordance
with the special purpose framework. Similarly, special considerations apply to an audit of a single
financial statement or of a specific element, account or item of a financial statement.
Specific responsibilities are cast upon an auditor in case of undertaking an engagement to report on
summary financial statements derived from financial statements audited in accordance with SAs by
that same auditor.
There are three separate SAs for the above specialised areas as under: -
• SA 800 deals with special considerations applicable in respect of the audit of financial
statements prepared in accordance with the special purpose framework.
• SA 805 deals with special considerations applicable to an audit of a single financial
statement or of a specific element, account or item of a financial statement.
• SA 810 deals with responsibilities of an auditor when undertaking an engagement to
report on summary financial statements derived from financial statements audited in
accordance with SAs by that same auditor.
© The Institute of Chartered Accountants of India
8.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
All the aforesaid discussed Standards on auditing broadly deal with following areas: -
2. SA 800 - SPECIAL CONSIDERATIONS - AUDITS OF
FINANCIAL STATEMENTS PREPARED IN
ACCORDANCE WITH SPECIAL PURPOSE
FRAMEWORKS
As discussed above, SA 800 deals with special considerations applicable in respect of audit of
financial statements prepared in accordance with special purpose framework.
SA 800 addresses special considerations that are relevant to: -
(a) The acceptance of the engagement
(b) The planning and performance of that engagement and
(c) Forming an opinion and reporting on the financial statements but not for the purpose of
expressing an opinion on the effectiveness of the entity’s internal control.
2.1 What is Special Purpose framework?
SA 800 defines special purpose framework as a financial reporting framework designed to meet the
financial information needs of specific users. The financial reporting framework may be a fair
presentation framework or a compliance framework.
The requirements of the applicable financial reporting framework determine the form and content of
the financial statements and what constitutes a complete set of financial statements.
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SPECIALISED AREAS 8.5
Examples of Special purpose frameworks are: -
• The cash receipts and disbursements basis of accounting for cash flow information that an
entity may be requested to prepare for creditors.
• The financial reporting provisions established by a regulator to meet the requirements of that
regulator.
• The financial reporting provisions of a contract, such as a bond indenture, a loan agreement,
or a project grant.
Special purpose framework is to be distinguished from general purpose framework. A financial
reporting framework designed to meet the common financial information needs of a wide range of
users is known as “General purpose framework” whereas a financial reporting framework designed
to meet the financial information needs of specific users is known as “Special purpose framework.”
2.2 Considerations When Accepting Such Engagement
In the case of special purpose financial statements, the financial information needs of the intended
users are a key factor in determining the acceptability of the financial reporting framework applied
in the preparation of the financial statements. The applicable financial reporting framework may
encompass the financial reporting standards established by an organisation that is authorised or
recognised to promulgate standards for special purpose financial statements.
In that case, those standards will be presumed acceptable for that purpose if the organisation follows
an established and transparent process involving deliberation and consideration of the views of
relevant stakeholders. Some laws or regulations may prescribe the financial reporting framework to
be used by management in the preparation of special purpose financial statements for a certain type
of entity. For example, a regulator may establish financial reporting provisions to meet the
requirements of that regulator. In the absence of indications to the contrary, such a financial
reporting framework is presumed acceptable for special purpose financial statements prepared by
such an entity.
Where the financial reporting standards referred to above are supplemented by legislative or
regulatory requirements, SA 210 requires the auditor to determine whether any conflicts between
the financial reporting standards and the additional requirements exist and prescribes actions to be
taken by the auditor if such conflicts exist.
The applicable financial reporting framework may encompass the financial reporting provisions of a
contract or sources other than those described in the preceding paras. In that case, the acceptability
of the financial reporting framework in the circumstances of the engagement is determined by
© The Institute of Chartered Accountants of India
8.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
considering whether the framework exhibits attributes normally exhibited by acceptable financial
reporting frameworks in accordance with the requirements of SA 210.
In the case of a special purpose framework, the relative importance to a particular engagement of
each of the attributes normally exhibited by acceptable financial reporting frameworks is a matter of
professional judgment.
For example, for purposes of establishing the value of net assets of an entity at the date of its sale,
the vendor and the purchaser may have agreed that very prudent estimates of allowances for
uncollectible accounts receivable are appropriate for their needs, even though such financial
information is not neutral when compared with financial information prepared in accordance with a
general purpose framework.
2.3 Considerations When Planning and Performing Such Audit
SA 200 requires the auditor to comply with (a) relevant ethical requirements, including those
pertaining to independence, relating to financial statement audit engagements, and (b) all SAs
relevant to the audit. It also requires the auditor to comply with each requirement of an SA unless,
in the circumstances of the audit, the entire SA is not relevant or the requirement is not relevant
because it is conditional and the condition does not exist. In exceptional circumstances, the auditor
may judge it necessary to depart from a relevant requirement in an SA by performing alternative
audit procedures to achieve the aim of that requirement.
Application of some of the requirements of the SAs in an audit of special purpose financial
statements may require special consideration by the auditor. For example, in SA 320, judgments
about matters that are material to users of the financial statements are based on a consideration of
the common financial information needs of users as a group. In the case of an audit of special
purpose financial statements, however, those judgments are based on a consideration of the
financial information needs of the intended users.
In the case of special purpose financial statements, such as those prepared in accordance with the
requirements of a contract, management may agree with the intended users on a threshold below
which misstatements identified during the audit will not be corrected or otherwise adjusted. The
existence of such a threshold does not relieve the auditor from the requirement to determine
materiality in accordance with SA 320 for purposes of planning and performing the audit of the
special purpose financial statements.
SA 260 (Revised) requires the auditor to determine the appropriate person(s) within the entity’s
governance structure with whom to communicate. SA 260 (Revised) notes that, in some cases, all
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.7
of those charged governance are involved in managing the entity, and the application of the
communication requirements is modified to recognize this position. When a complete set of general
purpose financial statements is also prepared by the entity, those person(s) responsible for the
oversight of the preparation of the special purpose financial statements may not be the same as
those charged with governance responsible for the oversight of the preparation of those general
purpose financial statements.
Forming an opinion and reporting considerations in such an audit : When forming an opinion
and reporting on special purpose financial statements, the auditor shall apply the requirements in
Revised SA 700.
2.4 Description of the Applicable Financial Reporting Framework
Revised SA 700 requires the auditor to evaluate whether the financial statements adequately refer
to or describe the applicable financial reporting framework. In the case of financial statements
prepared in accordance with the provisions of a contract, the auditor shall evaluate whether the
financial statements adequately describe any significant interpretations of the contract on which the
financial statements are based.
Revised SA 700 deals with the form and content of the auditor’s report. In the case of an auditor’s
report on special purpose financial statements: -
(a) The auditor’s report shall also describe the purpose for which the financial statements are
prepared and, if necessary, the intended users, or refer to a note in the special purpose
financial statements that contain that information; and
(b) If management has a choice of financial reporting frameworks in the preparation of such
financial statements, the explanation of management’s responsibility for the financial
statements shall also make reference to its responsibility for determining that the applicable
financial reporting framework is acceptable in the circumstances.
2.5 Alerting Readers that the Financial Statements Are Prepared in
Accordance with a Special Purpose Framework
The special purpose financial statements may be used for purposes other than those for which they
were intended. For example, a regulator may require certain entities to place the special purpose
financial statements on public record. To avoid misunderstandings, the auditor alerts users of the
auditor’s report that the financial statements are prepared in accordance with a special purpose
framework and, therefore, may not be suitable for another purpose.
© The Institute of Chartered Accountants of India
8.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.6 Restriction on Distribution or Use
In addition to the alert required as discussed above, the auditor may consider it appropriate to
indicate that the auditor’s report is intended solely for the specific users. Depending on the law or
regulation applicable, this may be achieved by restricting the distribution or use of the auditor’s
report. In these circumstances, the paragraph alerting the readers may be expanded to include these
other matters, and the heading modified accordingly.
TEST YOUR UNDERSTANDING 1
CA Lalita is auditor of a company. She is also offered professional work of audit of financial
statements prepared specifically for meeting requirements of a loan agreement for the same period.
She chooses to accept work and has made up her mind to disclose this fact in “Other matter
Paragraph” in audit report to be issued by her for this specific engagement. Is her approach proper?
TEST YOUR UNDERSTANDING 2
CA Lakshmi has prepared a draft audit report for financial statements of X Ltd. prepared in
accordance with financial reporting provisions of a contract with Y Ltd. She has drafted an
unmodified opinion to be given in audit report. Besides, she has also drawn attention in draft audit
report to Note “A “to the financial statements which describes the basis of accounting (under the
heading “Basis of accounting”). How she should ensure that report would not be misused? Draft a
suitable para to be included in the report for this purpose.
3. SA 805-SPECIAL CONSIDERATIONS—AUDITS OF
SINGLE FINANCIAL STATEMENTS AND SPECIFIC
ELEMENTS, ACCOUNTS OR ITEMS OF A FINANCIAL
STATEMENT
Standards on Auditing (SAs) in the 100-700 series apply to an audit of financial statements and are
to be adapted as necessary in the circumstances when applied to audits of other historical financial
information. SA 805 deals with special considerations in the application of those SAs to an audit of
a single financial statement or of a specific element, account or item of a financial statement. The
single financial statement or the specific element, account or item of a financial statement may be
prepared in accordance with a general or special purpose framework. If prepared in accordance with
a special purpose framework, SA 800 also applies to the audit.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.9
SA 805 does not apply to the report of a component auditor issued as a result of work performed on
the financial information of a component at the request of a group engagement team for purposes
of an audit of group financial statements.
The objective of the auditor, when applying SAs, in such an audit, is to address appropriately the
special considerations that are relevant to the acceptance of engagement, planning and
performance of engagement and forming an opinion and reporting but not for the purpose of
expressing an opinion on the effectiveness of the entity’s internal control.
3.1 What is a Single Financial Statement?
A single financial statement is to be distinguished from a complete set of financial statements. For
example, a cash flow statement is a single financial statement.
3.2 What is the Element of a Financial Statement?
“Element of a financial statement” or “element” means an “element, account or item of a financial
statement.” For example, trade receivables or cash and bank balances
A single financial statement or a specific element of a financial statement includes the related notes
ordinarily comprising a summary of significant accounting policies and other explanatory information
relevant to the financial statement or to the element.
3.3 Considerations When Accepting Such Engagement
3.3.1 Application of SAs
SA 200 requires the auditor to comply with all SAs relevant to the audit. In the case of an audit of a
single financial statement or of a specific element of a financial statement, this requirement applies
irrespective of whether the auditor is also engaged to audit the entity’s complete set of financial
statements. If the auditor is not also engaged to audit the entity’s complete set of financial
statements, the auditor shall determine whether the audit of a single financial statement or of a
specific element of those financial statements in accordance with SAs is practicable.
SA 200 requires the auditor to comply with (a) relevant ethical requirements, including those
pertaining to independence relating to financial statement audit engagements, and (b) all SAs
relevant to the audit. It also requires the auditor to comply with each requirement of an SA unless,
in the circumstances of the audit, the entire SA is not relevant or the requirement is not relevant
because it is conditional and the condition does not exist. In exceptional circumstances, the auditor
© The Institute of Chartered Accountants of India
8.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
may judge it necessary to depart from a relevant requirement in an SA by performing alternative
audit procedures to achieve the aim of that requirement.
Compliance with the requirements of SAs relevant to the audit of a single financial statement or of
a specific element of a financial statement may not be practicable when the auditor is not also
engaged to audit the entity’s complete set of financial statements. In such cases, the auditor often
does not have the same understanding of the entity and its environment, including its internal control,
as an auditor who also audits the entity’s complete set of financial statements. The auditor also does
not have audit evidence about the general quality of the accounting records or other accounting
information that would be acquired in an audit of the entity’s complete set of financial statements.
Accordingly, the auditor may need further evidence to corroborate audit evidence acquired from the
accounting records.
In the case of an audit of a specific element of a financial statement, certain SAs require audit work
that may be disproportionate to the element being audited. For example, although the requirements
of SA 570 are likely to be relevant in the circumstances of an audit of a schedule of accounts
receivable, complying with those requirements may not be practicable because of the audit effort
required. If the auditor concludes that an audit of a single financial statement or of a specific element
of a financial statement in accordance with SAs may not be practicable, the auditor may discuss with
management whether another type of engagement might be more practicable.
3.3.2 Acceptability of the Financial Reporting Framework
SA 210 requires the auditor to determine the acceptability of the financial reporting framework
applied in the preparation of the financial statements. In the case of an audit of a single financial
statement or of a specific element of a financial statement, this shall include whether application of
the financial reporting framework will result in a presentation that provides adequate disclosures to
enable the intended users to understand the information conveyed in the financial statement or the
element, and the effect of material transactions and events on the information conveyed in the
financial statement or the element.
A single financial statement or a specific element of a financial statement may be prepared in
accordance with an applicable financial reporting framework that is based on a financial reporting
framework established by an authorised or recognised standards setting organisation for the
preparation of a complete set of financial statements. If this is the case, determination of the
acceptability of the applicable framework may involve considering whether that framework includes
all the requirements of the framework on which it is based that are relevant to the presentation of a
single financial statement or of a specific element of a financial statement that provides adequate
disclosures.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.11
3.4 Considerations When planning and performing the Audit
In planning and performing the audit of a single financial statement or of a specific element of a
financial statement, the auditor shall adapt all SAs relevant to the audit as necessary in the
circumstances of the engagement.
When auditing a single financial statement or a specific element of a financial statement in
conjunction with the audit of the entity’s complete set of financial statements, the auditor may be
able to use audit evidence obtained as part of the audit of the entity’s complete set of financial
statements in the audit of the financial statement or the element. SAs, however, require the auditor
to plan and perform the audit of the financial statement or element to obtain sufficient appropriate
audit evidence on which to base the opinion on the financial statement or on the element.
The individual financial statements that comprise a complete set of financial statements, and many
of the elements of those financial statements, including their related notes, are interrelated.
Accordingly, when auditing a single financial statement or a specific element of a financial statement,
the auditor may not be able to consider the financial statement or the element in isolation.
Consequently, the auditor may need to perform procedures in relation to the interrelated items to
meet the objective of the audit.
Furthermore, the materiality determined for a single financial statement or for a specific element of
a financial statement may be lower than the materiality determined for the entity’s complete set of
financial statements; this will affect the nature, timing and extent of the audit procedures and the
evaluation of uncorrected misstatements.
3.5 Form of Opinion
SA 210 requires that the agreed terms of the audit engagement include the expected form of any
reports to be issued by the auditor. In the case of an audit of a single financial statement or of a
specific element of a financial statement, the auditor shall consider whether the expected form of
opinion is appropriate in the circumstances.
The form of opinion to be expressed by the auditor depends on the applicable financial
reporting framework and any applicable laws or regulations. In accordance with Revised
SA 700:
(a) When expressing an unmodified opinion on a complete set of financial statements prepared
in accordance with a fair presentation framework, the auditor’s opinion, unless otherwise
required by law or regulation, uses one of the following phrases: (i) the financial statements
present fairly, in all material respects, in accordance with the applicable financial reporting
© The Institute of Chartered Accountants of India
8.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
framework or (ii) the financial statements give a true and fair view in accordance with the
applicable financial reporting framework and
(b) When expressing an unmodified opinion on a complete set of financial statements prepared
in accordance with a compliance framework, the auditor’s opinion states that the financial
statements are prepared, in all material respects, in accordance with the applicable financial
reporting framework.
In the case of a single financial statement or of a specific element of a financial statement, the
applicable financial reporting framework may not explicitly address the presentation of the financial
statement or of the element. This may be the case when the applicable financial reporting framework
is based on a financial reporting framework established by an authorised or recognised standards
setting organisation for the preparation of a complete set of financial statements The auditor
therefore considers whether the expected form of opinion is appropriate in the light of the applicable
financial reporting framework.
Factors that may affect the auditor’s consideration as to whether to use the phrases
“presents fairly, in all material respects”, or “gives a true and fair view” in the auditor’s
opinion include:
• Whether the applicable financial reporting framework is explicitly or implicitly restricted to
the preparation of a complete set of financial statements.
• Whether the single financial statement or the specific element of a financial statement
will:
♦ Comply fully with each of those requirements ♦ If necessary to achieve fair
of the framework relevant to the particular presentation, provide disclosures
financial statement or the particular element, beyond those specifically
and the presentation of the financial required by the framework or, in
statement or the specific element of a exceptional circumstances,
financial statement include the related notes depart from a requirement of the
and disclosures framework.
The auditor’s decision as to the expected form of opinion is a matter of professional judgment. It
may be affected by whether use of the phrases “presents fairly, in all material respects”, or “gives a
true and fair view” in the auditor’s opinion on a single financial statement or on a specific element of
a financial statement prepared in accordance with a fair presentation framework is generally
accepted in the particular jurisdiction.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.13
3.6 Forming an Opinion and Reporting Considerations
When forming an opinion and reporting on a single financial statement or on a specific element of a
financial statement, the auditor shall apply the requirements in Revised SA 700, adapted as
necessary in the circumstances of the engagement.
If the auditor undertakes an engagement to report on a single financial statement or on a
specific element of a financial statement in conjunction with an engagement to audit the
entity’s complete set of financial statements, the auditor shall express a separate opinion for
each engagement.
An audited single financial statement or an audited specific element of a financial statement may be
published together with the entity’s audited complete set of financial statements. If the auditor
concludes that the presentation of a single financial statement or of the specific element of a financial
statement does not differentiate it sufficiently from the complete set of financial statements, the
auditor shall ask management to rectify the situation. The auditor shall also differentiate the opinion
on the single financial statement or on the specific element of a financial statement from the opinion
on the complete set of financial statements. The auditor shall not issue the auditor’s report containing
the opinion on the single financial statement or on the specific element of a financial statement until
satisfied with the differentiation.
If the opinion in the auditor’s report on an entity’s complete set of financial statements
is modified, or that report includes an Emphasis of matter paragraph or other matter
paragraph, the auditor shall determine the effect that this may have on the auditor’s
report on a single financial statement or on a specific element of those financial
statements. When deemed appropriate, the auditor shall modify the opinion on the
single financial statement or on the specific element of a financial statement, or include
an Emphasis of matter paragraph or other matter paragraph in the auditor’s report,
accordingly.
If the auditor concludes that it is necessary to express an adverse opinion or disclaim
an opinion on the entity’s complete set of financial statements as a whole, Revised SA
705 does not permit the auditor to include in the same auditor’s report an unmodified
opinion on a single financial statement that forms part of those financial statements or
on a specific element that forms part of those financial statements. This is because
such an unmodified opinion would contradict the adverse opinion or disclaimer of
opinion on the entity’s complete set of financial statements as a whole.
© The Institute of Chartered Accountants of India
8.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
If the auditor concludes that it is necessary to express an adverse opinion or disclaim an
opinion on the entity’s complete set of financial statements as a whole but, in the context of
a separate audit of a specific element that is included in those financial statements, the
auditor nevertheless considers it appropriate to express an unmodified opinion on that
element, the auditor shall only do so if:
(b) That opinion is
expressed in an
(c) The specific
auditor’s report that
element does not
(a) The auditor is not is not published
constitute a major
prohibited by law or together with the
portion of the
regulation from doing auditor’s report
entity’s complete set
so; containing the
of financial
adverse opinion or
statements.
disclaimer of opinion;
and
The auditor shall not express an unmodified opinion on a single financial statement of a complete
set of financial statements if the auditor has expressed an adverse opinion or disclaimed an opinion
on the complete set of financial statements as a whole. This is the case even if the auditor’s report
on the single financial statement is not published together with the auditor’s report containing the
adverse opinion or disclaimer of opinion. This is because a single financial statement is deemed to
constitute a major portion of those financial statements.
Revised SA 700 requires the auditor, in forming an opinion, to evaluate whether the financial
statements provide adequate disclosures to enable the intended users to understand the effect of
material transactions and events on the information conveyed in the financial statements. In the case
of a single financial statement or of a specific element of a financial statement, it is important that
the financial statement or the element, including the related notes, in view of the requirements of the
applicable financial reporting framework, provides adequate disclosures to enable the intended
users to understand the information conveyed in the financial statement or the element, and the
effect of material transactions and events on the information conveyed in the financial statement or
the element.
Even when the modified opinion on the entity’s complete set of financial statements, Emphasis of
matter paragraph or Other matter paragraph does not relate to the audited financial statement or the
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.15
audited element, the auditor may still deem it appropriate to refer to the modification in an Other
matter paragraph in an auditor’s report on the financial statement or on the element because the
auditor judges it to be relevant to the users’ understanding of the audited financial statement or the
audited element or the related auditor’s report.
In the auditor’s report on an entity’s complete set of financial statements, the expression of a
disclaimer of opinion regarding the results of operations and cash flows, where relevant, and an
unmodified opinion regarding the state of affairs is permitted since the disclaimer of opinion is being
issued in respect of the results of operations and cash flows only and not in respect of the financial
statements as a whole.
SA 800 and 805 do not override the requirements of the other SAs; nor do they purport to deal
with all special considerations that may be relevant in the circumstances of the engagement.
Examples ● Accounts receivable, allowance for doubtful accounts receivable, inventory,
the liability for accrued benefits of a private pension plan, the recorded value of
of Specific identified intangible assets, or the liability for “incurred but not reported” claims
in an insurance portfolio, including related notes.
Elements,
Accounts
or Items of ● A schedule of externally managed assets and income of a private pension
plan, including related notes.
a Financial
Statement ● A schedule of net tangible assets, including related notes.
are:
● A schedule of disbursements in relation to a lease property, including
explanatory notes.
TEST YOUR UNDERSTANDING 3
CA M. Surya is auditor for financial statements of an entity prepared in accordance with financial
reporting provisions of a contract. He is also offered audit of trade receivables appearing in above
financial statements. Can he accept such engagement? Discuss brief outline of his audit approach
in such a situation.
© The Institute of Chartered Accountants of India
8.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 4
CA G is offered appointment for audit of trade payables of financial statements of a company.
However, financial statements prepared under Companies Act, 2013 are audited by CA Jignesh.
Discuss why it would be practically difficult for CA G to perform such an audit.
4. SA 810 - ENGAGEMENTS TO REPORT ON SUMMARY
FINANCIAL STATEMENTS
SA 810 deals with the auditor’s responsibilities when undertaking an engagement to report on
summary financial statements derived from financial statements audited in accordance with SAs by
that same auditor.
4.1 What do Summary Financial Statements Reflect?
Summary financial statements reflect historical financial information that is derived from financial
statements, but that contains less detail than the financial statements while still providing a
structured representation consistent with that provided by the financial statements of the entity’s
economic resources or obligations at a point in time or the changes therein for a period of time.
4.2 Engagement Acceptance
The auditor shall, ordinarily, accept an engagement to report on summary financial statements in
accordance with this SA only when the auditor has been engaged to conduct an audit in accordance
with SAs of the financial statements from which the summary financial statements are derived. If the
auditor has not also audited the financial statements from which the summary financial statements
are derived, the auditor shall not have the necessary knowledge to discharge his responsibilities in
relation to the summary financial statements in accordance with this SA.
Herein lies the rationale behind the requirement that engagement to report on summary financial
statements shall, ordinarily, be accepted when the auditor has been engaged to conduct an audit of
financial statements from which summary financial statements are derived.
4.2.1 Before accepting an engagement to report on summary financial statements,
the auditor shall:
(a) Determine whether the applied criteria are acceptable.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.17
Applied criteria refer to the criteria applied by management in the preparation of the summary
financial statements. Management is responsible for the determination of the information that needs
to be reflected in the summary financial statements so that they are consistent, in all material
respects, with or represent a fair summary of the audited financial statements. Because summary
financial statements, by their nature contain aggregated information and limited disclosure, there is
an increased risk that they may not contain the information necessary so as not to be misleading in
the circumstances. This risk increases when established criteria for the preparation of summary
financial statements do not exist.
Factors affecting the auditor’s determination of the acceptability of the applied criteria:
The nature of the entity
The purpose of the summary financial statements
The information needs of the intended users of the summary financial statements and
Whether the applied criteria will result in summary financial statements that are not
misleading in the circumstances.
The criteria for the preparation of summary financial statements may be established by an authorised
or recognised standards setting organisation or by law or regulation. Similar to the case of financial
statements, as explained in SA 210, in many such cases, the auditor may presume that such criteria
are acceptable. Where established criteria for the preparation of summary financial statements do
© The Institute of Chartered Accountants of India
8.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
not exist, criteria may be developed by management, for example, based on practice in a particular
industry.
If the auditor concludes that the applied criteria are unacceptable or is unable to obtain the
agreement of management as discussed above, the auditor shall not accept the engagement to
report on the summary financial statements, unless required by law or regulation to do so. An
engagement conducted in accordance with such law or regulation does not comply with this SA.
Accordingly, the auditor’s report on the summary financial statements shall not indicate that the
engagement was conducted in accordance with this SA. The auditor shall include appropriate
reference to this fact in the terms of the engagement. The auditor shall also determine the effect that
this may have on the engagement to audit the financial statements from which the summary financial
statements are derived.
Adequate disclosure of the summarised nature of the summary financial statements and the identity
of the audited financial statements, may, for example, be provided by a title such as “Summary
financial statements prepared from the audited financial statements for the year ended
March 31, 20XX”
(b) Obtain the agreement of management that it acknowledges and understands its
responsibility:
i. For the preparation of the summary financial statements in accordance with the applied
criteria.
ii. To make the audited financial statements available to the intended users of the summary
financial statements without undue difficulty (or, if law or regulation provides that the audited
financial statements need not be made available to the intended users of the summary
financial statements and establishes the criteria for the preparation of the summary financial
statements, to describe that law or regulation in the summary financial statements)
The auditor’s evaluation whether the audited financial statements are available to the
intended users of the summary financial statements without undue difficulty is affected
by factors such as whether:
• The summary financial statements describe clearly from whom or where the
audited financial statements are available
• The audited financial statements are on public record; or
• Management has established a process by which the intended users of the
summary financial statements can obtain ready access to the audited financial
statements
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.19
iii. To include the auditor’s report on the summary financial statements in any document that
contains the summary financial statements and that indicates that the auditor has reported
on them
(c) Agree with management on the form of opinion to be expressed on the summary
financial statements.
4.3 Nature of Procedures to be Performed by Auditor
The auditor shall perform the following procedures, and any other procedures that the
auditor may consider necessary, as the basis for the auditor’s opinion on the summary
financial statements:
(a) Evaluate whether the summary financial statements adequately disclose their
summarised nature and identify the audited financial statements.
(b) When summary financial statements are not accompanied by the audited financial
statements, evaluate whether they describe clearly:
(i) From whom or where the audited financial statements are available; or
(ii) The law or regulation that specifies that the audited financial statements need not
be made available to the intended users of the summary financial statements and
establishes the criteria for the preparation of the summary financial statements.
(c) Evaluate whether the summary financial statements adequately disclose the
applied criteria.
(d) Compare the summary financial statements with the related information in the
audited financial statements to determine whether the summary financial
statements agree with or can be re-calculated from the related information in the
audited financial statements.
(e) Evaluate whether the summary financial statements are prepared in accordance
with the applied criteria.
(f) Evaluate, in view of the purpose of the summary financial statements, whether the
summary financial statements contain the information necessary, and are at an
appropriate level of aggregation, so as not to be misleading in the circumstances.
(g) Evaluate whether the audited financial statements are available to the intended
users of the summary financial statements without undue difficulty, unless law or
regulation provides that they need not be made available and establishes the
criteria for the preparation of the summary financial statements as discussed
already.
© The Institute of Chartered Accountants of India
8.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4.4 Form of Opinion
When the auditor has concluded that an unmodified opinion on the summary financial
statements is appropriate, the auditor’s opinion shall, unless otherwise required by law or
regulation, use one of the following phrases:
(a) The summary financial
(b) The summary financial
statements are consistent, in all
statements are a fair summary
material respects, with the
of the audited financial
audited financial statements, in
statements, in accordance with
accordance with the applied
the applied criteria
criteria or
If law or regulation prescribes the wording of the opinion on summary financial statements
in terms that are different from those described above, the auditor shall:
(b) Evaluate whether users of the summary
financial statements might misunderstand the
(a) Apply the procedures discussed earlier
auditor’s opinion on the summary financial
and any further procedures necessary to
statements and, if so, whether additional
enable the auditor to express the prescribed
explanation in the auditor’s report on the
opinion and
summary financial statements can mitigate
possible misunderstanding.
If, the auditor concludes that additional explanation in the auditor’s report on the summary financial
statements cannot mitigate possible misunderstanding, the auditor shall not accept the engagement,
unless required by law or regulation to do so. An engagement conducted in accordance with such
law or regulation does not comply with this SA. Accordingly, the auditor’s report on the summary
financial statements shall not indicate that the engagement was conducted in accordance with this
SA.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.21
4.5 Auditor’s Report on Summary Financial Statements
Elements of the Auditor’s Report : The auditor’s report on summary financial statements shall
include the following elements: -
(a) A title clearly indicating it as the report of an independent auditor
(b) An addressee: If the addressee of the summary financial statements is not the same as the
addressee of the auditor’s report on the audited financial statements, the auditor shall
evaluate the appropriateness of using a different addressee. Factors that may affect the
auditor’s evaluation of the appropriateness of the addressee of the summary financial
statements include the terms of the engagement, the nature of the entity, and the purpose of
the summary financial statements.
(c) An introductory paragraph:
An Introductory (i) Identifies the summary financial statements on which the
auditor is reporting, including the title of each statement
Paragraph included in the summary financial statements. When the auditor
is aware that the summary financial statements will be included
in a document that contains other information, the auditor may
consider, if the form of presentation allows, identifying the page
numbers on which the summary financial statements are
presented. This helps readers to identify the summary financial
statements to which the auditor’s report relates.
(ii) Identifies the audited financial statements
(iii) Refers to the auditor’s report on the audited financial
statements, the date of that report, and, in cases other than
where audited financial statements contain modified opinion,
emphasis of matter paragraph and other matter paragraph, the
fact that an unmodified opinion is expressed on the audited
financial statements;
(iv) If the date of the auditor’s report on the summary financial
statements is later than the date of the auditor’s report on the
audited financial statements, states that the summary financial
statements and the audited financial statements do not reflect
the effects of events that occurred subsequent to the date of the
auditor’s report on the audited financial statements; and
(v) A statement indicating that the summary financial statements
do not contain all the disclosures required by the financial
reporting framework applied in the preparation of the audited
financial statements, and that reading the summary financial
statements is not a substitute for reading the audited financial
statements.
© The Institute of Chartered Accountants of India
8.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) A description of management’s responsibility for the summary financial statements,
explaining that management is responsible for the preparation of the summary
financial statements in accordance with the applied criteria.
(e) A statement that the auditor is responsible for expressing an opinion on the summary
financial statements based on the procedures required by this SA.
(f) A paragraph clearly expressing an opinion.
(g) The auditor’s signature along with the firm registration number, wherever applicable,
and the membership number assigned by the Institute of Chartered Accountants of
India. Besides, UDIN is required to be stated.
(h) The date of the auditor’s report
The auditor shall date the auditor’s report on the summary
financial statements no earlier than:
(i) The date on which the auditor has
obtained sufficient appropriate evidence on
which to base the opinion, including
evidence that the summary financial (ii) The date of the auditor’s report on the
statements have been prepared and those audited financial statements.
with the recognised authority have asserted
that they have taken responsibility for them;
and
(i) The place of signature.
4.6 Modifications to the Opinion, Emphasis of Matter Paragraph or Other
Matter Paragraph in the Auditor’s Report on the Audited Financial
Statements
When the auditor’s report on the audited financial statements contains a qualified opinion, an
Emphasis of Matter paragraph, or an Other Matter paragraph, but the auditor is satisfied that the
summary financial statements are consistent, in all material respects, with or are a fair summary of
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.23
the audited financial statements, in accordance with the applied criteria, the auditor’s report on the
summary financial statements shall, also contain followings: -
(a) State that the auditor’s report on the audited financial statements contains a qualified opinion,
an Emphasis of Matter paragraph, or an Other Matter paragraph; and
(b) Describe:
(i) The basis for the qualified opinion on the audited
financial statements, and that qualified opinion; or the
Emphasis of Matter or the Other Matter paragraph in the
auditor’s report on the audited financial statements; and
Describe
(ii) The effect thereof on the summary financial statements,
if any.
When the auditor’s report on the audited financial statements
contains an adverse opinion or a disclaimer of opinion, the auditor’s
report on the summary financial statements shall, additionally: -
(a) State that the auditor’s (c) State that, as a result of the
report on the audited financial (b) Describe the basis for that adverse opinion or disclaimer
statements contains an adverse opinion or disclaimer of opinion, it is inappropriate to
adverse opinion or disclaimer of opinion; and express an opinion on the
of opinion; summary financial statements.
4.6.1 Modified Opinion on the Summary Financial Statements
If the summary financial statements are not consistent, in all material respects, with or are not a fair
summary of the audited financial statements, in accordance with the applied criteria, and
management does not agree to make the necessary changes, the auditor shall express an adverse
opinion on the summary financial statements.
4.7 Restriction on Distribution or Use or Alerting Readers to the Basis of
Accounting
When distribution or use of the auditor’s report on the audited financial statements is restricted, or
the auditor’s report on the audited financial statements alerts readers that the audited financial
© The Institute of Chartered Accountants of India
8.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
statements are prepared in accordance with a special purpose framework, the auditor shall include
a similar restriction or alert in the auditor’s report on the summary financial statements.
4.8 Comparatives
Comparatives in the audited financial statements may be regarded as corresponding figures or as
comparative financial information. If the audited financial statements contain comparatives, but the
summary financial statements do not, the auditor shall determine whether such omission is
reasonable in the circumstances of the engagement. The auditor shall determine the effect of an
unreasonable omission on the auditor’s report on the summary financial statements.
If the summary financial statements contain comparatives that were reported on by another auditor,
the auditor’s report on the summary financial statements shall also contain the matters that SA 710
requires the auditor to include in the auditor’s report on the audited financial statements.
4.9 Unaudited Supplementary Information Presented With Summary
Financial Statements
The auditor shall evaluate whether any unaudited supplementary information presented with the
summary financial statements is clearly differentiated from the summary financial statements. If the
auditor concludes that the entity’s presentation of the unaudited supplementary information is not
clearly differentiated from the summary financial statements, the auditor shall ask management to
change the presentation of the unaudited supplementary information. If management refuses to do
so, the auditor shall explain in the auditor’s report on the summary financial statements that such
information is not covered by that report.
4.10 Other Information in Documents Containing Summary Financial
Statements
The auditor shall read the other information included in a document containing the summary financial
statements and related auditor’s reports to consider whether there is a material inconsistency
between the other information and the summary financial statements. If the auditor identifies a
material inconsistency, the auditor shall determine whether the summary financial statements or the
other information needs to be revised. If, the auditor becomes aware that the other information needs
to be revised, the auditor shall discuss the matter with management.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.25
4.11 Auditor Association
If the auditor becomes aware that the entity plans to state that the auditor has reported on summary
financial statements in a document containing the summary financial statements, but does not plan
to include the related auditor’s report, the auditor shall request management to include the auditor’s
report in the document. If management does not do so, the auditor shall determine and carry out
other appropriate actions designed to prevent management from inappropriately associating the
auditor with the summary financial statements in that document.
The auditor may be engaged to report on the financial statements of an entity, while not
engaged to report on the summary financial statements. If, in this case, the auditor
becomes aware that the entity plans to make a statement in a document that refers to the
auditor and the fact that summary financial statements are derived from the financial
statements audited by the auditor, the auditor shall be satisfied that:
(a) The reference to the auditor is made in the context of the auditor’s report on the audited
financial statements; and
(b) The statement does not give the impression that the auditor has reported on the summary
financial statements.
If (a) or (b) are not met, the auditor shall request management to change the statement to meet
them, or not to refer to the auditor in the document. Alternatively, the entity may engage the auditor
to report on the summary financial statements and include the related auditor’s report in the
document. If management does not change the statement, delete the reference to the auditor, or
include an auditor’s report on the summary financial statements in the document containing the
summary financial statements, the auditor shall advise management that the auditor disagrees with
the reference to the auditor, and the auditor shall determine and carry out other appropriate actions
designed to prevent management from inappropriately referring to the auditor.
4.12 Timing of Work and Events Subsequent to the Date of the Auditor’s
Report on the Audited Financial Statements
When the auditor reports on the summary financial statements after the completion of the audit of
the financial statements, the auditor is not required to obtain additional audit evidence on the audited
financial statements, or report on the effects of events that occurred subsequent to the date of the
auditor’s report on the audited financial statements since the summary financial statements are
derived from the audited financial statements.
© The Institute of Chartered Accountants of India
8.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 5
CA Madhur is auditor of a company and has issued audit report dated 15th June of a particular year.
The audit report on summary financial statements derived from such audited financial statements is
dated 15th July of that particular year. Discuss whether there exists any additional reporting
responsibility for auditor in such a situation in respect of audit report on summary financial
statements.
TEST YOUR UNDERSTANDING 6
Consider that the audit report on financial statements issued by CA Madhur for above said company
contains qualified opinion. Can he issue an unmodified opinion on summary financial statements
derived from audited financial statements? Discuss.
INTEGRATED CASE SCENARIO
Given below is an extract of abridged financial statements of schemes of “Smart Investment
Mutual Fund”. The abridged financial statements have been derived from audited financial
statements of the schemes of “Smart Investment Mutual Fund” as at 31St March 20XX and for
year ended 31st March,20XX.
Abridged Balance sheet as at 31st March 20XX (in ` Lacs)
Liabilities Smart investment Smart investment
equity and debt fund equity savings fund
Unit Capital 20000.00 15000.00
Reserve and Surplus 160000.00 80000.00
Other current liabilities & provisions 100.00 100.00
Total 180100.00 95100.00
Assets
Investments 170000.00 90000.00
Deposits 100.00 100.00
Other Current assets 10000.00 5000.00
Total 180100.00 95100.00
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.27
Abridged revenue account for year ended 31st March 20XX (In ` Lacs)
Income Smart investment Smart investment
equity and debt equity savings
fund fund
Income 34000.00 1000.00
Expenses and losses 3400.00 1500.00
Net realized gains 30600.00 (500.00)
Add: Change in unrealized appreciation in 2000.00 700.00
value of investments
Net Surplus 32600.00 200.00
Dividend appropriation 3000.00 50.00
Retained Surplus 29600.00 150.00
The abridged financial statements of the Schemes of the Fund have been prepared by Board of
Trustees of Fund pursuant to SEBI regulations and in accordance with format prescribed by
SEBI. Previous year figures have been ignored for purpose of case.
Unmodified opinion has been expressed by auditor in audited financial statements of the
schemes of “Smart Investment Mutual Fund” as at 31St March 20XX and for year ended
31st March, 20XX.
Keeping in view above, answer the following questions: -
1. Given the above extract of abridged financial statements and description, which of
the following statements is most appropriate?
(a) The auditor may presume that criteria applied by the Board of Trustees in the
preparation of the abridged financial statements are acceptable.
(b) The auditor cannot presume that criteria applied by the Board of Trustees in
preparation of abridged financial statements are acceptable.
(c) The abridged financial statements have been prepared by the Board of Trustees.
The auditor cannot ordinarily accept criteria applied by them for the preparation of
such abridged financial statements before detailed evaluation.
(d) The auditor is duty bound to accept the criteria applied by the Board of Trustees in
the preparation of abridged financial statements.
2. Which of the following statements in reference to abridged financial statements is
not in accordance with the requirements of SA 810?
© The Institute of Chartered Accountants of India
8.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) The notes to accounts should specifically disclose that these abridged financial
statements have been derived from audited financial statements.
(b) The Board of Trustees has disclosed that audited financial statements are available
on the website of the company.
(c) It should be stated in the auditor’s report that abridged financial statements have
been compared with the related information in the audited financial statements to
determine whether the abridged financial statements agree with or can be re-
calculated from the related information in the audited financial statements.
(d) It should be stated in auditor’s report that reading the abridged financial statements
is not a substitute for reading the audited financial statements of the Schemes of
the Fund.
3. Which of the following paras is most appropriate to be included under heading
“Auditor’s responsibility” in the auditor’s report?
(a) Our responsibility is to express an opinion on the Abridged financial statements
based on our procedures, which were conducted in accordance with Standards on
Auditing issued by the Institute of Chartered Accountants of India.
(b) Our responsibility is to express an opinion on the Abridged financial statements
based on our procedures, which were conducted in accordance with Standard on
Auditing (SA) 810, “Engagements to Report on Summary Financial Statements”
issued by the Institute of Chartered Accountants of India.
(c) Our responsibility is to express an opinion on the Abridged financial statements
based on our procedures, which were conducted in accordance with Standards on
Auditing adapted in circumstances including (SA) 810, “Engagements to Report on
Summary Financial Statements” issued by the Institute of Chartered Accountants
of India.
(d) Our responsibility is to express an opinion on the Abridged financial statements
based on our procedures, which were conducted in accordance with SEBI
regulations and Standards on Auditing adapted in circumstances including (SA)
810, “Engagements to Report on Summary Financial Statements” issued by the
Institute of Chartered Accountants of India.
4. Which of the following paras is most appropriate to be included under heading
“Opinion” in auditor’s report?
(a) In our opinion, the abridged financial statements, derived from the audited financial
statements of the Schemes of the Fund as at March 31, 20XX and for the year
ended March 31, 20XX are a fair summary of those financial statements, and are
in accordance with the accounting policies and standards specified in SEBI
regulations and generally accepted accounting principles in India to the extent
applicable.
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.29
(b) In our opinion, the abridged financial statements, as at March 31, 20XX and for the
year ended March 31, 20XX are a fair summary of those financial statements.
(c) In our opinion, the abridged financial statements, derived from the audited financial
statements of the Schemes of the Fund as at March 31, 20XX and for the year
ended March 31, 20XX are consistent with audited financial statements and are in
accordance with the accounting policies and standards specified in SEBI
regulations and generally accepted accounting principles in India to the extent
applicable.
(d) In our opinion, the abridged financial statements, derived from the audited financial
statements of the Schemes of the Fund as at March 31, 20XX and for the year
ended March 31, 20XX are consistent with audited financial statements.
5. Which of the following is usually not an element of audit report on abridged financial
statements in accordance with SA 810?
(a) Emphasis of matter paragraph.
(b) Other matter paragraph.
(c) Management’s responsibility for abridged financial statements.
(d) Key audit matters.
Key Takeaways
SA 800 deals with special considerations applicable in respect of audit of financial statements
prepared in accordance with special purpose framework.
SA 800 defines special purpose framework as a financial reporting framework designed to
meet the financial information needs of specific users. The financial reporting framework may
be a fair presentation framework or a compliance framework.
SA 800 addresses special considerations that are relevant to the acceptance of the
engagement, the planning and performance of that engagement and forming an opinion and
reporting on the financial statements but not for the purpose of expressing an opinion on the
effectiveness of the entity’s internal control.
The special purpose financial statements may be used for purposes other than those for
which they were intended. To avoid misunderstandings, the auditor alerts users of the
auditor’s report that the financial statements are prepared in accordance with a special
purpose framework and, therefore, may not be suitable for another purpose.
© The Institute of Chartered Accountants of India
8.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SA 805 deals with special considerations applicable to an audit of a single financial statement
or of a specific element, account or item of a financial statement.
The single financial statement or the specific element, account or item of a financial statement
may be prepared in accordance with a general or special purpose framework. If prepared in
accordance with a special purpose framework, SA 800 also applies to such an audit of a
single financial statement or of a specific element, account or item of a financial statement.
Single financial statement is to be distinguished from complete set of financial statements.
For example, a cash flow statement is a single financial statement.
“Element of a financial statement” or “element” means an “element, account or item of a
financial statement.” For example, trade receivables or cash and bank balances
The objective of the auditor, when applying SAs, in such an audit, is to address appropriately
the special considerations that are relevant to acceptance of engagement, planning and
performance of engagement and forming an opinion and reporting but not for the purpose of
expressing an opinion on the effectiveness of the entity’s internal control.
In planning and performing the audit of a single financial statement or of a specific element
of a financial statement, the auditor shall adapt all SAs relevant to the audit as necessary in
the circumstances of the engagement.
If the auditor undertakes an engagement to report on a single financial statement or on a
specific element of a financial statement in conjunction with an engagement to audit the
entity’s complete set of financial statements, the auditor shall express a separate opinion for
each engagement.
SA 810 deals with responsibilities of an auditor when undertaking an engagement to report
on summary financial statements derived from financial statements audited in accordance
with SAs by that same auditor.
Summary financial statements reflect historical financial information that is derived from
financial statements but that contains less detail than the financial statements, while still
providing a structured representation consistent with that provided by the financial statements
of the entity’s economic resources or obligations at a point in time or the changes therein for
a period of time.
The auditor shall, ordinarily, accept an engagement to report on summary financial
statements in accordance with this SA only when the auditor has been engaged to conduct
© The Institute of Chartered Accountants of India
SPECIALISED AREAS 8.31
an audit in accordance with SAs of the financial statements from which the summary financial
statements are derived.
Before accepting an engagement to report on summary financial statements, the auditor shall
determine whether the applied criteria are acceptable. Applied criteria refer to the criteria
applied by management in the preparation of the summary financial statements.
If the date of the auditor’s report on the summary financial statements is later than the date
of the auditor’s report on the audited financial statements, auditor’s report on summary
financial statements states that the summary financial statements and the audited financial
statements do not reflect the effects of events that occurred subsequent to the date of the
auditor’s report on the audited financial statements.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. CA P is auditor of a company responsible for auditing complete set of financial statements.
He intends to express adverse opinion on complete set of financial statements considering
conclusions drawn by him during course of audit. He is also auditing trade receivables of
company for the same period in a separate engagement. Can he express unmodified opinion
in respect of trade receivables? If so, discuss those circumstances.
2. List out few factors affecting auditor’s determination of the acceptability of the applied criteria
before accepting audit of summary financial statements.
3. SA 800 deals with special considerations applicable in respect of audit of financial statements
prepared in accordance with special purpose framework. Explain, by giving examples,
meaning of special purpose framework.
4. CA Y is auditor of a company. He has expressed adverse opinion on audited financial
statements. What additional points he has to keep in mind while expressing opinion on
summary financial statements derived from such audited financial statements?
Answers to Test Your Understanding Questions
1. In the given situation, the approach of CA Lalita is proper. There is no bar upon accepting
such an engagement even though she is the auditor of the company. Besides, she has
intended to disclose this fact in “Other Matter Paragraph” of the audit report to be issued by
her for such specific engagement.
© The Institute of Chartered Accountants of India
8.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. She may consider it appropriate to indicate that the auditor’s report is intended solely for
specific users. Depending on the law or regulation applicable, this may be achieved by
restricting the distribution or use of the auditor’s report. In these circumstances, the paragraph
alerting the readers may be expanded to include these other matters and the heading
modified accordingly. The draft para should read as under: -
Basis of Accounting and Restriction on Distribution and Use
Without modifying our opinion, we draw attention to Note A to the financial statements, which
describes the basis of accounting. The financial statements are prepared to assist the
company to comply with the financial reporting provisions of the contract referred to above.
As a result, the financial statements may not be suitable for another purpose. Our report is
intended solely for X Ltd. and Y Ltd. and should not be distributed to or used by parties other
than X Ltd. and Y Ltd.
3. The single financial statement or the specific element, account or item of a financial statement
may be prepared in accordance with a general or special purpose framework. If prepared in
accordance with a special purpose framework, SA 800 also applies to the audit.
In the given case, financial statements of the entity are prepared in accordance with financial
reporting provisions of a contract. It is a special purpose framework. The auditor of financial
statements prepared in accordance with special purpose framework is also offered audit of
trade receivables appearing in above financial statements which relates to audit of element
of financial statements prepared in accordance with special purpose framework. Hence, his
audit approach should include considering requirements of both SA 800 and SA 805.
4. Compliance with the requirements of SAs relevant to the audit of a single financial statement
or of a specific element of a financial statement may not be practicable when the auditor is
not also engaged to audit the entity’s complete set of financial statements. In such cases, the
auditor often does not have the same understanding of the entity and its environment,
including its internal control, as an auditor who also audits the entity’s complete set of
financial statements. Accordingly, the auditor may need further evidence to corroborate audit
evidence acquired from the accounting records.
In the case of an audit of a specific element of a financial statement, certain SAs require audit
work that may be disproportionate to the element being audited. If the auditor concludes that
an audit of a single financial statement or of a specific element of a financial statement in
accordance with SAs may not be practicable, the auditor may discuss with management
whether another type of engagement might be more practicable.
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SPECIALISED AREAS 8.33
5. The audit report on summary financial statements derived from audited financial statements
is dated 15th July of that particular year. However, the audit report on audited financial
statements is dated 15th June of that year.
In the above situation, the auditor’s report on summary financial statements should state that
the summary financial statements and the audited financial statements do not reflect the
effects of events that occurred subsequent to the date of the auditor’s report on the audited
financial statements.
6. If the auditor is satisfied that the summary financial statements are consistent, in all material
respects, with or are a fair summary of the audited financial statements, in accordance with
the applied criteria, he can issue an unmodified opinion.
However, when auditor’s report on audited financial statements contains a qualified opinion,
the auditor’s report on the summary financial statements shall, also contain following:
(a) State that the auditor’s report on the audited financial statements contains a qualified
opinion
(b) Describe:
(i) The basis for the qualified opinion on the audited financial statements, and that
qualified opinion in the auditor’s report on the audited financial statements; and
(ii) The effect thereof on the summary financial statements, if any.
Hence, above points should be included by CA Madhur.
Answers to Case Scenario
1. (a)
2. (c)
3. (b)
4. (a)
5. (d)
Answers to Theoretical Questions
1. Refer to Para 3.6.
2. Refer to Para 4.2.
3. Refer to Para 2.1.
4. Refer to Para 4.6.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 9
7
RELATED SERVICES
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand meaning of “Related Services”.
Know about Standards on Related Services.
Understand nature of “Agreed-Upon Procedures”.
Gain knowledge about SRS 4400 Engagements to Perform Agreed-upon
Procedures regarding Financial Information.
Understand reporting requirements of SRS 4400.
Understand meaning and nature of “Compilation engagement”.
Gain knowledge about SRS 4410 Compilation Engagements.
Understand reporting requirements of SRS 4410.
© The Institute of Chartered Accountants of India
9.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Audit Related Services
Engagements to Perform Agreed-
SRS 4400 upon Procedures Regarding
Financial Information
SRS 4410 Compilation Engagements
Trends Multi Products Limited is engaged in the business of selling ethnic items. It involves
procuring of myriad stocks ranging from brassware, wooden to handloom home furnishings
and exotic handicrafts through a chain of dealers, who in turn, purchase these items directly
from artisans, weavers and tiny enterprises. Since procurement is done at multiple locations
all over the country, the company has set up an extensive system of inventory control.
Considering huge inventories at multiple locations and associated risks, it requests CA.
Shaan to undertake an exercise involving physical verification of inventories and its
reconciliation with inventory records for a handsome professional fee. The management also
offers suitable staff resources support to perform required procedures. Such an exercise has
to be performed in accordance with prevailing professional standards and management
wants a report in accordance with professional standards applicable to such engagements.
Drawn to such a work due to attractive fees offered, CA. Shaan is on two boats. At first place,
he is thinking whether such an engagement can be accepted at all. Even if it is to be accepted,
what should be the expected form and content of the report? Since engagement is to be
performed in accordance with professional standards, SA 501 instantly came to his mind.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.3
Immediately, a pack of thoughts obliterated this. SA 501 applies to audit of financial
statements-in part- for obtaining audit evidence pertaining to existence and condition of
inventories. Since he is not to conduct audit of financial statements of company, how can SA
501 be applicable? However, the outlook of assignment appeared to involve application of
procedures of an audit nature for performing it. Is there any Standard for such type of
engagements involving performing an agreed-upon procedure where factual findings are to
be reported? Whether such engagement would be in nature of assurance engagement or not?
Why does company need such type of report? Refining his search, he stumbled upon
Standard on Related Services 4400.
Sitting in his air-conditioned office in one sweltering afternoon in Kolkata, he is approached
by a client to help it prepare its financial statements. The client is agreeing to provide trial
balance and other required information. However, herein lies the catch. Not only client
requires his assistance in preparation and presentation of financial statements, a compilation
report is also required.
A similar question struck his mind. Whether such a compilation report would be in nature of
assurance report? What kind of responsibilities are entrusted to a professional accountant
while performing such an engagement?
1. INTRODUCTION
Chartered Accountants in practice are often asked to provide services to clients which do not involve
the expression of an opinion on the truth and fairness of the financial statements. For the purpose
of standardising the procedures to perform such kind of non-assurance services, the AASB of ICAI
issued two Standards on two different services i.e. Standards on Related Services.
The following standards have been issued under Standards on Related Services: -
• SRS 4400 Engagements to Perform Agreed-upon Procedures Regarding Financial Information
• SRS 4410 Compilation Engagements
What are Related Services?
“Assurance engagement” means an engagement in which a practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended users other than the responsible party
about the outcome of the evaluation or measurement of a subject matter against criteria. It means
that the practitioner gives an opinion about specific information due to which users of information
© The Institute of Chartered Accountants of India
9.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
are able to make confident decisions knowing well that chance of information being incorrect is
diminished.
Not all engagements performed by practitioners are assurance engagements. Other frequently
performed engagements that do not meet the definition of assurance engagements include: -
• The preparation of tax returns where no conclusion conveying assurance is expressed.
• Consulting (or advisory) engagements such as management and tax consulting.
• Engagements covered by Standards for Related Services, such as agreed-upon procedures
engagements and compilations of financial or other information.
The above engagements are in nature of related services.
What are Agreed-upon Procedures?
In an engagement to perform agreed-upon procedures, the auditor is engaged by the client to issue
a report of factual findings, based on specified procedures performed on specified subject matter of
specified elements, accounts or items of a financial statement.
For example, an engagement to perform agreed-upon procedures may require the auditor to perform
certain procedures concerning individual items of financial data, say, accounts payable, accounts
receivable, purchases from related parties and sales and profits of a segment of an entity, or a
financial statement, say, a balance sheet or even a complete set of financial statements.
However, a person performing related services need not necessarily be the auditor of the entity’s financial
statements.
2. SRS 4400 ENGAGEMENTS TO PERFORM AGREED-
UPON PROCEDURES REGARDING FINANCIAL
INFORMATION
SRS 4400 provides guidance on the auditor’s professional responsibilities when an engagement to
perform agreed-upon procedures regarding financial information is undertaken and, on the form, and
content of the report that the auditor issues in connection with such an engagement.
2.1 Objective in Accordance with SRS 4400
The objective of an agreed-upon procedures engagement is for the auditor to carry out 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 Institute of Chartered Accountants of India
RELATED SERVICES 9.5
As the auditor simply provides a report of the factual findings of agreed upon procedures, no
assurance is provided by him in his report. Instead, users of the report assess for themselves the
procedures and the findings reported by the auditor and draw their own conclusions from the work
done by the auditor.
The report is usually 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.
The objective of an agreed-upon procedures engagement is to carry out 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. No assurance is provided in such a report. Such agreed-upon procedures engagements are
non-assurance engagements.
2.2 Audit Vs. Agreed-upon Procedures
A key difference between an audit and agreed-upon procedures relates to assurance. An audit
expresses an opinion and provides assurance to users. However, in an agreed-procedures
engagement, only a report of the factual findings of agreed-upon procedures is provided. No
assurance is given to users. Instead, users draw their own conclusions based on factual findings
stated in the report.
For example, an agreed upon procedures engagement to
evaluate validity of accounts payable may state the following:
Comparing of names of major suppliers and the amounts
outstanding as on a date to the related names and amounts in the
trial balance
Obtaining suppliers statements or confirmations from suppliers to
confirm balances outstanding on a date
Comparison of such statements or confirmations to the amounts in
trial balance
© The Institute of Chartered Accountants of India
9.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Further, actual findings like variation in balances reflected in trial balance and statements or
confirmations are given. The actual findings are reported as such without providing an assurance.
2.3 General Principles of an Agreed-upon Procedures Engagement
The auditor should comply with the Code of Ethics, issued by the Institute of Chartered Accountants
of India. Ethical principles governing the auditor’s professional responsibilities for this type of
engagement include integrity, objectivity, professional competence and due care,
confidentiality, professional conduct and technical standards.
Integrity;
Technical
Objectivity;
standards
Professional
Professional competence and due
conduct; care;
Confidentiality;
Independence is not a requirement for agreed-upon procedures engagement. However, the terms
or objective of the engagement may require the auditor to comply with the independence
requirements of the Code of Ethics issued by the Institute of Chartered Accountants of India. Where
the auditor is not independent, a statement to that effect should be made in the report of factual
findings.
2.3.1 Defining the Terms of the Engagement
The auditor should ensure with representatives of the entity and, ordinarily, other specified parties
who will receive copies of the report of factual findings, that there is a clear understanding regarding
the agreed procedures and the conditions of the engagement.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.7
Matters to be agreed include the following: -
(a) Nature of the engagement including the fact that the procedures performed will not
constitute an audit or a review and that accordingly no assurance will be expressed.
(b) Stated purpose for the engagement.
(c) Identification of the financial information to which the agreed-upon procedures will be
applied.
(d) Nature, timing and extent of the specific procedures to be applied.
(e) Limitations on distribution of the report of factual findings. When such limitation would
be in conflict with the legal requirements, if any, the auditor would not accept the
engagement.
It is in the interests of both the client and the auditor that the auditor sends an engagement letter
documenting the key terms of the appointment. An engagement letter confirms the auditor’s
acceptance of the appointment and helps avoid misunderstanding regarding such matters as the
objectives and scope of the engagement, the extent of the auditor’s responsibilities and the form of
reports to be issued.
Matters that would be included in the engagement letter include: -
• A listing of the procedures to be performed as agreed-upon
between the parties.
• A statement that the distribution of the report of factual findings
would be restricted to the specified parties who have agreed to the
procedures to be performed.
2.3.2 Planning
The auditor should plan the work so that an effective engagement will be performed.
2.3.3 Procedures and Evidence
The auditor should carry out the procedures agreed-upon and use the evidence obtained as the
basis for the report of factual findings.
© The Institute of Chartered Accountants of India
9.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The procedures applied in an engagement to perform agreed-upon procedures may include:
• Inquiry and analysis
• Re computation, comparison and other clerical accuracy checks
• Observation
• Inspection
• Obtaining confirmations
Procedures perform Re computation,
Agreed-upon comparison and other
Procedures Inquiry and analysis
clerical accuracy
engagements: checks
Obtaining
Observation Inspection
confirmations
2.4 Reporting
The report on an agreed-upon procedures engagement needs to describe the purpose and the
agreed-upon procedures of the engagement in sufficient detail to enable the reader to understand
the nature and the extent of the work performed. The report should also clearly mention that no audit
or review has been performed.
The report of factual findings should contain: -
(a) Title
(b) Addressee (ordinarily, the appointing authority)
(c) Identification of specific financial or non-financial information to which the agreed-
upon procedures have been applied
(d) A statement that the procedures performed were those agreed-upon with the recipient
(e) A statement that the engagement was performed in accordance with the Standard on
Related Services applicable to agreed-upon procedures engagements
(f) Identification of the purpose for which the agreed-upon procedures were performed
(g) A listing of the specific procedures performed
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.9
(h) A description of the auditor’s factual findings including sufficient details of errors and
exceptions found
(i) A statement that the procedures performed do not constitute either an audit or a review
and, as such, no assurance is expressed
(j) A statement that had the auditor performed additional procedures, an audit or a review,
other matters might have come to light that would have been reported
(k) A statement that the report is restricted to those parties that have agreed to the
procedures to be performed
(l) A statement (when applicable) that the report relates only to the elements, accounts,
items or financial and non-financial information specified and that it does not extend to
the entity’s financial statements taken as a whole
(m) Date of the report
(n) Place of signature and
(o) Auditor’s signature
2.5 Documentation
The auditor should document matters which are important in providing evidence to support the report
of factual findings, and evidence that the engagement was carried out in accordance with this SRS
and the terms of the engagement.
TEST YOUR UNDERSTANDING 1
A company asks you to carry out process of confirmation of its accounts receivables having balances
in excess of `10 lacs as per its books of accounts at the close of the year. The work to be performed
only involves preparing and sending confirmation requests to such parties, analysis of variations on
receipt of confirmations and submission of a report in accordance with professional standards. What
points have to be kept in mind for inclusion in report specifically for such engagement?
3. SRS 4410 COMPILATION ENGAGEMENTS
SRS 4410 deals with the practitioner’s responsibilities when engaged to assist management with
the preparation and presentation of historical financial information without obtaining any assurance
on that information, and to report on the engagement in accordance with this SRS.
© The Institute of Chartered Accountants of India
9.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
It applies to compilation engagements for historical financial information. Compilation engagements
for financial information other than historical financial information, and compilation engagements for
non-financial information can be performed under this Standard after necessary adaptation.
SQC 1 is applicable to all Engagement Standards. Since SRS 4410 is also one of Engagement
Standards, SQC 1 applies to firms in respect of firm’s compilation engagements too.
What is a Compilation engagement?
Compilation engagement is an engagement in which a practitioner applies accounting and financial
reporting expertise to assist management in the preparation and presentation of financial information
of an entity in accordance with an applicable financial reporting framework and issues a report.
Management may request a professional accountant in public practice to assist with the preparation
and presentation of financial information of an entity.
a compilation engagement may be required
Financial information that is the subject of
for various purposes including: -
To comply with mandatory periodic financial • For management or those charged with
reporting requirements established in law or governance, prepared on a basis appropriate
regulation, if any or for their particular purposes (such as
preparation of financial information for internal
use).
• For periodic financial reporting undertaken
For purposes unrelated to mandatory financial for external parties under a contract or other
reporting under relevant law or regulation, form of agreement (such as financial
including for example: - information provided to a funding body to
support provision or continuation of a grant).
• For transactional purposes, for example to
support a transaction involving changes to the
entity’s ownership or financing structure (such
as for a merger or acquisition).
A compilation engagement is not an assurance engagement. A compilation engagement does not require
the practitioner to verify the accuracy or completeness of the information provided by management for
the compilation, or otherwise to gather evidence to express an audit opinion or a review conclusion on
the preparation of the financial information.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.11
3.1 Objectives in accordance with SRS 4410
The practitioner’s objectives in a compilation engagement under this SRS are to: -
(a) Apply accounting and financial reporting
Objectives in a Compilation expertise to assist management in the
Engagement to: - preparation and presentation of financial
Apply accounting and financial information in accordance with an applicable
reporting expertise to assist
management in the preparation financial reporting framework based on
and presentation of financial
information
information provided by management and
(b) Report in accordance with the requirements
Report in accordance with the of this SRS.
requirements of this SRS.
3.2 Scope of Compilation Engagements
The scope of a compilation engagement will vary depending on the circumstances of the
engagement. However, in every case it will involve assisting management in the preparation and
presentation of the entity’s financial information in accordance with the financial reporting framework,
based on information provided by management. In some compilation engagements, management
may have already prepared the financial information itself in a draft or preliminary form.
Management retains responsibility for the financial information and the basis on which it is
prepared and presented. That responsibility includes application by management of the judgment
required for the preparation and presentation of the financial information, including the selection and
application of appropriate accounting policies and, where needed, developing reasonable
accounting estimates.
Different financial reporting frameworks can be used to prepare and present financial
information, ranging from a simple entity-specific basis of accounting to established financial
reporting standards. The financial reporting framework adopted by management to prepare and
present the financial information will depend on the nature of the entity and the intended use of the
information.
3.3 Ethical Requirements
The practitioner shall comply with relevant ethical requirements. In complying with the Code of Ethics,
threats to the practitioner’s compliance with relevant ethical requirements are required to be identified
and appropriately addressed.
© The Institute of Chartered Accountants of India
9.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Being in nature of non-assurance engagement, independence requirements do not apply to
compilation engagements. However, laws or regulations may specify requirements or disclosure
rules pertaining to independence.
3.4 Engagement Acceptance and Continuance
The practitioner shall not accept the engagement unless the practitioner has agreed the terms of
engagement with management, and the engaging party if different, including: -
(a) The intended use and distribution of the financial information, and any restrictions on either its
use or its distribution where applicable
(b) Identification of the applicable financial reporting framework
(c) The objective and scope of the compilation engagement
(d) The responsibilities of the practitioner, including the requirement to comply with relevant ethical
requirements
(e) The responsibilities of management for: -
The responsibilities of management for
(i) The financial (ii) Design,
information, and for the implementation and (iv) Judgments needed in
(iii) The accuracy and
preparation and maintenance of such the preparation and
completeness of the
presentation thereof, in internal control as presentation of the
records, documents,
accordance with a management determines financial information,
explanations and other
financial reporting is necessary to enable including those for which
information provided by
framework that is the preparation of the practitioner may
management for the
acceptable in view of the financial statements that provide assistance in the
compilation engagement
intended use of the are free from material course of the compilation
and
financial information and misstatement, whether engagement
the intended users due to fraud or error
(f) The expected form and content of the practitioner’s report.
The practitioner shall record the agreed terms of engagement in an engagement letter or other
suitable form of written agreement, prior to performing the engagement.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.13
On recurring compilation engagements, the practitioner shall evaluate whether circumstances,
including changes in the engagement acceptance considerations, require the terms of engagement
to be revised and whether there is need to remind management of the existing terms of engagement.
3.5 Performing the Engagement
• The practitioner shall obtain an understanding of the following matters sufficient to be able
to perform the compilation engagement: -
(a) The entity’s business and operations, including the entity’s accounting system
and accounting records and
(b) The applicable financial reporting framework, including its application in the
entity’s industry.
• The practitioner shall compile the financial information using the records, documents,
explanations and other information, including significant judgments, provided by
management.
• The practitioner shall discuss with management, or those charged with governance as
appropriate, those significant judgments, for which the practitioner has provided assistance
in the course of compiling the financial information.
• Prior to completion of the compilation engagement, the practitioner shall read the compiled
financial information in light of the practitioner’s understanding of the entity’s
business and operations, and of the applicable financial reporting framework.
• If, in the course of the compilation engagement, the practitioner becomes aware that the
records, documents, explanations or other information, including significant judgments,
provided by management for the compilation engagement are incomplete, inaccurate or
otherwise unsatisfactory, the practitioner shall bring that to the attention of management and
request the additional or corrected information.
• If the practitioner is unable to complete the engagement because management has failed
to provide records, documents, explanations or other information, including significant
judgments, as requested, the practitioner shall withdraw from the engagement and inform
management and those charged with governance of the reasons for withdrawing.
• If the practitioner becomes aware during the course of the engagement that: -
© The Institute of Chartered Accountants of India
9.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) The compiled (b) Amendments to the
financial information compiled financial
(c) The compiled
does not adequately information are required
financial information is
refer to or describe the for the financial
otherwise misleading,
applicable financial information not to be
reporting framework materially misstated; or
the practitioner shall propose the appropriate amendments to management.
• If management declines, or does not permit the practitioner to make the proposed
amendments to the compiled financial information, the practitioner shall withdraw from the
engagement and inform management and those charged with governance of the reasons for
withdrawing.
• If withdrawal from the engagement is not possible, the practitioner shall determine the
professional and legal responsibilities applicable in the circumstances.
• The practitioner shall obtain an acknowledgement from management or those charged with
governance, as appropriate, that they have taken responsibility for the final version of the
compiled financial information.
3.6 Communication with Management and Those Charged with
Governance
The practitioner shall communicate with management or those charged with governance, as
appropriate, on a timely basis during the course of the compilation engagement, all matters
concerning the compilation engagement that, in the practitioner’s professional judgment, are of
sufficient importance to merit the attention of management or those charged with governance, as
appropriate.
3.7 The Practitioner’s Report
An important purpose of the practitioner’s report is to clearly communicate the nature of the
compilation engagement, and the practitioner’s role and responsibilities in the engagement. The
practitioner’s report is not a vehicle to express an opinion or conclusion on the financial information
in any form.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.15
The practitioner’s report issued for the compilation engagement shall be in writing, and shall
include the following elements: -
(a) The report title
(b) The addressee(s), as required by the terms of the engagement
(c) A statement that the practitioner has compiled the financial information based on information
provided by management
(d) A description of the responsibilities of management, or those charged with governance as
appropriate, in relation to the compilation engagement, and in relation to the financial
information
(e) Identification of the applicable financial reporting framework and, if a special purpose financial
reporting framework is used, a description or reference to the description of that special
purpose financial reporting framework in the financial information
(f) Identification of the financial information, including the title of each element of the financial
information if it comprises more than one element, and the date of the financial information or
the period to which it relates
(g) A description of the practitioner’s responsibilities in compiling the financial information,
including that the engagement was performed in accordance with this SRS, and that the
practitioner has complied with relevant ethical requirements
(h) A description of what a compilation engagement entails in accordance with this SRS
(i) Explanations that: -
(i) Since a compilation engagement (ii) Accordingly, the practitioner does not
is not an assurance engagement, express an audit opinion or a review
the practitioner is not required to conclusion on whether the financial
verify the accuracy or information is prepared in accordance
completeness of the information with the applicable financial reporting
provided by management for the framework.
compilation and
(j) If the financial information is prepared using a special purpose financial reporting
framework, an explanatory paragraph that: -
(i) Describes the purpose for which (ii) Draws the attention of readers of the
the financial information is report to the fact that the financial
© The Institute of Chartered Accountants of India
9.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
prepared and, if necessary, the information is prepared in accordance
intended users, or contains a with a special purpose framework and
reference to a note in the financial that, as a result, the information may not
information that discloses this be suitable for other purposes
information and
(k) The date of the practitioner’s report
(l) The practitioner’s signature and
(m) The place of signature.
3.8 Engagement Level Quality Control
The engagement partner shall take responsibility for: -
(a) The overall quality of each (b) The engagement being performed
compilation engagement to which in accordance with the firm’s quality
that partner is assigned and control policies and procedures
3.9 Documentation
The practitioner shall include in the engagement documentation: -
(a) Significant matters arising during the compilation engagement and how those matters were
addressed by the practitioner
(b) A record of how the compiled financial information reconciles with the underlying records,
documents, explanations and other information, provided by management and
(c) A copy of the final version of the compiled financial information for which management or
those charged with governance, as appropriate, has acknowledged their responsibility, and
the practitioner’s report.
The practitioner may consider also including in the engagement documentation a copy of the entity’s
trial balance, summary of significant accounting records or other information that the practitioner
used to perform the compilation.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.17
TEST YOUR UNDERSTANDING 2
During the course of performing a compilation engagement in accordance with SRS 4410, it
becomes known to you that client had suffered a theft loss of `100 lacs of its inventories over a
period of time at a storage location visited infrequently. A claim was lodged by the client with
insurance company which was repudiated due to certain technical reasons relating to coverage of
policy. The client has not preferred a complaint or an appeal against said repudiation. The amount
is reflected under the head “current assets” in trial balance of the client. Discuss, how you should
proceed to deal with the matter?
INTEGRATED CASE SCENARIO
KM Limited has engaged your firm for compilation of financial statements in accordance with
requirements of SRS 4410. You also come to know that company is setting up a new unit in
Rourkela, Odisha. The company management has provided you with draft trial balance and requires
assistance in preparation and presentation of its financial statements for year ended 31st March,
2023. The management requires such a preparation and presentation for its internal use.
During the course of engagement, it is noticed that: -
[1] There are apparent errors in few opening balances brought forward from previous year
relating to some outstanding incentives receivable from government authorities. These have been
swapped with some other balances in trial balance. However, there are no credit transactions in
such incentive accounts or accounts whose balances have been swapped during the year.
[2] One of the team members suggests that it is one of the duties to ensure that revenue figures
stated in trial balance, at least, are verified to ensure that all revenues required to be booked by the
company have, in fact, been booked.
[3] It is also suggested by this team member that even though it is a compilation engagement,
quality control aspects like adhering to appropriate Standards needed to be followed.
[4] Before signing and issuing report under SRS 4410, you once again read the financial
information. It comes to your notice that figures relating to setting up of a new unit of the company
coming up in Rourkela in Odisha have not been properly disclosed in compiled financial statements.
The expenditure was incurred from a bank account maintained in Rourkela and was omitted to be
shown under appropriate heads. You are vacillating regarding above considering scope of
compilation engagement.
[5] The team has prepared detailed documentation during the course of engagement.
© The Institute of Chartered Accountants of India
9.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Keeping in view above, answer the following questions: -
1. In respect of errors in some of opening balances noticed as described in case, which
of the following statements is most appropriate?
(a) Such errors should straight away lead to the qualification of a report to be issued.
(b) Such errors should be brought to the knowledge of management.
(c) Knowledge of such type of errors has no effect on compliance of ethical requirements by the
firm.
(d) The above said matter relates to SA 510 Initial Audit Engagements-Opening Balances and
has no effect on reporting obligations in a compilation engagement.
2. As regards the suggestion of one of the team members regarding the verification of all
revenues of the company, which of the following statements is most appropriate?
(a) Suggestion of team member is proper as such verification is part and parcel of such an
engagement.
(b) Suggestion of team member is proper as the absence of such verification may make financial
statements misleading.
(c) Suggestion of team member is not proper as verifying the accuracy or completeness of the
information provided by management is not required in such engagement.
(d) Suggestion of team member is not proper as compliance with qualitative requirements is not
required in such engagement.
3. In view of the team member’s suggestion relating to adherence to appropriate
Standards for quality control, which of the following statements is relevant in the context of
above said engagement?
(a) SA 220 is applicable in this engagement and has to be followed by the engagement partner
meticulously.
(b) SQC 1 is applicable in this engagement.
(c) Both SA 220 and SQC 1 are applicable in this engagement.
(d) SA 220 and SQC 1 are not applicable in this engagement. However, SRS 4410 lays down
detailed quality control requirements for such type of engagement.
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.19
4. Which of the following statements is most appropriate as regards omission of
expenditure under appropriate heads pertaining to the Rourkela unit in compiled financial
statements?
(a) The above-noted omission can be misleading. By disregarding such an omission, the
fundamental principle of integrity is violated and engagement cannot be performed in accordance
with ethical requirements.
(b) The above-noted omission can be misleading. By disregarding such an omission, the
fundamental principle of objectivity is violated and engagement cannot be performed in accordance
with ethical requirements.
(c) The above noted omission has no effect on performing such compilation engagement.
(d) The above-noted omission has no effect on performing and issuing reports under such
compilation engagement.
5. The detailed documentation is maintained during the course of compilation
engagement. Which of the following statements is most appropriate regarding the assembly
of the final engagement file?
(a) Final engagement file should be assembled in not more than 60 days after the date of the
report.
(b) Final engagement file should be assembled in not more than 120 days after the date of the
report.
(c) Final engagement file should be assembled on a timely basis after the engagement report
has been finalized in accordance with the time limits set by the firm.
(d) There is no requirement of assembling of final engagement file in a compilation engagement.
Key Takeaways
Related Services engagements are not assurance engagements. In such types of
engagements, no assurance is provided by the practitioner.
In an engagement to perform agreed-upon procedures, the auditor is engaged by the client
to issue a report of factual findings, based on specified procedures performed on specified
subject matter of specified elements, accounts or items of a financial statement.
SRS 4400 provides guidance on the auditor’s professional responsibilities when an
engagement to perform agreed-upon procedures regarding financial information is
© The Institute of Chartered Accountants of India
9.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
undertaken and, on the form, and content of the report that the auditor issues in connection
with such an engagement.
Compilation engagement is an engagement in which a practitioner applies accounting and
financial reporting expertise to assist management in the preparation and presentation of
financial information of an entity in accordance with an applicable financial reporting
framework and issues a report.
SRS 4410 deals with the practitioner’s responsibilities when engaged to assist management
with the preparation and presentation of historical financial information without obtaining any
assurance on that information, and to report on the engagement in accordance with this SRS.
Engagement documentation has to be maintained for an agreed-upon procedures
engagement and compilation engagement.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. List out few intended purposes of a “compilation engagement.”
2. A Chartered Accountant is offered appointment for a compilation engagement to be
performed under SRS 4410. Is he required to comply with ethical requirements of Code of
Ethics? Discuss briefly.
3. How do “related services” differ from assurance engagements?
4. Discuss main documentation requirements to be taken care of by a practitioner while
performing a compilation engagement under SRS 4410.
5. CA. P has been appointed to compile the financial information of X Limited. CA P is confused
whether he should apply the same procedures which are required to be applied to conduct
an audit or there are some other procedures to discharge the duties under such an
engagement. Define the characteristics of Compilation Engagement. What should be the
approach of CA P for performing the Engagement ?
Answers to Test your Understanding Questions
1. The described engagement is an agreed-upon procedures engagement. Following points
have to be kept in mind for being included in the report: -
© The Institute of Chartered Accountants of India
RELATED SERVICES 9.21
• A statement that the procedures performed were those agreed-upon with the recipient
• A statement that the engagement was performed in accordance with the Standard on
Related Services applicable to agreed-upon procedures engagements
• Identification of the purpose for which the agreed-upon procedures were performed
• A listing of the specific procedures performed
• A description of the auditor’s factual findings including sufficient details of errors and
exceptions found
• A statement that the procedures performed do not constitute either an audit or a review
and, as such, no assurance is expressed
• A statement that had the auditor performed additional procedures, an audit or a review,
other matters might have come to light that would have been reported
• A statement that the report is restricted to those parties that have agreed to the
procedures to be performed
• A statement that the report relates only to the elements, accounts, items or financial
and non-financial information specified and that it does not extend to the entity’s
financial statements taken as a whole
2. In this instant case, amount of `100 lacs is reflected under the head “current assets” in trial
balance. Since client’s claim has been repudiated and no appeal has been preferred, it is a
loss for the client and should be dealt accordingly. Therefore, amendments are required for
the financial information not to be materially misstated.
If the practitioner becomes aware during the course of the engagement that amendments to
the compiled financial information are required for the financial information not to be
materially misstated or the compiled financial information is otherwise misleading, the
practitioner shall propose the appropriate amendments to management.
If management declines, or does not permit the practitioner to make the proposed amendments
to the compiled financial information, the practitioner shall withdraw from the engagement and
inform management and those charged with governance of the reasons for withdrawing.
If withdrawal from the engagement is not possible, the practitioner shall determine the
professional and legal responsibilities applicable in the circumstances.
© The Institute of Chartered Accountants of India
9.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Integrated Case Scenario
1. (b)
2. (c)
3. (b)
4. (a)
5. (c)
Hints/Answers to Theoretical Questions
1. Refer to Para 3.
2. Refer to Para 3.3.
3. Refer to Para 1.
4. Refer to Para 3.9.
5. Refer to Para 3 and Para 3.5.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 10
7
REVIEW OF FINANCIAL
INFORMATION
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the meaning of review.
Know about Standards on Review Engagements.
Gain the Knowledge about SRE 2400 Engagements to Review Historical
Financial Statements.
Know about the importance of “Inquiry” and “Analytical Procedures” in a
review engagement.
Gain the Knowledge about SRE 2410 Review of Interim Financial
Information Performed by the Independent Auditor of the Entity.
Understand in detail about contents of review reports under SRE 2400
and SRE 2410 respectively.
© The Institute of Chartered Accountants of India
10.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Review of Basic and Overview of SRE 2400-Engagements to
Financial Review Historical Financial Statements;
Information
Basic and Overview of SRE 2410-Review of Interim
Financial Information Performed by the Independent
Auditor of the Entity.
Madhulika, a CA final student, was part of an engagement team conducting “Review” of
quarterly results of “Track Data Limited”, a listed company. The audit firm, she was working
with, was also statutory auditor of this company. It was a new assignment for her. She knew
about mandatory review of quarterly financial results of listed companies by auditors in
accordance with SEBI listing regulations.
She was trying to figure out the difference between scope of an audit and review. Why a
“Review” has been mandated by the regulator? Does such an exercise involve carrying out
of same procedures as in case of an audit? If no, which types of procedures are mainly
performed in such an engagement?
Are such procedures limited to reconciling financial statements with underlying accounting
records? Whether such an exercise involves performing some other necessary procedures
too? Another pertinent issue troubling her related to obtaining of evidence. Whether, in a
review, sufficient and appropriate evidence is gathered too? Are responsibilities of a
professional accountant performing a review similar to one performing an audit? Basically,
she wanted mist on very objective of a review exercise to be cleared.
Excited she was, to understand about reporting requirements, in case of a review
engagement. If there was difference in scope of “audit” and “review”, contents of a review
report ought to be different. What happens if misstatements identified during course of
reviewing quarterly results are not corrected by company management?
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.3
Is it possible to issue a modified review report just as in case of an audit? What are modalities
of the same? “Mandatory responsibilities of professional accountants for a review
engagement must have been clinically described in Standards on Review Engagements”- She
was seriously contemplating.
She was also considering possibilities of other usage of review of financial information.
Besides meeting with mandatory legal and regulatory requirements, what could be other
benefits of review engagements to different entities?
1. INTRODUCTION
What is REVIEW?
“Review” is a limited assurance engagement. Limited assurance is the level of assurance
obtained where engagement risk is reduced to a level that is acceptable in the circumstances of the
engagement, but where that risk is greater than for a reasonable assurance engagement, as the
basis for expressing a conclusion. The combination of the nature, timing and extent of evidence
gathering procedures is at least sufficient for the practitioner to obtain a meaningful level of
assurance. To be meaningful, the level of assurance obtained by the practitioner is likely to enhance
the intended users’ confidence about the financial statements.
In simpler terms, limited assurance engagement provides lower level of assurance than audit. It
involves fewer procedures and, gathers sufficient and appropriate evidence on basis of which limited
conclusions can be drawn up. However, “review” is related to financial statements prepared on basis
of historical financial information just like an audit.
1.1 Standards on Review Engagements
Standards on Review Engagements apply where “Review” of financial information is undertaken by
the practitioner. Following Standards on review engagements have been issued in this regard:
Standards on Review Engagements
• SRE 2400 Engagements to Review Historical Financial Statements
• SRE 2410 Review of Interim Financial Information Performed by the Independent Auditor
of the Entity
It is worth remembering that Standards on Quality Control (SQCs) are to be applied for all services
covered by Engagement Standards. Standards on review engagements are part of Engagement
© The Institute of Chartered Accountants of India
10.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Standards. Therefore, quality control at the level of individual review engagements is premised on
the basis that the firm is subject to SQC 1.
2. SRE 2400 ENGAGEMENTS TO REVIEW HISTORICAL
FINANCIAL STATEMENTS
SRE 2400 deals with: -
The practitioner’s responsibilities when engaged to
perform a review of historical financial statements,
when the practitioner is not the auditor of the entity’s
financial statements and
The form and content of the practitioner’s report on the
financial statements.
In a review of financial statements, the practitioner expresses a conclusion that is designed to
enhance the degree of confidence of intended users regarding the preparation of an entity’s financial
statements in accordance with an applicable financial reporting framework. Such financial
statements may have been prepared using general purpose framework or special purpose
framework.
The practitioner’s conclusion is based on the practitioner obtaining limited assurance. The
practitioner’s report includes a description of the nature of a review engagement as context for the
readers of the report to be able to understand the conclusion.
The practitioner performs primarily inquiry and analytical procedures to obtain sufficient and
appropriate evidence as the basis for a conclusion on the financial statements as a whole.
If the practitioner becomes aware of a matter that causes the practitioner to believe the financial
statements may be materially misstated, he/she designs and performs additional procedures, as
he/she considers necessary in the circumstances, to be able to conclude on the financial statements.
SRE 2400 deals with the practitioner’s responsibilities performing a review of historical financial
statements when the practitioner is not the auditor of the entity’s financial statements.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.5
2.1 Objectives in a review of financial statements in accordance with
SRE 2400
The practitioner’s objectives in a review of financial statements in accordance with SRE 2400 are as
under:
(a) Obtain limited assurance, primarily by making an inquiry and performing analytical
procedures, about whether the financial statements as a whole are free from material
misstatement, thereby enabling the practitioner to express a conclusion on whether
anything has come to his attention that causes him to believe the financial statements are
not prepared, in all material respects, in accordance with an applicable financial reporting
framework
(b) Report on the financial statements as a whole and communicate, as required by this SRE.
In all cases when limited assurance cannot be obtained and a modified conclusion in the
practitioner’s report is insufficient in the circumstances, this SRE requires that the practitioner either
to disclaim a conclusion in the report issued for the engagement or, where appropriate to withdraw
from the engagement if withdrawal is possible under applicable law or regulations.
TEST YOUR UNDERSTANDING 1
Roma Limited has entered into a contract with Dorma Limited. There is a condition in the contract
by virtue of which Roma Limited is required to get its financial statements reviewed for a year on a
quarterly basis in accordance with the financial reporting provisions of the contract. Can Roma
Limited get its financial statements reviewed from a professional accountant in practice?
2.2 Compliance with Ethical Requirements and Engagement Level
Quality Control
The practitioner shall comply with relevant ethical requirements, including those pertaining to
independence and the engagement partner is responsible for overall quality of each review
engagement.
Factors affecting Acceptance and Continuance of Client Relationships and Review Engagements:
Unless required by law or regulation, the practitioner shall not accept a review engagement
if:
(a) The practitioner is not satisfied:
© The Institute of Chartered Accountants of India
10.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(i) That there is a rational purpose for the (ii) That a review engagement would be
engagement. Assurance engagements may appropriate in the circumstances. When the
only be accepted when the engagement practitioner’s preliminary understanding of the
exhibits certain characteristics that are engagement circumstances indicates that
conducive to achieving the practitioner’s accepting a review engagement would not be
objectives specified for the engagement. appropriate, the practitioner may consider
recommending that another type of engagement
It may be unlikely that there is a rational
be undertaken. Depending on the circumstances,
purpose for the engagement if, for example,
the practitioner may, for example, believe that
there is a significant limitation on the scope performance of an audit engagement would be
of work or the practitioner suspects
more appropriate than a review. In other cases, if
association of the practitioner’s name with
the engagement circumstances preclude the
the financial statements in an inappropriate
performance of an assurance engagement, the
manner. Similarly, when the engagement is
practitioner may recommend a compilation
intended to meet compliance requirements of
engagement, or other accounting services
relevant law or regulation and such law or
engagement, as appropriate.
regulation requires the financial statements
to be audited, there is no rational purpose for
such a review engagement.
(b) The practitioner has reason to believe that relevant ethical requirements, including
independence, will not be satisfied.
(c) The practitioner’s preliminary understanding of the engagement circumstances indicates
that information needed to perform the review engagement is likely to be unavailable or unreliable.
(d) The practitioner has cause to doubt management’s integrity such that it is likely to affect
proper performance of the review or
(e) Management or those charged with governance impose a limitation on the scope of the
practitioner’s work in the terms of a proposed review engagement such that the practitioner
believes that the limitation will result in the practitioner disclaiming a conclusion on the financial
statements.
2.3 Preconditions for Accepting a Review Engagement
Acceptability of financial reporting framework applied in preparation of financial
statements.
Agreement of management in acknowledging and understanding its responsibility for
preparation of financial statements and internal control.
Providing access to all information to the practitioner for the purpose of review and
unrestricted access to persons within the entity.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.7
Prior to accepting a review engagement, the practitioner shall: -
(a) Determine whether the financial reporting framework applied in the preparation of the
financial statements is acceptable including, in the case of special purpose financial statements,
obtaining an understanding of the purpose for which the financial statements are prepared and of
the intended users, and;
(b) Obtain the agreement of management that it acknowledges and understands its
responsibilities:
(i) For the preparation of the financial statements in accordance with the applicable financial
reporting framework, including, where relevant, their fair presentation.
(ii) 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; and
(iii) To provide the practitioner with: -
a. Access to all information of b. Additional c. Unrestricted access
which management is aware that is information that the to persons within the entity
relevant to the preparation of the practitioner may request from whom the practitioner
financial statements, such as from management for the determines it necessary to
records, documentation and other purpose of the review; obtain evidence.
matters; and
If the practitioner is not satisfied as to any of the matters set out above as preconditions for accepting
a review engagement, the practitioner shall discuss the matter with the management or those
charged with governance.
If changes cannot be made to satisfy the practitioner as to those matters, the practitioner shall not
accept the proposed engagement unless required by law or regulation to do so. However, an
engagement conducted under such circumstances does not comply with this SRE. Accordingly, the
practitioner shall not include any reference within the practitioner’s report to the review having been
conducted in accordance with this SRE.
If it is discovered after the engagement has been accepted that the practitioner is not satisfied as to
any of the above preconditions, the practitioner shall discuss the matter with the management or
those charged with governance and shall determine:
(c) Whether and, if so, how to
(a) Whether the matter can be (b) Whether it is appropriate to
communicate the matter in the
resolved continue with the engagement and
practitioner’s report.
© The Institute of Chartered Accountants of India
10.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.4 Agreeing to the Terms of Engagement
The practitioner shall agree to the terms of the engagement with the management or those charged
with governance, as appropriate, prior to performing the engagement. The agreed terms of
engagement shall be recorded in an engagement letter or other suitable form of written agreement.
On recurring review engagements, the practitioner shall evaluate whether circumstances, including
changes in the engagement acceptance considerations, require the terms of engagement to be
revised and whether there is a need to remind management or those charged with governance, as
appropriate, of the existing terms of engagement.
The practitioner shall not agree to a change in the terms of the engagement where there is no
reasonable justification for doing so. If, prior to completing the review engagement, the practitioner
is requested to change the engagement to an engagement for which no assurance is obtained, the
practitioner shall determine whether there is reasonable justification for doing so.
If the terms of engagement are changed during the course of the engagement, the practitioner and
the management or those charged with governance, as appropriate, shall agree on and record the
new terms of engagement in an engagement letter or any other suitable form of written agreement.
Overview of performing the review engagement after its acceptance in accordance with
SRE2400
Determine materiality for financial statements as a whole
Obtain understanding of entity and applicable financial reporting
framework to identify areas of possible material misstatements
Design and perform "Inquiry" and "Analytical procedures"
Perform procedures to address specific circumstances
Perform other procedures, if necessary, in circumstances
(i) Materiality in a Review of Financial Statements
The practitioner shall determine materiality for the financial statements as a whole and apply this
materiality in designing the procedures and in evaluating the results obtained from those procedures.
The practitioner’s judgment about what is material in relation to the financial statements as a whole
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.9
is the same regardless of the level of assurance obtained by a practitioner as the basis for expressing
the conclusion on the financial statements.
The practitioner shall revise materiality for the financial statements as a whole in the event of
becoming aware of any information during the review that would have caused the practitioner to
have determined a different amount initially.
(ii) Obtaining Understanding of the Entity
The practitioner shall obtain an understanding of the entity and its environment and the applicable
financial reporting framework to identify areas in the financial statements where material
misstatements are likely to arise and thereby provide a basis for designing procedures to address
those areas.
(iii) Designing and Performing Procedures
In obtaining sufficient appropriate evidence as the basis for a conclusion on the financial statements
as a whole, the practitioner shall design and perform inquiry and analytical procedures: -
(a) To address all material
items in the financial (b) To focus on addressing
statements, including areas in the financial
disclosures and statements where material
misstatements are likely to
arise.
The requirements relating to designing and performing of inquiry and analytical procedures, and
procedures addressing specific circumstances, are designed to enable the practitioner to achieve
the objectives of this SRE. The circumstances of review engagements vary widely and, accordingly,
there may be circumstances where the practitioner may consider it effective or efficient to design
and perform other procedures.
For example, if in the course of obtaining an understanding of the entity, the practitioner becomes
aware of a significant contract the practitioner may choose to read the contract.
The fact that the practitioner may deem it necessary to perform other procedures does not alter the
practitioner’s objective of obtaining limited assurance in relation to the financial statements as a
whole.
© The Institute of Chartered Accountants of India
10.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The practitioner may consider, reviewing the accounting records with a view to identifying significant
or unusual transactions that may require specific attention in the review.
(a) Inquiry: In a review, inquiry includes seeking information from management and other
persons within the entity, as the practitioner considers appropriate in the engagement
circumstances.
Inquiries may include matters such as those relating to making of accounting estimates,
identification of related parties, about significant, complex or unusual transactions, existence
of any actual, suspected or alleged fraud, events occurring between the date of the financial
statements and practitioner’s report, basis for management’s assessment of the entity’s
ability to continue as a going concern, events or conditions that appear to cast doubt on the
entity’s ability to continue as a going concern, material commitments, contractual obligations
or contingencies that have affected or may affect the entity’s financial statements including
disclosures and material non-monetary transactions or transactions for no consideration in
the financial reporting period under consideration.
The practitioner may also extend Inquiries to obtain non-financial data if appropriate.
Evaluating the responses provided by the management is integral to the inquiry process.
Depending on the engagement circumstances, inquiries may also include
inquiries about:
• Actions taken at
meetings of owners, those
charged with governance • Communications the
and committees thereof, entity has received, or • Matters arising in the
and proceedings at other expects to receive or course of applying other
meetings, if any, that affect obtain, from regulatory procedures.
the information and agencies.
disclosures contained in
the financial statements.
When performing further inquiries in relation to identified inconsistencies, the practitioner
considers the reasonableness and consistency of management’s responses in light of the
results obtained from other procedures, and the practitioner’s knowledge and understanding
of the entity and the industry in which it operates.
(b) Analytical procedures: In designing analytical procedures, the practitioner shall consider
whether the data from the entity’s accounting system and accounting records are adequate
for the purpose of performing the analytical procedures.
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REVIEW OF FINANCIAL INFORMATION 10.11
In a review, the practitioner mainly focuses upon inquiry and analytical procedures for
obtaining sufficient appropriate evidence as the basis for conclusion on financial statements
as a whole.
Why “Inquiry” and “Analytical procedures” are important in Review?
Evidence obtained through inquiry is often the principal source of evidence about management
intent. However, information available to support management’s intent may be limited. In that case,
understanding management’s past history of carrying out its stated intentions, management’s stated
reasons for choosing a particular course of action, and management’s ability to pursue a specific
course of action may provide relevant information to corroborate the evidence obtained through
inquiry. Application of professional scepticism in evaluating responses provided by management is
important to enable the practitioner to evaluate whether there are any matters that would cause the
practitioner to believe the financial statements may be materially misstated.
Performing inquiry procedures also assists the practitioner in obtaining or updating the practitioner’s
understanding of the entity and its environment, to be able to identify areas where material
misstatements are likely to arise in the financial statements.
In a review of financial statements, performing analytical procedures assists the practitioner
in:
• Obtaining or updating the practitioner’s understanding of the entity and its environment,
including to be able to identify areas where material misstatements are likely to arise in the
financial statements.
• Identifying inconsistencies or variances from expected trends, values or norms in the financial
statements such as the level of congruence of the financial statements with key data,
including key performance indicators.
• Providing corroborative evidence in relation to other inquiries or analytical procedures already
performed.
• Serving as additional procedures when the practitioner becomes aware of matters that cause
the practitioner to believe that the financial statements may be materially misstated.
An example of such an additional procedure is a comparative analysis of monthly revenue and cost
figures across profit centers, branches or other components of the entity, to provide evidence about
financial information contained in line items or disclosures made in the financial statements.
Various methods may be used to perform analytical procedures ranging from performing simple
comparisons to performing complex analysis using statistical techniques. The practitioner may, for
© The Institute of Chartered Accountants of India
10.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
example, apply analytical procedures to evaluate the financial information underlying the financial
statements and assessment of results for consistency with expected values. Expectations may be
developed by the practitioner on information obtained from relevant sources like information
regarding the industry in which entity operates.
(iv) Procedures to Address Specific Circumstances
Related parties: During the review, the practitioner shall remain alert for arrangements or
information that may indicate the existence of related party relationships or transactions that
the management has not previously identified or disclosed to the practitioner. If the
practitioner identifies significant transactions outside the entity’s normal course of business
during the course of review, the practitioner shall inquire with the management about the
nature of those transactions, possible involvement of related parties and the business
rationale (or lack thereof) of those transactions.
Fraud and non-compliance with laws or regulations: When there is an indication that fraud
or non-compliance with laws or regulations, or suspected fraud or non-compliance with laws
or regulations, has occurred in the entity, the practitioner shall communicate that matter to
the appropriate level of senior management or those charged with governance as appropriate
and request management’s assessment of the effects, if any, on the financial statements.
The practitioner has to consider the effect, if any, of management’s assessment of the effects
of fraud or non-compliance with laws or regulations communicated to him on his conclusion
on the financial statements and on his report and determine whether there is a responsibility
to report the occurrence or suspicion of fraud or illegal acts to a party outside the entity.
Going concern: A review of financial statements includes consideration of the entity’s ability
to continue as a going concern. If, during the performance of the review, the practitioner
becomes aware of events or conditions that may cast significant doubt about the entity’s
ability to continue as a going concern, the practitioner shall:
(a) Inquire of management about plans for future actions affecting the entity’s ability
to continue as a going concern and about the feasibility of those plans, and also
whether management believes that the outcome of those plans will improve the
situation regarding the entity’s ability to continue as a going concern.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.13
(b) Evaluate the results of those inquiries, to consider whether management’s
responses provide a sufficient basis to: -
(i) Continue to present the financial statements on the going concern basis if
the applicable financial reporting framework includes the assumption of an
entity’s continuance as a going concern or
(ii) Conclude whether the financial statements are materially misstated, or are
otherwise misleading regarding the entity’s ability to continue as a going
concern and
(c) Consider management’s responses in light of all relevant information of which the
practitioner is aware as a result of the review.
Use of work performed by others: In performing the review, it may be necessary for the
practitioner to use work performed by other practitioners, or the work of an individual or
organization possessing expertise in a field other than accounting or assurance. If the
practitioner uses work performed by another practitioner or an expert in the course of
performing the review, the practitioner shall take appropriate steps to be satisfied that the
work performed is adequate for the practitioner’s purposes.
When the practitioner is engaged to review the financial statements of a group of entities, the
planned nature, timing and extent of the procedures for the review are directed at achieving
the practitioner’s objectives for the review engagement in accordance with this Standard but
in the context of the group financial statements.
(v) Additional procedures when the practitioner becomes aware that the financial
statements may be materially misstated:
If the practitioner becomes aware of matters that causes the practitioner to believe that the financial
statements may be materially misstated, the practitioner shall design and perform additional
procedures sufficient to enable the practitioner to:
(a) Conclude that the matter(s) is
(b) Determine that the matter(s)
not likely to cause the financial
causes the financial statements as a
statements as a whole to be
whole to be materially misstated.
materially misstated or
© The Institute of Chartered Accountants of India
10.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Additional procedures are required under this SRE if the practitioner becomes aware of a matter that
causes the practitioner to believe the financial statements may be materially misstated. The
practitioner’s response in undertaking additional procedures with respect to an item the practitioner
has cause to believe may be materially misstated in the financial statements will vary, depending on
the circumstances, and is a matter for the practitioner’s professional judgment.
Additional procedures focus on obtaining sufficient appropriate evidence to enable the practitioner
to form a conclusion on matters that the practitioner believes may cause the financial statements
to be materially misstated. The procedures may be:
• Additional inquiry or analytical procedures, for example, being performed in greater detail
or being focused on the affected items (i.e. amounts or disclosures concerning the affected
accounts or transactions as reflected in the financial statements); or
• Other types of procedures, for example, substantive test of details or external
confirmations.
Example explaining when additional procedures may be necessary in Review
In course of performing inquiry and analytical procedures for review, analysis of accounts receivable
shows a material amount of past due accounts receivable, for which there is no allowance for bad
or doubtful debts. This causes the practitioner to believe that the accounts receivable balance in the
financial statements may be materially misstated. The practitioner then inquire of management
whether there are uncollectible accounts receivable that would need to be shown as being impaired.
Depending on management’s response, the practitioner’s evaluation of the response may:
(a) Enable the practitioner to conclude that the accounts receivable balance is not likely to be
materially misstated. In that case, no further procedures are required.
(b) Enable the practitioner to determine that the matter causes the financial statements to be
materially misstated. No further procedures are required, and the practitioner would form the
conclusion that the financial statements as a whole are materially misstated.
(c) Lead the practitioner to continue to believe that the accounts receivable balance is likely to
be materially misstated, while not providing sufficient appropriate evidence for the practitioner to
determine that they are in fact misstated.
In that case, the practitioner is required to perform additional procedures, for example, requesting
from management an analysis of amounts received for those accounts after the balance sheet date
to identify uncollectible accounts receivable.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.15
The evaluation of the results of the additional procedures may enable the practitioner to get to (a)
or (b) above.
If not, the practitioner is required to: -
(i) Continue performing additional procedures until the practitioner reaches either (a) or (b)
above or
(ii) If the practitioner is not able to either conclude that the matter is not likely to cause the
financial statements as a whole to be materially misstated or to determine that the matter does cause
the financial statements as a whole to be materially misstated, then a scope limitation exists and the
practitioner is not able to form an unmodified conclusion on the financial statements.
If the practitioner becomes aware of events occurring between the date of the financial statements
and the date of the practitioner’s report that require adjustment of, or disclosure in, the financial
statements, the practitioner shall request management to correct those misstatements.
The practitioner has no obligation to perform any procedures regarding the financial statements after
the date of the practitioner’s report. However, if, after the date of the practitioner’s report but before
the date the financial statements are issued, a fact becomes known to the practitioner that, had it
been known to the practitioner at the date of the practitioner’s report, may have caused the
practitioner to amend the report, the practitioner shall: -
(a) Discuss the matter
(c) If so, inquire how
with management or (b) Determine whether
management intends to
those charged with the financial statements
address the matter in the
governance, as need amendment and
financial statements.
appropriate
If management does not amend the financial statements in circumstances where the practitioner
believes they need to be amended, and the practitioner’s report has already been provided to the
entity, the practitioner shall notify management and those charged with governance not to issue the
financial statements to third parties before the necessary amendments have been made. If the
financial statements are nevertheless subsequently issued without the necessary amendments, the
practitioner shall take appropriate action k to prevent reliance on the practitioner’s report.
(vi) Written Representations
Written representations are an important source of evidence in a review engagement. If management
modifies or does not provide the requested written representations, it may alert the practitioner to
the possibility that one or more significant issues may exist. Further, a request for written, rather
© The Institute of Chartered Accountants of India
10.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
than oral, representations in many cases may prompt management to consider such matters more
rigorously, thereby enhancing the quality of the representations.
The practitioner shall request management to provide a written representation that
management has fulfilled its responsibilities described in the agreed terms of engagement.
The written representation shall include that: -
(a) Management has fulfilled its responsibility for the preparation of financial statements in
accordance with the applicable financial reporting framework, including where relevant their fair
presentation, and has provided the practitioner with all relevant information and access to
information as agreed in the terms of the engagement; and
(b) All transactions have been recorded and are reflected in the financial statements.
If law or regulation requires management to make written public statements about its responsibilities,
and the practitioner determines that such statements provide some or all of the representations
required above, the relevant matters covered by such statements need not be included in the written
representation.
In addition to the written representations required under this SRE, the practitioner may consider it
necessary to request other written representations about the financial statements. These may be
needed, for example, to complete the practitioner’s evidence with respect to certain items or
disclosures reflected in the financial statements where the practitioner considers such
representations to be important in forming a conclusion on the financial statements on either a
modified or unmodified basis.
The practitioner shall also request management’s written representations that
management has disclosed to the practitioner: -
(a) The identity of the entity’s related parties and all the related party relationships and
transactions of which management is aware;
(b) Significant facts relating to any frauds or suspected frauds known to management that may
have affected the entity;
(c) Known actual or possible non-compliance with laws and regulations for which the effects
of non-compliance affect the entity’s financial statements;
(d) All information relevant to use of the going concern assumption in the financial statements;
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.17
(e) That all events occurring subsequent to the date of the financial statements and for which
the applicable financial reporting framework requires adjustment or disclosure, have been
adjusted or disclosed;
(f) Material commitments, contractual obligations or contingencies that have affected or may
affect the entity’s financial statements, including disclosures;
(g) Material non-monetary transactions or transactions for no consideration undertaken by the
entity in the financial reporting period under consideration.
If management does not provide one or more of the requested written representations, the
practitioner shall: -
(b) Re-evaluate the integrity of (c) Take appropriate actions,
(a) Discuss the matter with management, and evaluate the including determining the
management and those effect that this may have on the possible effect on the
charged with governance, as reliability of representations conclusion in the practitioner’s
appropriate; (oral or written) and evidence report in accordance with this
in general; and SRE.
The practitioner shall disclaim a conclusion on the financial statements, or withdraw from the
engagement if withdrawal is possible under applicable law or regulation, as appropriate, if: -
(a) The practitioner concludes that there is sufficient doubt about the integrity of management
such that the written representations are not reliable or
(b) Management does not provide the required representations in respect of its responsibilities
for preparation of financial statements and recording of all transactions in financial
statements.
(vii) Evaluating evidence obtained from the procedures performed
The practitioner shall evaluate whether sufficient appropriate evidence has been obtained from the
procedures performed and, if not, the practitioner shall perform other procedures judged by the
practitioner to be necessary in the circumstances to be able to form a conclusion on the financial
statements.
In some circumstances, the practitioner may not have obtained the evidence that the practitioner
had expected to obtain through the design of primarily inquiry and analytical procedures and
procedures addressing specific circumstances.
© The Institute of Chartered Accountants of India
10.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In these circumstances, the practitioner considers that the evidence obtained from the procedures
performed is not sufficient and appropriate to be able to form a conclusion on the financial
statements.
The practitioner may:
• Extend the work performed or
• Perform other procedures judged by the practitioner to be necessary in the circumstances.
Where neither of these is practicable in the circumstances, the practitioner will not be able to obtain
sufficient appropriate evidence to be able to form a conclusion and is required by this SRE to
determine the effect on the practitioner’s report, or on the practitioner’s ability to complete the
engagement, for example, if a member of management is unavailable at the time of the review to
respond to the practitioner's inquiries on significant matters.
If the practitioner is not able to obtain sufficient appropriate evidence to form a conclusion, the
practitioner shall discuss with management and those charged with governance, as appropriate, the
effects such limitations have on the scope of the review.
Inability to perform a specific procedure does not constitute a limitation on the scope of the review
if the practitioner is able to obtain sufficient appropriate evidence by performing other procedures.
Limitations on the scope of the review imposed by management may have other implications for the
review, such as for the practitioner’s consideration of areas where the financial statements are likely
to be materially misstated, and engagement continuance.
(viii) Forming the practitioner’s conclusion on the financial statements
In forming conclusion, the practitioner shall also consider the impact of: -
(a) Uncorrected misstatements identified during the review, and in the previous year’s review of
the entity’s financial statements, on the financial statements as a whole
(b) Qualitative aspects of the entity’s accounting practices, including indicators of possible bias
in management’s judgments.
If the financial statements are prepared using a fair presentation framework, the
practitioner’s consideration shall also include: -
(a) The overall presentation, structure and content of the financial statements in accordance
with the applicable framework and
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.19
(b) Whether the financial statements, including the related notes, appear to represent the
underlying transactions and events in a manner that achieves fair presentation or gives a
true and fair view, as appropriate, in the context of the financial statements as a whole.
The practitioner’s conclusion on the financial statements, whether unmodified or modified, shall be
expressed in the appropriate form in the context of the financial reporting framework applied in the
financial statements.
Unmodified Conclusion: The practitioner shall express an unmodified conclusion in the
practitioner’s report on the financial statements as a whole when the practitioner has obtained limited
assurance to be able to conclude that nothing has come to the practitioner’s attention that causes
the practitioner to believe that the financial statements are not prepared, in all material respects, in
accordance with the applicable financial reporting framework.
When the practitioner expresses an unmodified conclusion, the practitioner shall, unless
otherwise required by law or regulation, use one of the following phrases, as appropriate: -
(a) “Based on our review, nothing has come to our attention that causes us to believe
that the financial statements do not give a true and fair view (or do not present fairly,
in all material respects), in accordance with the applicable financial reporting
framework,” (for financial statements prepared using a fair presentation framework);
or
(b) “Based on our review, nothing has come to our attention that causes us to believe
that the financial statements are not prepared, in all material respects, in accordance
with the applicable financial reporting framework,” (for financial statements
prepared using a compliance framework).
Modified Conclusion: The practitioner shall express a modified conclusion in the practitioner’s
report on the financial statements as a whole when:
(b) The practitioner is unable to obtain
(a) The practitioner determines, based on the
sufficient and appropriate evidence in relation
procedures performed and the evidence
to one or more items in the financial
obtained, that the financial statements are
statements that are material in relation to the
materially misstated or
financial statements as a whole.
© The Institute of Chartered Accountants of India
10.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
When the practitioner modifies the conclusion expressed on the financial statements, the
practitioner shall:
(b) Provide a description of the matter
giving rise to the modification, under an
(a) Use the heading “Qualified Conclusion,” appropriate heading (for example, “Basis
“Adverse Conclusion” or “Disclaimer of for Qualified Conclusion,” “Basis for
Conclusion,” as appropriate, for the Adverse Conclusion” or “Basis for
conclusion paragraph in the practitioner’s Disclaimer of Conclusion,” as appropriate)
report and in a separate paragraph in the practitioner’s
report immediately before the conclusion
paragraph (referred to as the basis for
conclusion paragraph).
Financial statements are materially misstated.
If the practitioner determines that the financial statements are materially misstated,
the practitioner shall express:
(a) A qualified conclusion, when the practitioner (b) An adverse conclusion, when the effects of
concludes that the effects of the matter(s) giving the matter(s) giving rise to the modification are
rise to the modification are material, but not both material and pervasive to the financial
pervasive to the financial statements; or statements.
When the practitioner expresses a qualified conclusion on the financial statements
because of a material misstatement, the practitioner shall, unless otherwise required by
law or regulation, use one of the following phrases, as appropriate: -
(a) “Based on our review, except for the effects of the matter(s) described in the Basis for
Qualified Conclusion paragraph, nothing has come to our attention that causes us to
believe that the financial statements do not give a true and fair view (or do not present
fairly, in all material respects), in accordance with the applicable financial reporting
framework,” (for financial statements prepared using a fair presentation framework) or
(b) “Based on our review, except for the effects of the matter(s) described in the Basis for
Qualified Conclusion paragraph, nothing has come to our attention that causes us to
believe that the financial statements are not prepared, in all material respects, in
accordance with the applicable financial reporting framework,” (for financial statements
prepared using a compliance framework).
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.21
When the practitioner expresses an adverse conclusion on the financial statements, the practitioner
shall, unless otherwise required by law or regulation, use one of the following phrases, as
appropriate:
(a) “Based on our review, due to the significance of the matter(s) described in the Basis for
Adverse Conclusion paragraph, the financial statements do not give a true and fair view
(or do not present fairly, in all material respects), in accordance with the applicable
financial reporting framework,” (for financial statements prepared using a fair presentation
framework); or
(b) “Based on our review, due to the significance of the matter(s) described in the Basis for
Adverse Conclusion paragraph, the financial statements are not prepared, in all material
respects, in accordance with the applicable financial reporting framework,” (for financial
statements prepared using a compliance framework).
In the basis for conclusion paragraph, in relation to material misstatements that give rise to either
a qualified conclusion or an adverse conclusion, the practitioner shall: -
(a) Describe and quantify the financial effects of the misstatement if the material misstatement
relates to specific amounts in the financial statements (including quantitative disclosures),
unless impracticable, in which case the practitioner shall so state;
(b) Explain how disclosures are misstated if the material misstatement relates to narrative
disclosures; or
(c) Describe the nature of omitted information if the material misstatement relates to the non-
disclosure of information required to be disclosed. Unless prohibited by law or regulation,
the practitioner shall include the omitted disclosures where practicable to do so.
Narrative accounting disclosures are an integral part of the corporate financial reporting
package. They are deemed to provide a view of the company “through the eyes of
management”. The narratives represent management's construal of corporate events and
are largely discretionary.
Inability to obtain sufficient and appropriate evidence:
If the practitioner is unable to form a conclusion on the financial statements due to the inability to
obtain sufficient appropriate and evidence, the practitioner shall:
© The Institute of Chartered Accountants of India
10.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(a) Express a qualified conclusion if the practitioner concludes that the possible effects on the
financial statements of undetected misstatements, if any, could be material but not
pervasive or
(b) Disclaim a conclusion if the practitioner concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and pervasive.
The practitioner shall withdraw from the engagement if the following
conditions are present: -
(a) Due to a limitation on the scope
of the review imposed by
(b) The practitioner has determined
management after the practitioner
that the possible effects on the
has accepted the engagement, the (c) Withdrawal is possible under
financial statements of undetected
practitioner is unable to obtain applicable law or regulation.
misstatements are material and
sufficient appropriate and evidence
pervasive and
to form a conclusion on the financial
statements;
When the practitioner expresses a qualified conclusion on the financial statements due to
inability to obtain sufficient and appropriate evidence, the practitioner shall, unless otherwise
required by law or regulation, use one of the following phrases, as appropriate:
(a) “Based on our review, except for the possible effects of the matter(s) described in the Basis
for Qualified Conclusion paragraph, nothing has come to our attention that causes us to
believe that the financial statements do not give a true and fair view (or do not present fairly,
in all material respects) in accordance with the applicable financial reporting framework,” (for
financial statements prepared using a fair presentation framework); or
(b) “Based on our review, except for the possible effects of the matter(s) described in the Basis
for Qualified Conclusion paragraph, nothing has come to our attention that causes us to
believe that the financial statements are not prepared, in all material respects, in accordance
with the applicable financial reporting framework,” (for financial statements prepared using a
compliance framework).
When disclaiming a conclusion on the financial statements the practitioner shall state in the
conclusion paragraph that:
(a) Due to the significance of the matter(s) described in the Basis for Disclaimer of Conclusion
paragraph, the practitioner is unable to obtain sufficient appropriate evidence to form a
conclusion on the financial statements; and
(b) Accordingly, the practitioner does not express a conclusion on the financial statements.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.23
In the basis for conclusion paragraph, in relation to either the qualified conclusion due to inability of
obtaining sufficient and appropriate evidence or when the practitioner disclaims a conclusion, the
practitioner shall include the reason(s) for the inability to obtain sufficient and appropriate evidence.
(ix) The Practitioner’s Report
The practitioner’s report for the review engagement shall be in writing and shall contain the following
elements: -
(a) A title, which shall clearly indicate that it is the report of an independent practitioner for a
review engagement
(b) The addressee(s), as required by the circumstances of the engagement
(c) An introductory paragraph that:
(1) Identifies the financial statements reviewed, including identification of the title of
each of the statements contained in the set of financial statements and the date and
period covered by each financial statement
(2) Refers to the summary of significant accounting policies and other explanatory
information and
(3) States that the financial statements have been reviewed
(d) A description of the responsibility of management for the preparation of the financial
statements, including an explanation that management is responsible for:
(1) Their preparation in accordance with the applicable financial reporting framework
including, where relevant, their fair presentation;
(2) 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;
(e) If the financial statements are special purpose financial statements:
(1) A description of the purpose for which the financial statements are prepared and, if
necessary, the intended users, or reference to a note in the special purpose
financial statements that contains that information; and
(2) If management has a choice of financial reporting frameworks in the preparation of
such financial statements, a reference within the explanation of management’s
responsibility for the financial statements to management’s responsibility for
© The Institute of Chartered Accountants of India
10.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
determining that the applicable financial reporting framework is acceptable in the
circumstances
(f) A description of the practitioner’s responsibility to express a conclusion on the financial
statements including reference to this SRE and, where relevant, applicable law or
regulation.
(g) A description of a review of financial statements and its limitations, and the
following statements:
(1) A review engagement under this SRE is a limited assurance engagement.
(2) The practitioner performs procedures, primarily consisting of making inquiries of
management and others within the entity, as appropriate, and applying analytical
procedures, and evaluates the evidence obtained and
(3) The procedures performed in a review are substantially less than those performed
in an audit conducted in accordance with Standards on Auditing (SAs), and,
accordingly, the practitioner does not express an audit opinion on the financial
statements.
(h) A paragraph under the heading “Conclusion” that contains:
(1) The practitioner’s conclusion on the financial statements as a whole as appropriate
and
(2) A reference to the applicable financial reporting framework used to prepare the
financial statements.
(i) When the practitioner’s conclusion on the financial statements is modified:
(1) A paragraph under the appropriate heading that contains the practitioner’s modified
conclusion as appropriate and
(2) A paragraph, under an appropriate heading, that provides a description of the
matter(s) giving rise to the modification
(j) A reference to the practitioner’s obligation under this SRE to comply with relevant ethical
requirements
(k) The date of the practitioner’s report: The practitioner shall date the report no earlier
than the date on which the practitioner has obtained sufficient appropriate evidence as the
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.25
basis for the practitioner’s conclusion on the financial statements, including being satisfied
that: -
(1) All the statements that comprise the financial statements under the applicable
financial reporting framework, including the related notes where applicable, have
been prepared and
(2) Those with the recognized authority have asserted that they have taken
responsibility for those financial statements.
(l) The practitioner’s signature and
(m) The place of signature.
2.5 Emphasis of Matter and Other Matter Paragraphs in the
Practitioner’s Report
The practitioner may consider it necessary to draw users’ attention to a matter presented or
disclosed in the financial statements that, in the practitioner’s judgment, is of such importance that
it is fundamental to users’ understanding of the financial statements. In such cases, the practitioner
shall include an Emphasis of Matter paragraph in the practitioner’s report, provided the practitioner
has obtained sufficient appropriate evidence to conclude that the matter is not likely to be materially
misstated as presented in the financial statements. Such paragraph shall refer only to the information
presented or disclosed in the financial statements.
The practitioner shall include an Emphasis of Matter paragraph immediately after the paragraph that
contains the practitioner’s conclusion on the financial statements under the heading “Emphasis of
Matter,” or other appropriate heading.
If the practitioner considers it necessary to communicate a matter other than those that are
presented or disclosed in the financial statements that, in the practitioner’s judgment, is relevant to
users’ understanding of the review, the practitioner’s responsibilities or the practitioner’s report and
this is not prohibited by law or regulation, the practitioner shall do so in a paragraph in the
practitioner’s report with the heading “Other Matter” or other appropriate heading.
2.6 Other Reporting Responsibilities
A practitioner may be requested to address other reporting responsibilities in the practitioner’s report
on the financial statements that are in addition to the practitioner’s responsibilities under this SRE
to report on the financial statements. In such situations, those other reporting responsibilities shall
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10.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
be addressed by the practitioner in a separate section in the practitioner’s report headed “Report on
Other Legal and Regulatory Requirements,” or otherwise as appropriate to the context of the section,
following the section of the report headed “Report on the Financial Statements.”
2.7 Documentation
The preparation of documentation for the review provides evidence that the review was performed
in accordance with this SRE along with legal and regulatory requirements where relevant and a
sufficient and appropriate record of the basis for the practitioner’s report.
The practitioner shall document the following aspects of the engagement in a timely manner,
sufficient to enable an experienced practitioner, having no previous connection with the
engagement, to understand:
(a) The nature, timing, and extent of the procedures performed to comply with this SRE and
applicable legal and regulatory requirements
(b) Results obtained from the procedures, and the practitioner’s conclusions formed on the
basis of those results and
(c) Significant matters arising during the engagement, the practitioner’s conclusions reached
thereon, and significant professional judgments made in reaching those conclusions.
While documenting the nature, timing and extent of procedures performed as required in this
SRE, the practitioner shall record:
(a) Who performed the work and the date such work was completed and
(b) Who reviewed the work performed for the purpose of quality control for the
engagement, and the period and extent of the review.
The practitioner shall also document discussions with the management, those charged with
governance, and others as relevant to the performance of the review of significant matters arising
during the engagement, including the nature of those matters.
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If, in the course of the engagement, the practitioner identified information that is inconsistent with
the practitioner’s findings regarding significant matters affecting the financial statements, the
practitioner shall document how the inconsistency was addressed.
2.8 Audit Vs. Review
An audit engagement has many similarities with a review engagement. However, there are certain
important areas of distinction relating to the nature of engagement, its performance, objective and
reporting highlighted under: -
Overview of distinctive areas between Audit and Review
Audit Review
Audit is a type of reasonable assurance Review is a type of limited assurance engagement
engagement providing reasonable level of providing a lower level of assurance than
assurance. reasonable assurance engagement.
It performs elaborate and extensive It performs fewer procedures primarily focusing on
procedures including tests of controls and inquiry and analytical procedures.
substantive procedures.
It draws reasonable conclusions on the It draws limited conclusions on the basis of
basis of sufficient appropriate evidence. sufficient appropriate evidence.
It provides an assurance opinion. The It provides an assurance conclusion. The language
language of assurance opinion is positively of assurance conclusion is negatively worded.
worded.
TEST YOUR UNDERSTANDING 2
You are conducting a review of the financial statements of a company. It is gathered upon inquiry
that there is a possibility of material misstatements in financial statements. Discuss, how you would
proceed further in the matter under SRE 2400.
© The Institute of Chartered Accountants of India
10.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3. SRE 2410 REVIEW OF INTERIM FINANCIAL
INFORMATION PERFORMED BY THE INDEPENDENT
AUDITOR OF THE ENTITY
SRE 2410 deals with the auditor’s professional responsibilities when the auditor undertakes an
engagement to review the interim financial information of an audit client and on the form and content
of the report. In other words, SRE 2410 applies when review of interim financial information is
performed by the independent auditor of the financial statements of the entity.
What is Interim Financial Information?
Interim financial information is financial information that is prepared and presented in accordance
with an applicable financial reporting framework and comprises either a complete or a condensed
set of financial statements for a period that is shorter than the entity’s financial year. For example,
interim financial information may relate to financial statements of a quarter of financial year.
3.1 Objective of an Engagement to Review Interim Financial Information
in Accordance with SRE 2410
The objective of an engagement to review interim financial information is to enable the auditor to
express a conclusion whether, on the basis of the review, anything has come to the auditor’s
attention that causes the auditor to believe that the interim financial information is not prepared, in
all material respects, in accordance with an applicable financial reporting framework. The auditor
makes inquiries and performs analytical and other review procedures in order to reduce to a
moderate level risk of expressing an inappropriate conclusion when the interim financial information
is materially misstated.
The objective of a review of interim financial information differs significantly from that of an audit
conducted in accordance with Standards on Auditing (SAs). A review of interim financial information
does not provide a basis for expressing an opinion on whether the financial information gives a true
and fair view, or is presented fairly, in all material respects, in accordance with an applicable financial
reporting framework.
A review, in contrast to an audit, is not designed to obtain reasonable assurance that the interim
financial information is free from material misstatement. A review consists of making inquiries,
primarily of persons responsible for financial and accounting matters, and applying analytical and
other review procedures. A review may bring significant matters affecting the interim financial
information to the auditor’s attention, but it does not provide all of the evidence that would be required
in an audit.
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REVIEW OF FINANCIAL INFORMATION 10.29
SRE 2410 applies when review of interim financial information is performed by the independent
auditor of the financial statements of the entity.
3.2 Agreeing the Terms of the Engagement
The auditor and the client should agree on the terms of the engagement. The agreed terms of the
engagement are ordinarily recorded in an engagement letter. Such communication helps to avoid
misunderstandings regarding the nature of the engagement and, in particular, the objective and
scope of the review, management’s responsibilities, the extent of the auditor’s responsibilities, the
assurance obtained, and the nature and form of the report.
3.3 Understanding the Entity and its Environment including its Internal
Control
The auditor should have an understanding of the entity and its environment, including its internal
control, as it relates to the preparation of both annual and interim financial information, sufficient to
plan and conduct the engagement so as to be able to:
(b) Select the inquiries, analytical and other
review procedures that will provide the auditor
with a basis for reporting whether anything
(a) Identify the types of potential
has come to the auditor’s attention that
material misstatement and consider
causes the auditor to believe that the interim
the likelihood of their occurrence and
financial information is not prepared, in all
material respects, in accordance with the
applicable financial reporting framework.
The auditor who has audited the entity’s financial statements for one or more annual periods has
obtained an understanding of the entity and its environment, including its internal control, as it relates
to the preparation of annual financial information that was sufficient to conduct the audit.
In planning a review of interim financial information, the auditor updates this understanding. The
auditor also obtains a sufficient understanding of internal control as it relates to the preparation of
interim financial information as it may differ from internal control as it relates to annual financial
information.
Some of the procedures performed by the auditor to update the understanding of the entity
and its environment, including its internal control, ordinarily include the following:
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10.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Reading the documentation, to the extent necessary, of the preceding year’s audit and reviews of
prior interim period(s) of the current year and corresponding interim period(s) of the prior year, to
enable the auditor to identify matters that may affect the current-period interim financial
information.
• Considering any significant risks, including the risk of management override of controls, that were
identified in the audit of the prior year’s financial statements.
• Reading the most recent annual and comparable prior period interim financial information.
• Considering materiality with reference to the applicable financial reporting framework as it relates
to interim financial information to assist in determining the nature and extent of the procedures to
be performed and evaluating the effect of misstatements.
• Considering the nature of any corrected material misstatements and any identified uncorrected
immaterial misstatements in the prior year’s financial statements.
• Considering significant financial accounting and reporting matters that may be of continuing
significance such as material weaknesses in internal control.
• Considering the results of any audit procedures performed with respect to the current year’s
financial statements.
• Considering the results of any internal audit performed and the subsequent actions taken by the
management.
• Inquiring of management about the results of management’s assessment of the risk that the
interim financial information may be materially misstated as a result of fraud.
• Inquiring of management about the effect of changes in the entity’s business activities.
• Inquiring of management about any significant changes in internal control and the potential effect
of any such changes on the preparation of interim financial information.
• Inquiring of management of the process by which the interim financial information has been
prepared and the reliability of the underlying accounting records to which the interim financial
information is agreed or reconciled.
In order to plan and conduct a review of interim financial information, a recently appointed auditor,
who has not yet performed an audit of the annual financial statements in accordance with SAs,
should obtain an understanding of the entity and its environment, including of its internal control, as
it relates to the preparation of both annual and interim financial information.
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Besides, the auditor determines the nature of the review procedures, if any, to be performed for
components and, where applicable, communicates these matters to other auditors involved in the review.
3.4 Inquiries, Analytical and other Review procedures
The auditor should make inquiries, primarily of persons responsible for financial and accounting
matters, and perform analytical and other review procedures to enable the auditor to conclude
whether, on the basis of the procedures performed, anything has come to the auditor’s attention that
causes the auditor to believe that the interim financial information is not prepared, in all material
respects, in accordance with the applicable financial reporting framework.
A review ordinarily does not require tests of the accounting records through inspection, observation
or confirmation. Procedures for performing a review of interim financial information are ordinarily
limited to making inquiries, primarily of persons responsible for financial and accounting matters,
and applying analytical and other review procedures, rather than corroborating information obtained
concerning significant accounting matters relating to the interim financial information.
The auditor’s understanding of the entity and its environment including its internal control, the results
of the risk assessments relating to the preceding audit and the auditor’s consideration of materiality
as it relates to the interim financial information, affects the nature and extent of the inquiries made,
and analytical and other review procedures applied.
The auditor ordinarily performs the following procedures: -
• Reading the minutes of the meetings of shareholders, those charged with governance, and
other appropriate committees to identify matters that may affect the interim financial
information, and inquiring about matters dealt with at meetings for which minutes are not
available that may affect the interim financial information.
• Considering the effect, if any, of matters giving rise to a modification of the audit or review
report, accounting adjustments or unadjusted misstatements, at the time of the previous audit
or reviews.
• Communicating, where appropriate, with other auditors who are performing a review of the
interim financial information of the reporting entity’s significant components.
• Inquiring of members of management responsible for financial and accounting matters, and
others as appropriate about the following:
♦ Whether the interim financial information has been prepared and presented in
accordance with the applicable financial reporting framework.
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10.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
♦ Whether there have been any changes in accounting principles or in the methods of
applying them.
♦ Whether any new transactions have necessitated the application of a new accounting
principle.
♦ Whether the interim financial information contains any known uncorrected
misstatements.
♦ Unusual or complex situations that may have affected the interim financial information,
such as a business combination or disposal of a segment of the business.
♦ Significant assumptions that are relevant to the fair value measurement or disclosures
and management’s intention and ability to carry out specific courses of action on behalf
of the entity.
♦ Whether related party transactions have been appropriately accounted for and
disclosed in the interim financial information.
♦ Significant changes in commitments and contractual obligations.
♦ Significant changes in contingent liabilities including litigation or claims.
♦ Compliance with debt covenants.
♦ Matters about which questions have arisen in the course of applying the review
procedures.
♦ Significant transactions occurring in the last several days of the interim period or the
first several days of the next interim period.
♦ Knowledge of any fraud or suspected fraud affecting the entity involving management,
employees who have significant roles in internal control or others where the fraud
could have a material effect on the interim financial information.
♦ Knowledge of any allegations of fraud, or suspected fraud, affecting the entity’s interim
financial information communicated by employees, former employees, analysts,
regulators, or others.
♦ Knowledge of any actual or possible non-compliance with laws and regulations that
could have a material effect on the interim financial information.
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• Applying analytical procedures to the interim financial information designed to identify
relationships and individual items that appear to be unusual and that may reflect a material
misstatement in the interim financial information.
• Reading the interim financial information, and considering whether anything has come to the
auditor’s attention that causes the auditor to believe that the interim financial information is
not prepared, in all material respects, in accordance with the applicable financial reporting
framework.
The auditor may perform many of the review procedures before or simultaneously with the entity’s
preparation of the interim financial information. For example, it may be practicable to update the
understanding of the entity and its environment, including its internal control, and begin reading
applicable minutes before the end of the interim period.
Performing some of the review procedures earlier in the interim period also permits early
identification and consideration of significant accounting matters affecting the interim financial
information.
The auditor performing the review of interim financial information is also engaged to perform an
audit of the annual financial statements of the entity. For convenience and efficiency, the auditor
may decide to perform certain audit procedures concurrently with the review of interim financial
information.
A review of interim financial information ordinarily does not require corroborating the inquiries
about litigation or claims. It is, therefore, ordinarily not necessary to send an inquiry letter to the
entity’s lawyer. Direct communication with the entity’s lawyer with respect to litigation or claims
may, however, be appropriate if a matter comes to the auditor’s attention that causes the auditor
to question whether the interim financial information is not prepared, in all material respects, in
accordance with the applicable financial reporting framework, and the auditor believes the entity’s
lawyer may have pertinent information.
The auditor may obtain evidence that the interim financial information agrees or reconciles with
the underlying accounting records by tracing the interim financial information to:
(a) The accounting records, such as the general ledger, or a consolidating schedule that
agrees or reconciles with the accounting records; and
(b) Other supporting data in the entity’s records as necessary.
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10.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The auditor should inquire whether management has identified all events up to the date of the
review report that may require adjustment to or disclosure in the interim financial information. It is
not necessary for the auditor to perform other procedures to identify events occurring after the
date of the review report.
The auditor should inquire whether management has changed its assessment of the entity’s ability
to continue as a going concern. When, as a result of this inquiry or other review procedures, the
auditor becomes aware of events or conditions that may cast significant doubt on the entity’s
ability to continue as a going concern, the auditor should:
(a) Inquire of management as to its plans for future actions based on its going
concern assessment, the feasibility of these plans, and whether management
believes that the outcome of these plans will improve the situation and
(b) Consider the adequacy of the disclosure about such matters in the interim
financial information.
Events or conditions which may cast significant doubt on the entity’s ability to continue as a going
concern may have existed at the date of the annual financial statements or may be identified as a
result of inquiries of management or in the course of performing other review procedures.
When such events or conditions come to the auditor’s attention, the auditor inquires of
management as to its plans for future action, such as its plans to liquidate assets, borrow money
or restructure debt, reduce or delay expenditures, or increase capital. The auditor also inquires
as to the feasibility of management’s plans and whether management believes that the outcome
of these plans will improve the situation. However, it is not ordinarily necessary for the auditor to
corroborate the feasibility of management’s plans and whether the outcome of these plans will
improve the situation.
When a matter comes to the auditor’s attention that leads the auditor to question whether a
material adjustment should be made for the interim financial information to be prepared, in all
material respects, in accordance with the applicable financial reporting framework, the auditor
should make additional inquiries or perform other procedures to enable the auditor to express a
conclusion in the review report.
For example, if the auditor’s review procedures lead the auditor to question whether a significant
sales transaction is recorded in accordance with the applicable financial reporting framework, the
auditor performs additional procedures sufficient to resolve the auditor’s questions, such as
discussing the terms of the transaction with senior marketing and accounting personnel, or reading
the sales contract.
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3.5 Evaluation of Misstatements
The auditor should evaluate, individually and in the aggregate, whether uncorrected
misstatements that have come to the auditor’s attention are material to the interim financial
information.
Misstatements which come to the auditor’s attention, including inadequate disclosures, are
evaluated individually and in the aggregate to determine whether a material adjustment is required
to be made to the interim financial information for it to be prepared, in all material respects, in
accordance with the applicable financial reporting framework.
The auditor exercises professional judgment in evaluating the materiality of any misstatements
that the entity has not corrected.
3.6 Management representations
The auditor should obtain written representation from management that: -
(a) It acknowledges its responsibility for the design and implementation of
internal control to prevent and detect fraud and error
(b) The interim financial information is prepared and presented in accordance with
the applicable financial reporting framework
(c) It believes the effect of those uncorrected misstatements aggregated by the
auditor during the review are immaterial, both individually and in the aggregate, to
the interim financial information taken as a whole. A summary of such items is
included in or attached to the written representations
(d) 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
(e) It has disclosed to the auditor the results of its assessment of the risks that
the interim financial information may be materially misstated as a result of fraud
(f) It has disclosed to the auditor all known actual or possible non-compliance
with laws and regulations whose effects are to be considered when preparing the
interim financial information; and
(g) It has disclosed to the auditor all significant events that have occurred
subsequent to the balance sheet date and through to the date of the review report
that may require adjustment to or disclosure in the interim financial information.
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10.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3.7 Auditor’s Responsibility for Accompanying Information
The auditor should read the other information that accompanies the interim financial information to
consider whether any such information is materially inconsistent with the interim financial
information.
If the auditor identifies a material inconsistency, the auditor considers whether the interim financial
information or the other information needs to be amended. If an amendment is necessary in the
interim financial information and management refuses to make such amendment, the auditor
considers the implications for the review report.
If an amendment is necessary in the other information and management refuses to make such
amendment, the auditor considers including in the review report an additional paragraph describing
the material inconsistency, or taking other actions, such as withholding the issuance of the review
report or withdrawing from the engagement. For example, management may present alternative
measures of earnings that more positively portray results of operations than the interim financial
information, and such alternative measures are given excessive prominence, are not clearly defined,
or not clearly reconciled to the interim financial information such that they are confusing and
potentially misleading.
If a matter comes to the auditor’s attention that causes the auditor to believe that the other
information appears to include a material misstatement of fact, the auditor should discuss the matter
with the entity’s management.
While reading the other information for the purpose of identifying material inconsistencies, an
apparent material misstatement of fact may come to the auditor’s attention (i.e., information, not
related to matters appearing in the interim financial information, that is incorrectly stated or
presented). When discussing the matter with the entity’s management, the auditor considers the
validity of the other information and management’s responses to the auditor’s inquiries, whether
valid differences of judgment or opinion exist and whether to request management to consult with a
qualified third party to resolve the apparent misstatement of fact.
If an amendment is necessary to correct a material misstatement of fact and management refuses
to make the amendment, the auditor considers taking further action as appropriate, such as notifying
those charged with governance and obtaining a legal advice.
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3.8 Communication
When, as a result of performing the review of interim financial information, a matter comes to the
auditor’s attention that causes the auditor to believe that it is necessary to make a material
adjustment to the interim financial information for it to be prepared, in all material respects, in
accordance with the applicable financial reporting framework, the auditor should communicate this
matter as soon as practicable to the appropriate level of management.
When, in the auditor’s judgment, management does not respond appropriately within a reasonable
period of time, the auditor should inform those charged with governance. The communication is
made as soon as practicable, either orally or in writing. The auditor’s decision whether to
communicate orally or in writing is affected by factors such as the nature, sensitivity and significance
of the matter to be communicated and the timing of such communications. If the information is
communicated orally, the auditor documents the communication.
When, in the auditor’s judgment, those charged with governance do not respond appropriately within a
reasonable period, the auditor should consider:
(b) The possibility of (c) The possibility of resigning
(a) Whether to modify the report
withdrawing from the from the appointment to audit
or
engagement and the annual financial statements.
When, as a result of performing the review of interim financial information, a matter comes to the
auditor’s attention that causes the auditor to believe in the existence of fraud or noncompliance by
the entity with laws and regulations, the auditor should communicate the matter as soon as
practicable to the appropriate level of management. The determination of which level of management
is the appropriate one is affected by the likelihood of collusion or the involvement of a member of
management. The auditor also considers the need to report such matters to those charged with
governance and considers the implication for the review.
The auditor should communicate relevant matters of governance interest arising from the review of
interim financial information with those charged with governance. As a result of performing the
review of the interim financial information, the auditor may become aware of matters that in the
opinion of the auditor are both important and relevant to those charged with governance in
overseeing the financial reporting and disclosure process. The auditor communicates such matters
to those charged with governance.
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10.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3.9 Reporting the Nature, Extent and Results of the Review of Interim
Financial Information
The auditor should issue a written report that contains the following: -
Content of Written Report:
(a) An appropriate title.
(b) An addressee, as required by the circumstances of the engagement.
(c) Identification of the interim financial information reviewed, including identification of the
title of each of the statements contained in the complete or condensed set of financial
statements and the date and period covered by the interim financial information.
(d) If the interim financial information comprises a complete set of general-purpose financial
statements prepared in accordance with a financial reporting framework designed to
achieve fair presentation, a statement that management is responsible for the preparation
and fair presentation of the interim financial information in accordance with the applicable
financial reporting framework.
(e) In other circumstances, a statement that management is responsible for the preparation
and presentation of the interim financial information in accordance with the applicable
financial reporting framework.
(f) A statement that the auditor is responsible for expressing a conclusion on the interim
financial information based on the review.
(g) A statement that the review of the interim financial information was conducted in
accordance with Standard on Review Engagements (SRE) 2410, “Review of Interim
Financial Information Performed by the Independent Auditor of the Entity,” and a statement
that that such a review consists of making inquiries, primarily of persons responsible for
financial and accounting matters, and applying analytical and other review procedures.
(h) A statement that a review is substantially less in scope than an audit conducted in
accordance with Standards on Auditing and consequently does not enable the auditor to
obtain assurance that the auditor would become aware of all significant matters that might
be identified in an audit and that accordingly no audit opinion is expressed.
(i) If the interim financial information comprises a complete set of general purpose financial
statements prepared in accordance with a financial reporting framework designed to
achieve fair presentation, a conclusion as to whether anything has come to the auditor’s
attention that causes the auditor to believe that the interim financial information does not
give a true and fair view, or does not present fairly, in all material respects, in accordance
with the applicable financial reporting framework.
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REVIEW OF FINANCIAL INFORMATION 10.39
(j) In other circumstances, a conclusion as to whether anything has come to the auditor’s
attention that causes the auditor to believe that the interim financial information is not
prepared, in all material respects, in accordance with the applicable financial reporting
framework
(k) The date of the report.
(l) Place of Signature.
(m) The auditor’s signature and membership number assigned by the Institute of Chartered
Accountants of India (ICAI).
(n) The Firm’s registration number of the member of the Institute, wherever applicable, as
allotted by ICAI.
Besides, UDIN has also to be generated and stated for review engagement as it is also in nature of
an assurance engagement. UDIN has to be stated for engagements performed in accordance with
SRE 2400 or SRE 2410.
3.10 Departure from the Applicable Financial Reporting Framework
The auditor should express qualified or adverse conclusion when a matter has come to the auditor’s
attention that causes the auditor to believe that a material adjustment should be made to the interim
financial information for it to be prepared, in all material respects, in accordance with the applicable
financial reporting framework.
If matters have come to the auditor’s attention that cause the auditor to believe that the interim
financial information is or may be materially affected by a departure from the applicable financial
reporting framework, and management does not correct the interim financial information, the auditor
modifies the review report.
The modification describes the nature of the departure and, if practicable, states the effects on the
interim financial information. If the information that the auditor believes is necessary for adequate
disclosure is not included in the interim financial information, the auditor modifies the review report
and, if practicable, includes the necessary information in the review report. The modification to the
review report is ordinarily accomplished by adding an explanatory paragraph to the review report
and qualifying the conclusion.
When the effect of the departure is so material and pervasive to the interim financial information that
the auditor concludes a qualified conclusion is not adequate to disclose the misleading or incomplete
nature of the interim financial information, the auditor expresses an adverse conclusion.
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10.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3.11 Limitation on Scope
A limitation on scope ordinarily prevents the auditor from completing the review. When the auditor
is unable to complete the review, the auditor should communicate, in writing, to the appropriate level
of management and to those charged with governance the reason why the review cannot be
completed and consider whether it is appropriate to issue a report.
3.11.1 Limitation on Scope Imposed by Management
The auditor does not accept an engagement to review the interim financial information if the auditor’s
preliminary knowledge of the engagement circumstances indicates that the auditor would be unable
to complete the review because there will be a limitation on the scope of the auditor’s review imposed
by the management of the entity.
If, after accepting the engagement, management imposes a limitation on the scope of the review,
the auditor requests the removal of that limitation. If management refuses to do so, the auditor is
unable to complete the review and express a conclusion. In such cases, the auditor communicates,
in writing, to the appropriate level of management and those charged with governance the reason
why the review cannot be completed. Nevertheless, if a matter comes to the auditor’s attention that
causes the auditor to believe that a material adjustment to the interim financial information is
necessary for it to be prepared, in all material respects, in accordance with the applicable financial
reporting framework, the auditor communicates such matters.
The auditor also considers the legal and regulatory responsibilities, including whether there is a
requirement for the auditor to issue a report. If there is such a requirement, the auditor disclaims a
conclusion, and provides in the review report the reason why the review cannot be completed.
However, if a matter comes to the auditor’s attention that causes the auditor to believe that a material
adjustment to the interim financial information is necessary for it to be prepared, in all material
respects, in accordance with the applicable financial reporting framework, the auditor also
communicates such a matter in the report.
3.11.2 Other Limitations on Scope
A limitation on scope may occur due to circumstances other than a limitation on scope imposed by
management. In such circumstances, the auditor is ordinarily unable to complete the review and
express a conclusion. There may be, however, some rare circumstances where the limitation on the
scope of the auditor’s work is clearly confined to one or more specific matters that, while material,
are not in the auditor’s judgment pervasive to the interim financial information. In such
circumstances, the auditor modifies the review report by indicating that, except for the matter which
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REVIEW OF FINANCIAL INFORMATION 10.41
is described in an explanatory paragraph to the review report, the review was conducted in
accordance with this SRE, and by qualifying the conclusion.
The auditor may have expressed a qualified opinion on the audit of the latest annual financial
statements because of a limitation on the scope of that audit. The auditor considers whether that
limitation on scope still exists and, if so, the implications for the review report.
3.12 Going Concern and Significant Uncertainties
If, as a result of inquiries or other review procedures, a material uncertainty relating to an event or
condition comes to the auditor’s attention that may cast significant doubt on the entity’s ability to
continue as a going concern, and adequate disclosure is made in the interim financial information
the auditor modifies the review report by adding an emphasis of matter paragraph.
The auditor may have modified a prior audit or review report by adding an emphasis of matter
paragraph to highlight a material uncertainty relating to an event or condition that may cast
significant doubt on the entity’s ability to continue as a going concern. If the material uncertainty still
exists and adequate disclosure is made in the interim financial information, the auditor modifies the
review report on the current interim financial information by adding a paragraph to highlight the
continued material uncertainty.
If a material uncertainty that casts significant doubt about the entity’s ability to continue as a going
concern is not adequately disclosed in the interim financial information, the auditor should express
a qualified or adverse conclusion, as appropriate. The report should include specific reference to
the fact that there is such a material uncertainty.
3.13 Other Considerations
The terms of the engagement include management’s agreement that where any document
containing interim financial information indicates that such information has been reviewed by the
entity’s auditor, the review report will also be included in the document. If management has not
included the review report in the document, the auditor considers seeking legal advice to assist in
determining the appropriate course of action in the circumstances.
If the auditor has issued a modified review report and management issues the interim financial
information without including the modified review report in the document containing the interim
financial information, the auditor considers seeking legal advice to assist in determining the
appropriate course of action in the circumstances, and the possibility of resigning from the
appointment to audit the annual financial statements.
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10.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Interim financial information consisting of a condensed set of financial statements does not
necessarily include all the information that would be included in a complete set of financial
statements, but may rather present an explanation of the events and changes that are significant to
an understanding of the changes in the state of affairs and performance of the entity since the annual
reporting date. This is because it is presumed that the users of the interim financial information will
have access to the latest audited financial statements, such as is the case with listed entities.
In other circumstances, the auditor discusses with management the need for such interim financial
information to include a statement that it is to be read in conjunction with the latest audited financial
statements. In the absence of such a statement, the auditor considers whether, without a reference
to the latest audited financial statements, the interim financial information is misleading in the
circumstances, and the implications for the review report.
3.14 Documentation
The auditor should prepare review documentation that is sufficient and appropriate to provide a basis
for the auditor’s conclusion and to provide evidence that the review was performed in accordance
with this SRE and applicable legal and regulatory requirements.
TEST YOUR UNDERSTANDING 3
During review of quarterly results of a company of which you are auditor, it is gathered on inquiries
made that there has been a major fire in fabric processing plant of the company during the quarter.
It has resulted in massive disruption in operations of the company. Worse still, machinery and
inventories of plant were uninsured due to carelessness of concerned staff leading to substantial
losses. The matter has been disclosed in interim financial information appropriately. Discuss, how
you would proceed to deal with the same in review report?
TEST YOUR UNDERSTANDING 4
CA. Seerat is conducting review of the quarterly financial information of a company of which she is
also auditor. She believes that it is necessary to make a material adjustment to the quarterly financial
information for it to be prepared, in all material respects, in accordance with the applicable financial
reporting framework. She has communicated the matter to CFO and audit committee. However, no
response was received even after waiting for a reasonable time. What are the options available to
her?
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REVIEW OF FINANCIAL INFORMATION 10.43
Integrated Case Scenario
Below is given an incomplete draft text of the review report on the review of financial results of Fast
Operations Limited, a listed company in accordance with SEBI regulations. The review is a
compulsory requirement under SEBI (Listing Obligations and Disclosure Requirements)
Regulations. The incomplete areas of the report have been marked as XXXX.
INDEPENDENT AUDITOR’S REVIEW REPORT ON REVIEW OF INTERIM STANDALONE
FINANCIAL RESULTS
TO XXXX
1. We have reviewed the accompanying Statement of Standalone unaudited financial results of
Fast Operations Limited (“the Company”), for the quarter and six months ended September
30, 2022 (“the Statement”), being submitted by the Company pursuant to the requirement of
Regulation 33 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations,
2015, as amended.
2. This Statement, which is the responsibility of the Company’s Management and approved by
the Company’s Board of Directors, has been prepared in accordance with the recognition and
measurement principles laid down in the Indian Accounting Standard 34 “Interim Financial
Reporting” (“Ind AS 34”), prescribed under Section 133 of the Companies Act, 2013 read with
relevant rules issued thereunder and other accounting principles generally accepted in India.
Our responsibility XXXXXXXXXXX.
3. We conducted our review of the Statement in accordance with the Standard XXXX, issued by
the Institute of Chartered Accountants of India (ICAI). A review of interim financial information
consists of making inquiries, primarily of the company’s personnel responsible for financial
and accounting matters, and applying analytical and other review procedures. A review is
substantially XXXXXXXXXXXXXXXXXXXXXXXXX.
4. Based on our review conducted as stated in paragraph 3 above,
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
Using your knowledge, answer the following questions to complete the draft text of review report of
Fast Operations Limited: -
1. The name of addressee is missing from text of draft review report. Identify the most
appropriate option:
(a) Audit Committee
© The Institute of Chartered Accountants of India
10.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) Board of Directors
(c) CFO
(d) Stock exchange on which shares of company are listed
2. Under para 2 of the case study, choose the appropriate sentence beginning with “Our
responsibility XXXX”:
(a) Our responsibility is to express an opinion on the Statement based on our review.
(b) Our responsibility is to express a conclusion on the Statement based on our review.
(c) Our responsibility is to provide a reasonable assurance on the Statement based on
our review.
(d) Our responsibility is to express a compliance statement on the Statement based on
our review.
3. Given the description of case study, which of the following engagement standards is
most appropriate to be stated in para 3?
(a) SRE 2410 ‘Review of Interim Financial Information Performed by the Independent
Auditor of the Entity’.
(b) SRE 2400 Engagements to Review Historical Financial Statements.
(c) SA 700 Forming an Opinion and Reporting on Financial Statements.
(d) SA 810 Engagements to Report on Summary Financial Statements.
4. Which of the following statements is most appropriate to be inserted in sentence
beginning with “A review is substantially XXXX” in para 3?
(a) A review is substantially broader in scope than an audit conducted in accordance with
Standards on Auditing specified under section 143(10) of the Companies Act, 2013
and consequently does not enable us to obtain assurance that we would become
aware of all significant matters that might be identified in a review. Accordingly, we do
not express an audit opinion.
(b) A review is substantially broader in scope than an audit conducted in accordance with
Standards on Auditing specified under section 143(10) of the Companies Act, 2013
and consequently does not enable us to obtain assurance that we would become
aware of all significant matters that might be identified in an audit. Accordingly, we do
not express an audit opinion.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.45
(c) A review is substantially narrower in scope than an audit conducted in accordance with
Standards on Auditing specified under section 143(10) of the Companies Act, 2013
and consequently does not enable us to obtain assurance that we would become
aware of all significant matters that might be identified in a review. Accordingly, we do
not express an audit opinion.
(d) A review is substantially less in scope than an audit conducted in accordance with
Standards on Auditing specified under section 143(10) of the Companies Act, 2013
and consequently does not enable us to obtain assurance that we would become
aware of all significant matters that might be identified in an audit. Accordingly, we do
not express an audit opinion.
5. Complete the paragraph 4 of case study from following options: -
(a) Nothing has come to our attention that causes us to believe that the accompanying
Statement, prepared in accordance with the recognition and measurement principles
laid down in the aforesaid Indian Accounting Standard and other accounting principles
generally accepted in India, has not disclosed the information required to be disclosed
in terms of Regulation 33 of the SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015, as amended, including the manner in which it is to
be disclosed, or that it contains any material misstatement.
(b) Nothing has come to our attention that causes us to believe that the accompanying
Statement, prepared in accordance with the recognition and measurement principles
laid down in the aforesaid Indian Accounting Standard and other accounting principles
generally accepted in India, has disclosed the information required to be disclosed in
terms of Regulation 33 of the SEBI (Listing Obligations and Disclosure Requirements)
Regulations, 2015, as amended, including the manner in which it is to be disclosed, or
that it does not contain any material misstatement.
(c) The accompanying Statement, prepared in accordance with the recognition and
measurement principles laid down in the aforesaid Indian Accounting Standard and
other accounting principles generally accepted in India, has disclosed the information
required to be disclosed in terms of Regulation 33 of the SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015, as amended, including the manner in
which it is to be disclosed, or that it does not contain any material misstatement.
© The Institute of Chartered Accountants of India
10.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) The accompanying Statement, prepared in accordance with the recognition and
measurement principles laid down in the aforesaid Indian Accounting Standard and
other accounting principles generally accepted in India, has disclosed the information
required to be disclosed in terms of Regulation 33 of the SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015, as amended, including the manner in
which it is to be disclosed, or that it does not contain any material misstatement and
gives a true and fair view of the state of affairs of the company as on date of interim
financial statements.
Key Takeaways
“Review” is a limited assurance engagement. Limited assurance engagement provides lower
level of assurance than audit. It involves fewer procedures and gathers sufficient appropriate
evidence on basis of which limited conclusions can be drawn up.
Standards on review engagements apply where “review” of financial information is
undertaken by the practitioner. SRE 2400 and SRE 2410 have been issued in this regard.
SRE 2400 deals with the practitioner’s responsibilities performing a review of historical
financial statements when the practitioner is not the auditor of the entity’s financial
statements.
The practitioner’s objectives in accordance with SRE 2400 includes obtaining limited
assurance, primarily by performing inquiry and analytical procedures, about whether the
financial statements as a whole are free from material misstatement and to report on the
financial statements as a whole and communicate, as required by this SRE.
Prior to accepting a review engagement, the practitioner shall determine that preconditions
for accepting a review engagement exist.
The practitioner performs review engagement mainly focussing upon inquiry and analytical
procedures. Besides, procedures to address specific circumstances, are also performed.
Additional procedures are also performed when the practitioner becomes aware that the
financial statements may be materially misstated.
Written representations are obtained and evidence from performing procedures is evaluated.
Limited conclusions are drawn and a review report is issued.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.47
SRE 2410 applies when review of interim financial information is performed by the
independent auditor of the financial statements of the entity.
Interim financial information is financial information that is prepared and presented in
accordance with an applicable financial reporting framework and comprises either a complete
or a condensed set of financial statements for a period that is shorter than the entity’s financial
year.
The objective of an engagement to review interim financial information is to enable the auditor
to express a conclusion whether, on the basis of the review, anything has come to the
auditor’s attention that causes the auditor to believe that the interim financial information is
not prepared, in all material respects, in accordance with an applicable financial reporting
framework.
The auditor makes inquiries and performs analytical and other review procedures in order to
reduce to a moderate level the risk of expressing an inappropriate conclusion when the
interim financial information is materially misstated.
Review documentation should be prepared that is sufficient and appropriate to provide a basis
to provide evidence that the review was performed in accordance with requirements.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Discuss why “inquiry” is important as an audit procedure in an engagement to review
financial statements.
2. CA. Aditya Jain is auditor of a listed company. He is also required to carry out quarterly
review of financial statements of company in terms of regulatory requirements. He is
already well-versed with business of company and has deep understanding of the company.
Discuss, any five procedures, by which he can update his understanding of the company
for carrying out quarterly review.
3. What is significance of “date of report” in a review report?
4. CA. Pankaj Chaturvedi has issued a review report dated 28.7.2022 for financial results of
a company for quarter ending 30.6.2022. Describe his responsibility, if any, for events
occurring from 1.7.2022 till date of review report in accordance with SRE 2410.
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10.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Test Your Understanding
1. The above financial statements are prepared in accordance with special purpose framework
in accordance with requirements of a contract. Financial statements prepared in accordance
with special purpose framework can also be reviewed by a professional accountant in practice
and review report may be issued in accordance with SRE 2400.
2. If the practitioner becomes aware of matters that causes the practitioner to believe the
financial statements may be materially misstated, the practitioner shall design and perform
additional procedures sufficient to enable the practitioner to: -
(a) Conclude that the matter(s) is not likely to cause the financial statements as a whole
to be materially misstated or
(b) Determine that the matter(s) causes the financial statements as a whole to be
materially misstated.
Additional procedures focus on obtaining sufficient appropriate evidence to enable the
practitioner to form a conclusion on matters that the practitioner believes may cause the
financial statements to be materially misstated. The procedures may be:
• Additional inquiry or analytical procedures, for example, being performed in greater
detail or being focused on the affected items (i.e. amounts or disclosures concerning
the affected accounts or transactions as reflected in the financial statements); or
• Other types of procedures, for example, substantive test of details or external
confirmations.
3. Uninsured assets in a disaster are examples of events or conditions that, individually or
collectively, may cast significant doubt about the going concern assumption. As a result of
fire, there is massive disruption in operations of the company. Besides, the company would
have to bear losses as its damaged assets are uninsured.
In accordance with SRE 2410, if, as a result of inquiries or other review procedures, a material
uncertainty relating to an event or condition comes to the auditor’s attention that may cast
significant doubt on the entity’s ability to continue as a going concern, and adequate
disclosure is made in the interim financial information, the auditor modifies review report by
adding an emphasis of matter paragraph.
Therefore, Emphasis of matter paragraph should be added in review report.
© The Institute of Chartered Accountants of India
REVIEW OF FINANCIAL INFORMATION 10.49
4. In such a case, options available to her in accordance with SRE 2410 are: -
(a) Whether to modify the report or
(b) The possibility of withdrawing from the engagement and
(c) The possibility of resigning from the appointment to audit the annual financial
statements.
Answers to Integrated Case Scenario
1. (b)
2. (b)
3. (a)
4. (d)
5. (a)
Answers to Theoretical Questions
1. Refer to Para 2.4.
2. Refer to Para 3.3.
3. Refer to Para 2.4.
4. The auditor should inquire whether management has identified all events up to the date of
the review report that may require adjustment to or disclosure in the interim financial
information.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 11
7
PROSPECTIVE FINANCIAL
INFORMATION AND OTHER
ASSURANCE SERVICES
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Gain knowledge about Standards on Assurance Engagements.
Understand the meaning of Prospective financial information.
Know about the responsibilities of professional accountants in examining and
reporting on prospective financial information under SAE 3400.
Understand the meaning of Service Organization.
Understand the importance of controls of a service organization to a user
entity’s internal controls relating to financial reporting.
Know about the responsibilities of professional accountants under
SAE 3402.
Understand the meaning of Pro forma financial information.
Understand about responsibilities of practitioners in assurance engagements
to report on the compilation of Pro forma financial information included in a
prospectus under SAE 3420.
© The Institute of Chartered Accountants of India
11.2 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
SAE 3400 -
The Examination of Prospective
Financial Information
SAE 3402 -
Standards on Assurance
Assurance Reports on Controls at
Engagement a Service Organisation
SAE 3420 -
Assurance Engagements to Report
on the Compilation of Pro Forma
Financial Information Included in a
Prospectus
XP Limited, a company engaged in manufacturing of paints, is set to launch a new project for
setting up a food processing plant at NOIDA lured by slew of investor friendly measures
announced by state government in recently held Global Investors Summit. Being a new line
of activity for the company, it asks Chirag (having MBA finance qualification) employed as a
senior finance executive in the company to prepare detailed projection and feasibility of the
said project. The company management wants him to make a detailed study conforming to
acquisition of land, construction of plant building, procurement of plant machinery, projected
targets of turnover, profits, sources of funds including financial assistance to be taken from
banks etc. The said study is also to be used for submission to bankers for borrowing purpose.
Adept in preparing such studies, he prepared such a projection considering above factors
highlighting expected sales, profits, key financial ratios, debt service coverage ratio over a
period of seven years, payback period and IRR (Internal rate of return) replete with charts,
bar graphs and diagrams. The said study was also submitted to bankers for providing
financial assistance for upcoming project of the company.
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.3
ASSURANCE SERVICES
The bankers of the company now require an assurance report from a professional accountant
on information contained in above study. Bewildered to know this, he wanted to understand
reason of such a report from a professional accountant. Coming back to his office, he
discussed the matter with CFO who asked him to meet CA. Dilip in this regard.
During discussions with CA, it transpired that for issuance of such an assurance report, it
would be examined whether prospective financial information is prepared on the basis of
assumptions; whether such assumptions are not unreasonable and are consistent with
purpose of study. Not only this, it would also be looked into whether such information is
consistent with past financial statements and uses appropriate accounting principles. He
started ground work in these areas as instructed by CFO before engaging services of
professional accountant.
Learning about assurance report on prospective financial information, he was also wondering
whether professional accountants can also provide such reports intended to enhance degree
of confidence of users in respect of non-financial matters. What could be such
circumstances? What could be such type of matters?
1. INTRODUCTION
Traditionally, the attest function performed by a Chartered Accountant in practice has been in
relation to past events. However, growing and dynamic society has now started seeking
professional association in its exercises relating to future. A manifestation of this is the
requirement of banks, financial institutions and prospective investors regarding the preparation of
projected cash flow and profitability statements by intending borrowers or investees for the
purpose of making an appropriate appraisal of their loan applications and equity proposals. These
institutions place a greater reliance on such statements if they are prepared or reviewed by
chartered accountants. These future oriented financial statements are generally known as
Prospective Financial Statements.
For example - The shareholders of X Limited have given consent to board of directors to plan to
raise funds from the prospective equity investor and have asked your firm to report on the accuracy
of the profit forecast and Statements of Financial Position of the entity for the following five years
so that it could be placed before the equity investor.
© The Institute of Chartered Accountants of India
11.4 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1.1 Standards on Assurance Engagements
An assurance engagement may relate to examination of subject matters other than examination
of financial statements prepared on basis of “historical financial information”. In such type of
assurance engagements, examination may relate to prospective financial information or to
providing assurance regarding non-financial matters like design and operation of internal control
in an entity.
Standards on Assurance Engagements deal with responsibilities of professional
accountants in assurance engagements dealing such matters. The level of assurance
provided by these Standards on Assurance Engagements is moderate.
Following Standards on Assurance Engagements have been issued: -
• SAE 3400 The Examination of Prospective Financial Information
• SAE 3402 Assurance Reports on Controls at a Service Organisation
• SAE 3420 Assurance Engagements to Report on the Compilation of Pro Forma Financial
Information Included in a Prospectus
2. SAE 3400 THE EXAMINATION OF PROSPECTIVE
FINANCIAL INFORMATION
SAE 3400 provides guidance on engagements to examine and report on prospective financial
information including examination procedures for best-estimate and hypothetical assumptions.
Examination of prospective financial information need not necessarily be performed by statutory
auditor of the entity’s financial statements.
What is Prospective financial information?
“Prospective financial information” is Financial information based on:
• Assumptions about events that may occur in the future and
• Possible actions by an entity.
It is highly subjective in nature and its preparation requires the exercise of considerable judgment.
Prospective financial information can be in the form of :
• a forecast,
• a projection,
• or a combination of both (for example a 1-year, forecast plus a 5-year, projection.)
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.5
ASSURANCE SERVICES
What is Forecast?
Forecast means Prospective Financial Information prepared on the basis of:
• Assumptions as to future events which management expects to take place and
• The actions management expects to take as of the date the information is prepared. (Best-
estimate assumptions- An assumption that reflects anticipated experience with no provision
for risk of adverse deviation.).
In present market conditions, supply availability, historical buying patterns and
seasonal trends, the CFO of a X ltd a expects sales to increase by 5% over the next
quarter. Therefore, a 5% sales increase is his financial forecast for the period.
What is Projection?
Prospective Financial Information prepared on the basis of:
• Hypothetical assumptions about future events and management actions which are not
necessarily expected to take place, such as when some entities are in a start-up phase or
are considering a major change in the nature of operations; or
• A mixture of best-estimate and hypothetical assumptions (imagined or suggested)
1. X Ltd may project a course of action to take when one or more hypothetical
situations arise, such as creating a new product to meet the demand of expected
market growth. As a result of assuming the possibility of different events occurring,
financial projections typically serve as an outline for evaluating the desired outcomes x ltd. is
expects to see, including its financial, cash flow and operational outcomes.
2. A company plans to raise funds from a prospective equity investor and has asked
a firm of Chartered Accountants to examine the profit forecast for placing it before
prospective equity investor.
3. A company is in the process of setting up a new plant. It needs financial assistance
from bank in shape of term loan and working capital credit facilities. The company has
prepared a projection of its profits, cash flows for next seven years along with its
underlying assumptions.
© The Institute of Chartered Accountants of India
11.6 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.1 Scope of SAE-3400
The purpose of this Standard on Assurance Engagement (SAE) is to establish standards and provide
guidance on engagements to examine and report on prospective financial information including
examination procedures for best-estimate and hypothetical assumptions.
This SAE does not apply to the examination of prospective financial information expressed in general
or narrative terms, such as that found in management’s discussion and analysis in an entity’s annual
report, though many of the procedures outlined herein may be suitable for such an examination.
Further, the principles laid down in the other Standards on Auditing, issued by the Institute of
Chartered Accountants of India, should be used by the auditor, to the extent practicable, in applying
this SAE.
The term “auditor” is used throughout this SAE when describing services involving examination of
prospective financial information. Such reference is not intended to imply that a member performing
such services need necessarily be the statutory auditor of the entity’s financial statements.
2.2 Nature of Assurance Regarding Prospective Financial Information
Prospective financial information relates to events and actions that have not yet occurred and might
not occur. While evidence may be available to support the assumptions on which the prospective
financial information is based, such evidence is itself generally future- oriented and, therefore,
speculative in nature, as distinct from the evidence ordinarily available in the examination of
historical financial information. Therefore, an opinion as to whether the results shown in the
prospective financial information will be achieved cannot be expressed.
2.3 Responsibility of Preparation and Presentation of Prospective
Financial Information
Management is responsible for the preparation and presentation of the prospective financial
information including the :
• Identification and disclosure of Prospective Financial Information;
• Explaining the basis of forecast;
• Underlying assumptions.
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.7
ASSURANCE SERVICES
Can Professional Accountants be associated with Prospective Financial Information?
Traditionally, the attest function performed by a Chartered Accountant in practice has been in
relation to “historical financial information”. Recognizing the professional skill and competence of
Chartered accountants, varied stakeholders like banks, financial institutions and prospective
investors intend to place greater reliance on reports of projected cash flow and profitability
statements examined and signed by Chartered accountants.
Clause 3 of the Second Schedule to the Chartered Accountants Act, 1949 states that that a chartered
accountant in practice shall be deemed to be guilty of professional misconduct, if he permits his name
or the name of his firm to be used in connection with an estimate of earnings contingent upon future
transactions in a manner which may lead to the belief that he vouches for the accuracy of the forecast.
The above clause does not preclude a Chartered accountant from associating his name with
prospective financial statements. A chartered accountant can participate in the preparation of profit
or financial forecasts and can review them, provided he indicates clearly in his report the sources of
information, the basis of forecasts and also the major assumptions made in arriving at the forecasts
and so long as he does not vouch for the accuracy of the forecasts.
The same also applies to projections made on the basis of hypothetical assumptions about future
events and management actions which are not necessarily expected to take place so long as
vouching for the accuracy of the projection is not made.
2.4 Duties of Member who is Examining the Prospective Financial
Information
In an engagement to examine prospective financial information, the auditor should obtain
sufficient appropriate evidence as to whether:
(a) management’s best-estimate assumptions on which the prospective financial information
is based are not unreasonable and, in the case of hypothetical assumptions, such
assumptions are consistent with the purpose of the information;
(b) the prospective financial information is properly prepared on the basis of the
assumptions;
(c) the prospective financial information is properly presented and all material assumptions
are adequately disclosed, including a clear indication as to whether they are best-estimate
assumptions or hypothetical assumptions; and
(d) the prospective financial information is prepared on a consistent basis with historical
financial statements, using appropriate accounting principles.
© The Institute of Chartered Accountants of India
11.8 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
While examining prospective financial information, principles laid down in other Standards on
Auditing should be applied to the extent practicable.
2.5 Nature of Assurance regarding Prospective Financial Information
Prospective financial information relates to events and actions that have not yet occurred and might
not occur. While evidence may be available to support the assumptions on which the prospective
financial information is based, such evidence is itself generally future- oriented and, therefore,
speculative in nature, as distinct from the evidence ordinarily available in the examination of
historical financial information. Therefore, an opinion as to whether the results shown in the
prospective financial information will be achieved cannot be expressed.
2.6 Acceptance of Engagement: Precautions to be taken by Auditor
Before Accepting such an Engagement
Before accepting an engagement to examine prospective financial information, the auditor would
consider, amongst other things:
• The intended use of the information;
• Whether the information will be for general or limited distribution;
• The nature of the assumptions, that is, whether they are best estimates or hypothetical
Assumptions;
• The elements to be included in the information; and
• The period covered by the information.
Acceptance of
Engagement
The nature of the
The intended use of Whether the assumptions, that is, The elements to be
the information; information will be whether they are included in the The period covered
for general or limited best-estimates or information; and by the information.
distribution; hypothetical
assumptions;
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. The auditor should consider the extent to which
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.9
ASSURANCE SERVICES
reliance on the entity’s historical financial information is justified. Like in other engagements, it is
necessary that terms of engagements should be agreed with client by sending an engagement letter.
2.7 Examination Procedures
When determining the nature, timing and extent of examination procedures, the following
matters should be considered such as: -
(a) the knowledge obtained during any previous engagements
(b) management’s competence regarding the preparation of prospective financial
information
(c) the likelihood of material misstatement
Examination
Procedures (d) the extent to which the prospective financial information is affected by the
management’s judgment
(e) the sources of information considered by the management for the purpose, their
adequacy, reliability of the underlying data, including data derived from third parties,
such as industry statistics, to support the assumptions
(f) the stability of entity’s business and
(g) the engagement team’s experience with the business and the industry in which the
entity operates and with reporting on prospective financial information
In performing these procedures, source and reliability of the evidence supporting management’s
best-estimate assumptions needs to be assessed. Such evidence may be available from varied
sources like entity’s budgets, debt agreements, industry publications etc.
When hypothetical assumptions are used, all significant implications of such assumptions should
have been taken into consideration. For example, if sales are assumed to grow beyond the entity’s
current plant capacity, the prospective financial information will need to include the necessary
investment in the additional plant capacity or the costs of alternative means of meeting the
anticipated sales, such as subcontracting production. It needs to be verified that the hypothetical
assumptions are consistent with the purpose of the prospective financial information and that there
is no reason to believe they are clearly unrealistic.
2.8 Presentation and Disclosure
When assessing the presentation and disclosure of the prospective financial information and the
underlying assumptions, in addition to the specific requirements of any relevant statutes, regulations
as well as the relevant professional pronouncements, it needs to be considered whether: -
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(a) the presentation of prospective financial information is informative and not misleading
(b) the accounting policies are clearly disclosed in the notes to the prospective financial information;
(c) the assumptions are adequately disclosed in the notes to the prospective financial information. It needs to be
clear whether assumptions represent management’s best-estimates or are hypothetical and, when assumptions
are made in areas that are material and are subject to a high degree of uncertainty, this uncertainty and the
resulting sensitivity of results needs to be adequately disclosed
(d) the date as of which the prospective financial information was prepared is disclosed. Management needs to
confirm that the assumptions are appropriate as of this date, even though the underlying information may have
been accumulated over a period of time
(e) the basis of establishing points in a range is clearly indicated and the range is not selected in a biased or
misleading manner when results shown in the prospective financial information are expressed in terms of a range
and
(f) if there is any change in the accounting policy of the entity from that disclosed in the most recent historical
financial statements, whether reason for the change and the effect of such change on the prospective financial
information has been adequately disclosed.
2.9 Report on Examination of Prospective Financial Information
The report for an examination of prospective financial information should contain the following:
(a) Title
(b) Addressee
(c) Identification of the prospective financial information
(d) Reference to the Standards on Auditing applicable to the examination of prospective
financial information
(e) Statement that management is responsible for the prospective financial information
including the underlying assumptions
(f) When applicable, a reference to the purpose and/or restricted distribution of the
prospective financial information
(g) Statement that the examination procedures included examination, on a test basis, of
evidence supporting the assumptions, amounts and other disclosures in the forecast or
projection
(h) Statement of negative assurance as to whether the assumptions provide a reasonable
basis for the prospective financial information
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(i) Opinion as to whether the prospective financial information is properly prepared on the
basis of the assumptions and is presented in accordance with the relevant financial
reporting framework
(j) Appropriate caveats concerning the achievability of the results indicated by the
prospective financial information
(k) Date of report (which should be the date procedures have been completed)
(l) Place of signature and
(m) Signature.
(d) Reference to the
Standards on Auditing
(c) Identification of the
applicable to the
(a) Title (b) Addressee prospective financial
examination of
information
prospective financial
information
(g) Statement that the
(e) Statement that (f) When applicable, a examination procedures (h) Statement of negative
management is reference to the purpose included examination, on assurance as to whether
responsible for the and/or restricted a test basis, of evidence the assumptions provide
prospective financial distribution of the supporting the a reasonable basis for the
information including the prospective financial assumptions, amounts prospective financial
underlying assumptions information and other disclosures in information
the forecast or projection
(i) Opinion as to whether
the prospective financial (j) Appropriate caveats
information is properly concerning the (k) Date of report (which
prepared on the basis of achievability of the results should be the date
(l) Place of signature and
the assumptions and is indicated by the procedures have been
presented in accordance prospective financial completed)
with the relevant financial information
reporting framework
(m) Signature
Such a report would: -
• state whether, based on the examination of the evidence supporting the assumptions,
anything has come to attention, which causes the belief that the assumptions do not provide
a reasonable basis for the prospective financial information.
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• express an opinion as to whether the prospective financial information is properly prepared
on the basis of the assumptions and is presented in accordance with the relevant financial
reporting framework.
• state that: -
Actual results are likely to be different from the prospective financial information since anticipated events
frequently do not occur as expected and the variation could be material. Likewise, when the prospective financial
information is expressed as a range, it would be stated that there can be no assurance that actual results will fall
within the range and
In the case of a projection, the prospective financial information has been prepared for (intended use), using a set
of assumptions that include hypothetical assumptions about future events and management’s actions that are not
necessarily expected to occur. Consequently, readers are cautioned that the prospective financial information
should not be used for purposes other than the abovementioned intended use.
When it is believed that the presentation and disclosure of the prospective financial information is
not adequate, a qualified or adverse opinion in the report on the prospective financial information
should be expressed or withdrawal from engagement should be made as appropriate.
An example would be where financial information fails to disclose adequately the consequences
of any assumptions, which are highly sensitive.
When it is believed that one or more significant assumptions do not provide a reasonable basis
for the prospective financial information prepared on the basis of best-estimate assumptions or
that one or more significant assumptions do not provide a reasonable basis for the prospective
financial information given the hypothetical assumptions, an adverse opinion setting out the
reasons in the report on the prospective financial information should be expressed, or withdrawal
from the engagement should be made.
When the examination is affected by conditions that preclude application of one or more
procedures considered necessary in the circumstances, either withdrawal from the engagement
or disclaimer of the opinion and describing the scope limitation in the report on the prospective
financial information is considered.
2.10 Documentation
Matters, which are important in providing evidence to support report on examination of prospective
financial information, and evidence that such examination was carried out in accordance with this
SAE should be documented.
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TEST YOUR UNDERSTANDING 1
A company has approached CA. Hemant for an assurance report in respect of prospective financial
information of a project. On going through the project details, it is noticed that depreciation reflected
on proposed fixed assets to be acquired in prospective financial information has been calculated in
accordance with provisions of the Income Tax Act. No disclosure is made in this respect too. How
the matter should be proceeded with?
3. SAE 3402 Assurance Reports on Controls at a Service
Organisation
SAE 3402 deals with assurance engagements undertaken by a professional accountant in public
practice to provide a report for use by user entities and their auditors on the controls at a service
organization that provides a service to user entities that is likely to be relevant to user entities’
internal control as it relates to financial reporting. It complements SA 402, in that reports prepared
in accordance with this SAE are capable of providing appropriate evidence under SA 402.
3.1 Scope of SAE 3402
SAE 3402 applies only when the service organization is responsible for, or otherwise able to make
an assertion about, the suitable design of controls. It does not deal with assurance engagements:
(a) To report only on whether controls at a service organization operated as described or
(b) To report only on controls at a service organization other than those related to a service
that is likely to be relevant to user entities’ internal control as it relates to financial reporting
(for example, controls that affect user entities’ production or quality control).
What is a Service Organisation?
Service organization refers to a third-party organization (or segment of a third-party organization)
that provides services to user entities that are likely to be relevant to user entities internal control as
it relates to financial reporting. User entity refers to an entity that uses a service organization.
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Why controls of a service organization are important to a user entity’s internal controls
relating to financial reporting?
Controls related to a service organization’s operations and compliance objectives may be relevant
to a user entity’s internal control as it relates to financial reporting. Such controls may pertain to
assertions about presentation and disclosure relating to account balances, classes of transactions,
or disclosures, or may pertain to evidence that the user auditor evaluates or uses in applying auditing
procedures.
For example, a company has outsourced its payroll processing functions to a service organization.
The service organization is responsible for the accurate preparation of payrolls and timely remittance
of statutory dues to government authorities on behalf of the company. Payroll processing service
organization’s controls related to the timely remittance of payroll deductions to government
authorities may be relevant to the company (user entity) as late remittances could result in interest
and penalties resulting in liabilities for the user entity.
“Controls at the service organization” includes aspects of user entities’ information systems
maintained by the service organization, and may also include aspects of one or more of the other
components of internal control at a service organization.
For example, such controls at a service organization may include aspects of a service organization’s
control environment, monitoring, and control activities when they relate to the services provided. It
does not, however, include controls at a service organization that are not related to the achievement
of the control objectives stated in the service organization’s description of its system, for example,
controls related to the preparation of the service organization’s own financial statements.
The determination of whether controls at a service organization related to operations and compliance
are likely to be relevant to user entities’ internal control as it relates to financial reporting is a matter
of professional judgment, having regard to the control objectives set by the service organization and
the suitability of the criteria.
User Auditor and Service Auditor
User auditor refers to an auditor who audits and reports on the financial statements of a user entity.
Service auditor refers to a professional accountant in public practice who, at the request of the
service organization, provides an assurance report on controls at a service organization.
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3.2 Objectives of Service Auditor in Accordance with SAE 3402
The objectives of the service auditor are: -
(a) To obtain reasonable assurance about whether, in all material respects, based on
suitable criteria: -
(i) The service organization’s description of its system fairly presents the system as
designed and implemented throughout the specified period (or in the case of a type
1 report, as at a specified date)
(ii) The controls related to the control objectives stated in the service organization’s
description of its system were suitably designed throughout the specified period (or
in the case of a type 1 report, as at a specified date)
(iii) Where included in the scope of the engagement, the controls operated effectively
to provide reasonable assurance that the control objectives stated in the service
organization’s description of its system were achieved throughout the specified
period.
(b) To report on the matters in (a) above in accordance with the service auditor’s
findings.
3.3 Type 1 Report & Type 2 Report
Type 1 report is a report that comprises: Type 2 report is a report that comprises:
(i) The service organization’s description of (i) The service organization’s description of
its system; its system
(ii) A written assertion by the service (ii) A written assertion by the service
organization that, in all material organization that, in all material
respects, and based on suitable criteria: respects, and based on suitable criteria:
a. The description fairly presents a. The description fairly presents
the service organization’s system the service organization’s system
as designed and implemented at as designed and implemented
the specified date throughout the specified period
b. The controls related to the control b. The controls related to the control
objectives stated in the service objectives stated in the service
organization’s description of its organization’s description of its
system were suitably designed system were suitably designed
as at the specified date and
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(iii) A service auditor’s assurance report that throughout the specified period
conveys reasonable assurance about and
the matters referred to in (ii)
c. The controls related to the control
objectives stated in the service
organization’s description of its
system operated effectively
throughout the specified period
and
(iii) A service auditor’s assurance report
that: -
a. Conveys reasonable assurance
about the matters in (ii) and
b. Includes a description of the tests
of controls and the results
thereof.
Type 1 report is a report on the description and design of controls at a service organization
whereas type 2 report is a report on the description, design and operating effectiveness of controls
at a service organization.
3.4 How such an Engagement is Proceeded with?
1) Compliance with ethical requirements: The service auditor shall comply with relevant
ethical requirements, including those pertaining to independence, relating to assurance
engagements.
2) Determination of Management and those charged with governance and communication
with them: The service auditor shall inquire of, request representations from, communicate
with, or otherwise interact with the service organization wherever required. The service
auditor shall determine the appropriate persons within the service organization’s
management or governance structure with whom to interact.
3) Acceptance and changes in terms of engagement: Before, accepting such an
engagement, it has to be ensured by service auditor that necessary capabilities and
competence to carry out such engagement are possessed by him. It also needs to be ensured
that the criteria to be applied by the service organization to prepare the description of its
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system will be suitable and available to user entities and their auditors and the scope of the
engagement and the service organization’s description of its system will not be so limited that
they are unlikely to be useful to user entities and their auditors.
If the service organization requests a change in the scope of the engagement before the
completion of the engagement, the service auditor shall be satisfied that there is a reasonable
justification for the change.
4) Assessing of suitability of the Criteria: The service auditor shall assess whether the
service organization has used suitable criteria in preparing the description of its system, in
evaluating whether controls are suitably designed, and, in the case of a type 2 reports, in
evaluating whether controls are operating effectively.
5) Determination of Materiality: When planning and performing the engagement, the service
auditor shall consider materiality with respect to the fair presentation of the description, the
suitability of the design of controls and, in the case of a type 2 report, the operating
effectiveness of controls.
6) Obtaining an understanding of the Service organization’s system: The service Auditor
shall obtain an understanding of the service organization’s system, including controls that are
included in the scope of engagement.
7) Obtaining evidence regarding the description: The service auditor shall obtain and read
the service organization’s description of its system and evaluate whether those aspects of
the description included in the scope of engagement are fairly presented.
8) Obtaining evidence regarding the design of controls: The service auditor shall determine
which of the controls at the service organization are necessary to achieve the control
objectives stated in the service organization’s description of its system and shall assess
whether those controls were suitably designed.
9) Obtaining evidence regarding operating effectiveness of controls: When providing a
type 2 report, the service auditor shall test those controls that the service auditor has
determined are necessary to achieve the control objectives stated in the service
organization’s description of its system, and assess their operating effectiveness throughout
the period.
10) Understanding the internal audit function: If the service organization has an internal audit
function, the service auditor shall obtain an understanding of the nature of the responsibilities
of the internal audit function and of the activities performed in order to determine whether the
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internal audit function is likely to be relevant to the engagement in order for the service auditor
to use specific work of the internal auditors.
11) Asking for Written Representations: The service auditor shall request the service
organization to provide written representations: -
Asking for Written Representation from the
(a) That reaffirm the assertion accompanying the
description of the system
service organization -
(i) Non-compliance with laws and regulations, fraud,
or uncorrected deviations attributable to the service
organization that may affect one or more user
entities
(b) That it has provided the service auditor with all
relevant information and access agreed to and
(ii) Design deficiencies in controls
(c) That it has disclosed to the service auditor any
of the following of which it is aware:-
(iii) Instances where controls have not operated as
described and
(iv) Any events subsequent to the period covered
by the service organization’s description of its
system up to the date of the service auditor’s
assurance report that could have a significant effect
on the service auditor’s assurance report.
12) Subsequent Events: The service auditor shall inquire whether the service organization is
aware of any events subsequent to the period covered by the service organization’s
description of its system up to the date of the service auditor’s assurance report that could
have a significant effect on the service auditor’s assurance report.
3.5 Reporting
The service auditor’s assurance report shall include the following basic elements: -
(a) A title that clearly indicates the report is an independent service auditor’s assurance
report.
(b) An addressee.
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(c) Identification of:
(i) The service organization’s description of its system, and the service organization’s
assertion, which includes the matters for a type 2 report, or for a type 1 report.
(ii) Those parts of the service organization’s description of its system, if any, that are
not covered by the service auditor’s opinion.
(iii) If the description refers to the need for complementary user entity controls, a
statement that the service auditor has not evaluated the suitability of design or
operating effectiveness of complementary user entity controls, and that the control
objectives stated in the service organization’s description of its system can be
achieved only if complementary user entity controls are suitably designed or
operating effectively, along with the controls at the service organization.
(iv) If services are performed by a subservice organization, the nature of activities
performed by the subservice organization as described in the service
organization’s description of its system.
(d) Identification of the criteria, and the party specifying the control objectives.
(e) A statement that the report and, in the case of a type 2 report, the description of tests of
controls are intended only for user entities and their auditors, who have a sufficient
understanding to consider it, along with other information including information about
controls operated by user entities themselves, when assessing the risks of material
misstatements of user entities’ financial statements.
(f) A statement that the service organization is responsible for: -
(i) Preparing the description of its system, and the accompanying assertion, including
the completeness, accuracy and method of presentation of that description and
that assertion;
(ii) Providing the services covered by the service organization’s description of its
system;
(iii) Stating the control objectives (where not identified by law or regulation, or another
party, for example, a user group or a professional body) and
(iv) Designing and implementing controls to achieve the control objectives stated in
the service organization’s description of its system.
(g) A statement that the service auditor’s responsibility is to express an opinion on the service
organization’s description, on the design of controls related to the control objectives
stated in that description and, in the case of a type 2 report, on the operating effectiveness
of those controls, based on the service auditor’s procedures.
(h) A statement that the engagement was performed in accordance with SAE 3402,
“Assurance Reports on Controls at a Service Organization,” which requires that the
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service auditor comply with ethical requirements and plan and perform procedures to
obtain reasonable assurance about whether, in all material respects, the service
organization’s description of its system is fairly presented and the controls are suitably
designed and, in the case of a type 2 report, are operating effectively.
(i) A summary of the service auditor’s procedures to obtain reasonable assurance and a
statement of the service auditor’s belief that the evidence obtained is sufficient and
appropriate to provide a basis for the service auditor’s opinion, and, in the case of a type
1 report, a statement that the service auditor has not performed any procedures regarding
the operating effectiveness of controls and therefore no opinion is expressed thereon.
(j) A statement of the limitations of controls and, in the case of a type 2 report, of the risk of
projecting to future periods any evaluation of the operating effectiveness of controls.
(k) The service auditor’s opinion, expressed in the positive form, on whether, in all material
respects, based on suitable criteria:
(i) In the case of a type 2 report: - (ii) In the case of a type 1 report: -
a. The description fairly presents the a. The description fairly presents the
service organization’s system that service organization’s system that
had been designed and had been designed and implemented
implemented throughout the as at the specified date and
specified period;
b. The controls related to the control
b. The controls related to the control objectives stated in the service
objectives stated in the service organization’s description of its
organization’s description of its system were suitably designed as at
system were suitably designed the specified date.
throughout the specified period;
and
c. The controls tested, which were
those necessary to provide
reasonable assurance that the
control objectives stated in the
description were achieved,
operated effectively throughout the
specified period.
(l) The date of the service auditor’s assurance report, which shall be no earlier than the date
on which the service auditor has obtained sufficient appropriate evidence on which to
base the opinion.
(m) Signature-The report should be signed by the practitioner.
(n) The place of signature – the report should name specific location, which is ordinarily the
city where the report is signed.
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Additional matters requiring reporting in type 2 report: In the case of a type 2 report, the service
auditor’s assurance report shall include a separate section after the opinion, or an attachment, that
describes the tests of controls that were performed and the results of those tests.
In describing the tests of controls, the service auditor shall clearly state which controls were tested,
identify whether the items tested represent all or a selection of the items in the population, and
indicate the nature of the tests in sufficient detail to enable user auditors to determine the effect of
such tests on their risk assessments.
If deviations have been identified, the service auditor shall include the extent of testing performed
that led to identification of the deviations (including the sample size where sampling has been used),
and the number and nature of the deviations noted.
The service auditor shall report deviations even if, on the basis of tests performed, the service auditor
has concluded that the related control objective was achieved.
Modified Opinions
If the service auditor concludes that:
(c) In the case of a type 2 report, the
controls tested, which were those (d) The service auditor is unable to
necessary to provide reasonable obtain sufficient appropriate
(a) The service organization’s (b) The controls related to the
assurance that the control evidence, the service auditor’s
description does not fairly present, control objectives stated in the
objectives stated in the service opinion shall be modified, and the
in all material respects, the system description were not suitably
organization’s description of its service auditor’s assurance report
as designed and implemented; designed, in all material respects
system were achieved, did not shall contain a clear description of
operate effectively, in all material all the reasons for the modification.
respects or
3.6 Documentation
The service auditor shall prepare documentation that is sufficient to enable an experienced service
auditor, having no previous connection with the engagement, to understand:
(a) The nature, timing, and extent of the procedures performed to comply with this SAE and
applicable legal and regulatory requirements
(b) The results of the procedures performed, and the evidence obtained and
(c) Significant matters arising during the engagement, and the conclusions reached thereon and
significant professional judgments made in reaching those conclusions
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TEST YOUR UNDERSTANDING 2
Bansi Group is a leading institution running prestigious post graduate courses in the field of
management. Its financial statements are audited by an independent auditor. Before the start of this
academic session, the Board of the institution had outsourced its entire process of inviting student
applications, submission of applications, and collection of application fees including late fees and
such matters to Easy Solutions Limited.
The auditors of Bansi Group want to be sure about the design and operating effectiveness of controls
at Easy Solutions Limited. What should be the nature of the report to be provided by auditors of
Easy Solutions Limited specifically for use by Bansi Group and its auditors in this regard in terms of
SA 3402?
4. SAE 3420 Assurance Engagements to Report on the
Compilation of Pro Forma Financial Information
Included in a Prospectus
SA 3420 deals with reasonable assurance engagements undertaken by a practitioner to report on
the responsible party’s compilation of pro forma financial information included in a prospectus. It
applies where such reporting is required by securities law or regulation of the security exchange in
the jurisdiction in which the prospectus is to be issued or this reporting is generally accepted practice
in such jurisdiction.
What is Pro forma financial information?
Pro forma financial information refers to financial information shown together with adjustments to
illustrate the impact of an event or transaction on unadjusted financial information as if the event
had occurred or the transaction had been undertaken at an earlier date selected for purposes of the
illustration.
The Pro forma financial information is, normally, used in the offer documents to demonstrate the
effect of a transaction on the financial statements of a company as if those transactions had occurred
at an earlier date. The Pro forma financial information may take the form of Statement of Profit and
Loss and Balance Sheet to illustrate how the transactions might have affected the assets, liabilities
and earnings of the Issuer. They also include notes in relation to the significant aspects of the
transactions, assumptions used to prepare the Pro forma financial information and the adjustments
made.
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The purpose of pro forma financial information included in a prospectus is solely to illustrate the
impact of a significant event or transaction on unadjusted financial information of the entity as if the
event had occurred or the transaction had been undertaken at an earlier date selected for purposes
of the illustration. This is achieved by applying pro forma adjustments to the unadjusted financial
information. Pro forma financial information does not represent the entity’s actual financial position,
financial performance, or cash flows.
4.1 Objectives in Accordance with SA 3420
The objectives of the practitioner in accordance with SA 3420 are: -
(a) To obtain reasonable assurance about whether the pro forma financial information has been
compiled, in all material respects, by the responsible party on the basis of the applicable
criteria and
(b) To report in accordance with the practitioner’s findings.
4.2 Compilation of Pro forma financial information
The compilation of pro forma financial information involves the responsible party gathering,
classifying, summarising and presenting financial information that illustrates the impact of a
significant event or transaction on the unadjusted financial information of the entity as if the event
had occurred or the transaction had been undertaken at the selected date.
Steps involved in this process include:-
Identifying the source of the unadjusted financial information to be used in compiling the
pro forma financial information, and extracting the unadjusted financial information from
that source
Making pro forma adjustments to the unadjusted financial information for the purpose for
which the pro forma financial information is presented and
Presenting the resulting pro forma financial information with accompanying disclosures.
4.3 Nature of the Practitioner’s Responsibility
In such an engagement performed under this SAE, the practitioner has no responsibility to compile
the pro forma financial information for the entity. Such responsibility rests with the responsible party.
The practitioner’s sole responsibility is to report on whether the pro forma financial information has
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been compiled, in all material respects, by the responsible party on the basis of the applicable
criteria.
It is a reasonable assurance engagement to report on the compilation of pro forma financial
information involving performing the procedures to assess whether the applicable criteria used by
the responsible party in the compilation of the pro forma financial information provide a reasonable
basis for presenting the significant effects directly attributable to the event or transaction.
4.4 Steps involved in such an Engagement
Planning and
Engagement Written Forming the Preparing the
performing the
acceptance Representations opinion assurance report
engagement
4.4.1 Engagement Acceptance
Before agreeing to accept an engagement to report on whether pro forma financial information
included in a prospectus has been compiled, in all material respects, on the basis of the applicable
criteria, the practitioner shall consider matters stated below. “Applicable criteria” are criteria used by
the responsible party when compiling the pro forma financial information. Criteria may be established
by an authorized or recognized standard-setting organization or by law or regulation. Where
established criteria do not exist, they will be developed by the responsible party.
(a) Determine that the practitioner has the capabilities and competence to perform the
engagement
(b) On the basis of a preliminary knowledge of the engagement circumstances and discussion
with the responsible party, determine that the applicable criteria are suitable and that it is
unlikely that the pro forma financial information will be misleading for the purpose for which
it is intended.
(c) Evaluate the wording of the opinion prescribed by the relevant law or regulation, if any, to
determine that the practitioner will likely be able to express the opinion so prescribed based
on performing the procedures specified in this SAE
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(d) Where the sources from which the unadjusted financial information and any acquiree or
divestee financial information have been extracted have been audited or reviewed and a
modified audit opinion or review conclusion has been expressed, or the report contains an
Emphasis of Matter paragraph, consider whether or not the relevant law or regulation permits
the use of, or reference in the practitioner’s report to, the modified audit opinion or review
conclusion or the report containing the Emphasis of Matter paragraph with respect to such
sources
(e) If the entity’s historical financial information has never been audited or reviewed, consider
whether the practitioner can obtain a sufficient understanding of the entity and its accounting
and financial reporting practices to perform the engagement
(f) If the event or transaction includes an acquisition and the acquiree’s historical financial
information has never been audited or reviewed, consider whether the practitioner can obtain
a sufficient understanding of the acquiree and its accounting and financial reporting practices
to perform the engagement and
(g) Obtain the agreement of the responsible party that it acknowledges and understands its
responsibility for:
a. Access to all information (including,
when needed for purposes of the
engagement, information of the
acquiree(s) in a business
(i) Adequately disclosing and combination), such as records,
describing the applicable criteria to the
Agreement of the Responsible Part:
documentation and other material,
intended users if these are not publicly relevant to evaluating whether the pro
available forma financial information has been
compiled, in all material respects, on
the basis of the applicable criteria
(ii) Compiling the pro forma financial
information on the basis of the
applicable criteria and b. Additional information that the
practitioner may request from the
responsible party for the purpose of
the engagement
(iii) Providing the practitioner with:-
c. Access to those within the entity
and the entity’s advisors from whom
the practitioner determines it
necessary to obtain evidence relating
to evaluating whether the pro forma
financial information has been
compiled, in all material respects, on
the basis of the applicable criteria; and
d. When needed for purposes of the
engagement, access to appropriate
individuals within the acquiree(s) in a
business combination.
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4.4.2 Planning and Performing the Engagement
• The practitioner shall assess whether the applicable criteria are suitable, as required by the
Framework for Assurance Engagements
• When planning and performing the engagement, the practitioner shall consider materiality
with respect to evaluating whether the pro forma financial information has been compiled, in
all material respects, on the basis of the applicable criteria.
• An understanding of how the responsible party has compiled the pro forma financial
Information and other engagement circumstances
• The practitioner shall obtain evidence about the appropriateness of the source from which
the unadjusted financial information has been extracted
• If there is no audit or review report on the source from which the unadjusted financial
information has been extracted, the practitioner shall perform procedures to be satisfied that
the source is appropriate.
• The practitioner shall determine whether the responsible party has appropriately extracted
the unadjusted financial information from the source.
• The practitioner shall obtain evidence about the appropriateness of the pro forma
adjustments.
In relation to unadjusted financial information, Pro forma adjustments include:
(a) Adjustments to unadjusted financial information that illustrate the impact of a
significant event or transaction as if the event had occurred or the transaction had
been undertaken at an earlier date selected for purposes of the illustration and
(b) Adjustments to unadjusted financial information that are necessary for the pro
forma financial information to be compiled on a basis consistent with the
applicable financial reporting framework of the reporting entity and its accounting
policies under that framework.
• The practitioner shall evaluate the presentation of pro forma financial information.
• The practitioner shall read the other information included in the Prospectus containing the
pro forma financial information to identify material inconsistencies, if any, with pro forma
financial information.
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PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.27
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4.4.3 Written Representations
The practitioner shall request written representations from the responsible party that:-
(a) In compiling the pro forma financial
(b) The pro forma financial information
information, the responsible party has identified
has been compiled, in all material
all appropriate pro forma adjustments necessary
respects, on the basis of the applicable
to illustrate the impact of the event or transaction
criteria.
at the date or for the period of the illustration and
4.4.4 Opinion
Unmodified Opinion
The practitioner shall express an unmodified opinion when the practitioner concludes that the pro
forma financial information has been compiled, in all material respects, by the responsible party on
the basis of the applicable criteria.
Modified Opinion
(a) Where the relevant law or regulation precludes publication of a prospectus that contains a
modified opinion with regard to whether the pro forma financial information has been compiled, in
all material respects, on the basis of the applicable criteria and the practitioner concludes that a
modified opinion is nevertheless appropriate in accordance with the Framework for Assurance
Engagements, the practitioner shall discuss the matter with the responsible party.
Withdraw from the
engagement or
If the responsible party does
not agree to make the
necessary changes, the
practitioner shall: -
Consider seeking legal
advice.
(b) Where the relevant law or regulation may not preclude publication of a prospectus that contains
a modified opinion with regard to whether the pro forma financial information has been compiled, in
all material respects, on the basis of the applicable criteria and the practitioner determines that a
modified opinion is appropriate in accordance with the Framework for Assurance Engagements, the
practitioner shall apply the requirements in the Framework for Assurance Engagements regarding
modified opinions.
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11.28 ADVANCED AUDITING
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Emphasis of Matter Paragraph
In some circumstances, the practitioner may consider it necessary to draw the user’s attention to a
matter presented or disclosed in the pro forma financial information or the accompanying explanatory
notes. This would be the case when, in the practitioner’s opinion, the matter is of such importance
that it is fundamental to the user’s understanding of whether the pro forma financial information has
been compiled, in all material respects, on the basis of the applicable criteria.
In such circumstances, the practitioner shall include an Emphasis of Matter paragraph in the
practitioner’s report provided that the practitioner has obtained sufficient appropriate evidence that
the matter does not affect whether the pro forma financial information has been compiled, in all
material respects, on the basis of the applicable criteria. Such a paragraph shall refer only to
information presented or disclosed in the pro forma financial Information or the accompanying
explanatory notes.
4.4.5 Preparing the Assurance Report
The practitioner’s report shall include the following basic elements: -
Basic elements of Assurance Report
(a) A title that clearly indicates that the report is an independent assurance report
(b) An addressee(s), as agreed in the terms of engagement
(c) Introductory paragraphs that identify: -
(i) The pro forma financial information
(ii) The source from which the unadjusted financial information has been extracted and
whether or not an audit or review report on such a source has been published
(iii) The period covered by, or the date of, the pro forma financial information and
(iv) A reference to the applicable criteria on the basis of which the responsible party
has performed the compilation of the pro forma financial information, and the source
of the criteria
(d) A statement that the responsible party is responsible for compiling the pro forma financial
information on the basis of the applicable criteria
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PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.29
ASSURANCE SERVICES
(e) A description of the practitioner’s responsibilities, including statements that: -
(i) The practitioner’s responsibility is to express an opinion about whether the pro
forma financial information has been compiled, in all material respects, by the
responsible party on the basis of the applicable criteria
(ii) For purposes of this engagement, the practitioner is not responsible for updating or
reissuing any reports or opinions on any historical financial information used in
compiling the pro forma financial information, nor has the practitioner, in the course
of this engagement, performed an audit or review of the financial information used
in compiling the pro forma financial information and
(iii) The purpose of pro forma financial information included in a prospectus is solely to
illustrate the impact of a significant event or transaction on unadjusted financial
information of the entity as if the event had occurred or the transaction had been
undertaken at an earlier date selected for purposes of the illustration. Accordingly,
the practitioner does not provide any assurance that the actual outcome of the event
or transaction at that date would have been as presented
(f) A statement that the engagement was performed in accordance with SAE 3420,
‘Assurance Engagements to Report on the Compilation of Pro Forma Financial Information
Included in a Prospectus’, which requires that the practitioner comply with ethical
requirements and plan and perform procedures to obtain reasonable assurance about
whether the responsible party has compiled, in all material respects, the pro forma financial
information on the basis of the applicable criteria
(g) Statements that: -
(i) A reasonable assurance engagement to report on whether the pro forma financial
information has been compiled, in all material respects, on the basis of the
applicable criteria involves performing procedures to assess whether the applicable
criteria used by the responsible party in the compilation of the pro forma financial
information provide a reasonable basis for presenting the significant effects directly
attributable to the event or transaction and to obtain sufficient appropriate evidence
about whether: -
© The Institute of Chartered Accountants of India
11.30 ADVANCED AUDITING
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The pro forma financial information
The related pro forma adjustments give reflects the proper application of those
appropriate effect to those criteria; and adjustments to the unadjusted financial
information
(ii) The procedures selected depend on the practitioner’s judgment, having regard to
the practitioner’s understanding of the nature of the entity, the event or transaction
in respect of which the pro forma financial information has been compiled, and other
relevant engagement circumstances and
(iii) The engagement also involves evaluating the overall presentation of the pro forma
financial information
(h) Unless otherwise required by law or regulation, the practitioner’s opinion using one of the
following phrases, which are regarded as being equivalent: -
(i) The pro forma financial information has been compiled, in all material respects, on
the basis of the applicable criteria or
(ii) The pro forma financial information has been properly compiled on the basis stated.
(i) The practitioner’s signature
(j) The date of the report and
(k) The place of signature.
4.5 Documentation
As in case of all assurance engagements, documentation has to be ensured by the practitioner while
performing engagement under SAE 3420.
TEST YOUR UNDERSTANDING 3
The management of S Ltd. requests you to accept an engagement to report on the compilation of
pro forma financial information to be included in a prospectus. In light of SAE 3420, what factors you
will consider regarding the company acknowledging and understanding its responsibility in this
matter before accepting engagement?
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.31
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Integrated Case Scenario
Below is given draft text of the “Report on Examination of Prospective Financial Information” of
Top Edge Limited in relation to the company’s upcoming project prepared by a staff member in a
CA firm unfamiliar with drafting such reports. The report has been drafted in a casual manner and
may consist of omissions and errors.
Report on Examination of Prospective Financial Information
To
The Board of Directors
Top Edge Limited
We have examined the projection of the upcoming project to come up at Ratnagiri of Top Edge
Limited for the period from April 2023 to March 2030 as given in the Prospective Financial
Information from page 1 to 250 in accordance with Standard on Assurance Engagement 3400,
“The Examination of Prospective Financial Information”, issued by the Institute of Chartered
Accountants of India.
The preparation and presentation of the projection is the responsibility of the Management and
has been approved by the Board of Directors of the company.
Our responsibility is to examine the evidence supporting the assumptions (excluding the
hypothetical assumption) and other information in the prospective financial information.
The projection has been prepared using a set of assumptions that include hypothetical
assumptions about future events and management’s actions that are not necessarily expected to
occur.
We have carried out our examination of the prospective financial information thoroughly.
Further, in our opinion the projection is properly prepared on the basis of the assumptions as set
out in Note 1 to 50 to the Prospective Financial Information and on a consistent basis with the
historical financial statements, using appropriate accounting principles. Even if the events
anticipated under the hypothetical assumptions described above occur, actual results are still
likely to be different from the projection since other anticipated events frequently do not occur as
expected and the variation may be material.
For PCK & Co.
Chartered Accountants
Signature
Designation
Membership number
© The Institute of Chartered Accountants of India
11.32 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Based on your knowledge and description of the case, answer the following questions: -
1. Whose responsibility is to list out assumptions underlying prospective financial
information?
(a) Professional Accountant issuing report on prospective financial information.
(b) Auditor of Company issuing report on prospective financial information.
(c) Management of company.
(d) Banker of company.
2. Which of the following statements is most appropriate regarding “use of prospective
financial information” to be included in such a report?
(a) Intended use of projection is required to be disclosed. It is further necessary to caution the
users regarding inappropriateness of projections for other purposes.
(b) It is discretionary to state intended use of projection in such a report.
(c) Intended use of projection is required to be disclosed. It is not necessary to caution the
users regarding inappropriateness of projections for other purposes.
(d) It is prerogative of management to use report in the manner it deems fit.
3. What should be language of such an unmodified assurance report regarding
underlying assumptions?
(a) Positively worded to suggest assumptions are a reasonable basis.
(b) Negatively worded to suggest assumptions are not on a reasonable basis.
(c) Neither positively worded nor negatively worded about assumptions.
(d) Depends upon the professional judgment of the Chartered Accountant.
4. Which of the following statements is most appropriate regarding the examination of
prospective financial information by a Chartered accountant in accordance with SAE 3400?
(a) Accuracy of projections is vouched for based upon performing procedures thoroughly.
(b) Projections can go haywire; It depends upon the professional judgment of the Chartered
Accountant to vouch for the accuracy of projections.
(c) Accuracy of projections is not at all vouched for in an assurance report on prospective
financial information.
(d) The matter of accuracy of projections or otherwise is not domain of such an examination.
Therefore, there is no reporting requirement under SAE 3400.
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.33
ASSURANCE SERVICES
5. Which of the following statements is most appropriate regarding UDIN in context of
examination of prospective financial information by a Chartered Accountant?
(a) It is mandatory to state UDIN in such type of reports.
(b) It is desirable to state UDIN in such type of reports.
(c) It is not required to state UDIN in such type of reports as it is not an audit engagement.
(d) It is not required to state UDIN in such type of reports as it is not an engagement related
to historical financial information.
Key Takeaways
An assurance engagement may relate to the examination of subject matters other than an
examination of financial statements prepared on the basis of “historical financial information”.
In such types of assurance engagements, the examination may relate to prospective financial
information or to providing assurance regarding non-financial matters like the design and
operation of internal control in an entity. Standards on Assurance Engagements deal with the
responsibilities of professional accountants in assurance engagements dealing with such
matters.
“Prospective financial information” means financial information based on assumptions about
events that may occur in the future and possible actions by an entity. It can be in the form of
a forecast, a projection, or a combination of both.
SAE 3400 provides guidance on engagements to examine and report on prospective financial
information including examination procedures for best-estimate and hypothetical
assumptions.
Service organization refers to a third-party organization (or segment of a third-party
organization) that provides services to user entities that are likely to be relevant to user
entities’ internal control as it relates to financial reporting.
Controls related to a service organization’s operations and compliance objectives may be
relevant to a user entity’s internal control as it relates to financial reporting.
SAE 3402 deals with assurance engagements undertaken by a professional accountant in
public practice to provide a report for use by user entities and their auditors on the controls
at a service organization that provides a service to user entities that is likely to be relevant to
user entities internal control as it relates to financial reporting.
© The Institute of Chartered Accountants of India
11.34 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Pro forma financial information refers to financial information shown together with
adjustments to illustrate the impact of an event or transaction on unadjusted financial
information as if the event had occurred or the transaction had been undertaken at an earlier
date selected for purposes of the illustration.
The Pro forma financial information is, normally, used in the offer documents to demonstrate
the effect of a transaction on the financial statements of a company as if those transactions
had occurred at an earlier date.
SA 3420 deals with reasonable assurance engagements undertaken by a practitioner to
report on the responsible party’s compilation of pro forma financial information included in a
prospectus.
SA 3420 applies where such reporting is required by securities law or regulation of the
security exchange in the jurisdiction in which the prospectus is to be issued or this reporting
is generally accepted practice in such jurisdiction.
TEST YOUR KNOWLEDGE
Theoretical Questions
1 Ayurda Ltd.is a fast-growing and award-winning SaaS software company which is
headquartered in Mumbai. It also has offices in the UK and provides cloud-based
professional services automation (PSA) software solutions to professional services
organizations around the world. They want to engage you to provide an assurance report for
one of its major clients over the controls it operates as a service organisation. Can you provide
such an assurance report?
2. Discuss the significance of Pro forma financial information included in prospectus of a
company.
3. Discuss the term “Pro forma adjustment” under SAE 3420.
4. Discuss, how, a Chartered Accountant can be associated with prospective financial
information without violating relevant provisions of the Chartered Accountants Act, 1949.
© The Institute of Chartered Accountants of India
PROSPECTIVE FINANCIAL INFORMATION AND OTHER 11.35
ASSURANCE SERVICES
Answers to Test Your Understanding
1. In such types of engagements, it is the duty of a professional accountant to see that
prospective financial information is based on a consistent basis with historical financial
statements using appropriate accounting principles.
In the case of a company, historical financial statements are prepared considering the
requirements of the Companies Act, and depreciation is calculated accordingly. However, in
the given situation, depreciation has been calculated in accordance with Income Tax Act
which is not consistent with historical financial statements. Therefore, it is not proper.
The fact that the projection has not been prepared on a consistent basis with the historical
financial statements, using appropriate accounting principles needs to be stated.
Further, when presentation and disclosure are not adequate, a qualified or adverse opinion
should be given or withdrawal from engagement should be made as appropriate.
2. In such a case, the auditors of Bansi Group want to be sure about the design and operating
effectiveness of controls at the organization which is providing services to their client. Type
2 report is a report on the description, design and operating effectiveness of controls
operating at the service organization. Auditors of Easy Solutions Limited should provide such
a report giving assurance on these matters. It should also include details of tests of controls
performed and details of deviations, if any.
3. The company’s responsibility has to be acknowledged for the following matters:-
(i) Adequately disclosing and describing the applicable criteria to the intended users if
these are not publicly available
(ii) Compiling the pro forma financial information on the basis of the applicable criteria
and
(iii) Providing the practitioner with:-
a. Access to all information (including, when needed for purposes of the
engagement, information of the acquiree(s) in a business combination), such
as records, documentation and other material, relevant to evaluating whether
the pro forma financial information has been compiled, in all material respects,
on the basis of the applicable criteria
b. Additional information that the practitioner may request from the responsible
party for the purpose of the engagement
© The Institute of Chartered Accountants of India
11.36 ADVANCED AUDITING
AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
c. Access to those within the entity and the entity’s advisors from whom the
practitioner determines it necessary to obtain evidence relating to evaluating
whether the pro forma financial information has been compiled, in all material
respects, on the basis of the applicable criteria; and
d. When needed for purposes of the engagement, access to appropriate
individuals within the acquiree(s) in a business combination.
Answers to Integrated Case Scenario
1. (c)
2. (a)
3. (b)
4. (c)
5. (a)
Hints /Answers to Theoretical Questions
1. Assurance report can be provided under SAE 3402. Refer to Para 3.
2. Refer to Para 4.
3. Refer to Para 4.4.2
4. Refer to Para 2.3.
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 12
7
DIGITAL AUDITING AND
ASSURANCE
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the key features of digital auditing and auditing digitally.
Understand IT environment and its complexity.
Know how to identify the IT dependencies impacting the audit.
Gain the knowledge of how to identify IT related risks and controls that
exists in an automated environment.
Learn key considerations to assess the cyber risks and remote audit.
Learn the control objectives that auditor should consider in performing IT
audit.
Know the types and tools available to perform digital audit.
Learn the usage of data analytics in assessing and analysing the key data.
© The Institute of Chartered Accountants of India
12.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Key features of Digital Auditing and
Auditing Digitally
Understand the IT enviroment
Identifying the risks arising from usage
of IT
Assessing Cyber Risks(including
remote audit)
Overview
Emerging Technologies in Audit
Automation in Audit - RPA, AI
Control considerations of Auditing
Digitally
Next Gen Audit
CA M woke up on a leisurely Sunday morning to find a report in his favourite pink
newspaper about ICAI and Indian Banks Association plans to develop a balance
confirmation portal. The report further indicated that such a proposed common platform
would ensure authenticated balance confirmations by auditors directly from banks.
“Auditing digitally improves efficiency and quality of audits”- he thought. Wondering that
besides ushering in an era of transparency, such initiatives are likely to enhance efficiency
and reduce costs. What does auditing digitally precisely signify?
Auditing digitally is using the advancements in technology for conducting an effective and
efficient audit. With a rapidly growing IT environment, adaptation of technology in auditing
practices is imminent requirement. Use of data analytics, artificial intelligence and robotics
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.3
process automation can go a long way in improving quality of audit. Data analytics involves
analysing large sets of data to find actionable insights, trends and drawing of conclusions
for informed decision making. Currently, audit approach is based upon sampling. This is
undergoing transformation and process is likely to be accelerated in times to come.
Robotics Process Automation (RPA) involves use of programs to perform repetitive tasks.
Such computer coded software is useful in many business processes like payroll
generation, order processing, invoice processing and a host of other business functions
involving repetitive tasks. RPA can help auditor in automating classification for risk
assessment process with the help of bots. Bots can even be used to prepare report on
automated controls configured on ERP!
He was also reading an article as to how disruptive blockchain technology could be as
internet was in 90s and its impact on auditing profession. Blockchain as a technology takes
the connectivity of the internet one step further. It offers users the internet of value.
Blockchain is a shared immutable ledger and is replicated across several systems in almost
real time. It is put together in encrypted blocks. It was further opined that Blockchain will
do for transactions what the Internet did for information.
With emerging technologies like Blockchain and its combination with data analytics, big
data and robotics, it is going to be possible to audit all of information. Since blockchain
allows access to transaction history, it is going to revolutionize audit approach and work.
The information stored on a blockchain is likely to be available to the auditor as soon as it
is generated. How exciting outcomes of such a scenario could be? The dependency on the
client to provide information may become redundant in coming future. Another important
application of it is use of “smart contracts” which can be embedded in a blockchain to
automate business processes. It is likely to lead to more emphasis on “tests of controls”
than “tests on details”.
His discerning mind was quickly realizing that with advancements in technology, cyber-
attacks are also bound to grow. It is not an IT issue alone. It affects an entity’s reputation
and theft of sensitive information like intellectual property rights, personally identifiable
information and disruptions in automated operations. Auditor should consider whether
cyber risk represents a risk of material misstatement to the financial statement as part of
the audit risk assessment activities. Focus should be on understanding the cyber risks
affecting the entity and the actions being taken to address these risks.
© The Institute of Chartered Accountants of India
12.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1. DIGITAL AUDIT
1.1 What is a Digital Audit?
Digital Audit is placing assurance on the effectiveness of the IT systems implemented in an
organization. Technology is becoming an integral part of day-to-day business operations. It is
essential that organizations review their technology-related controls to identify gaps and risks for
continuous improvement and to ensure regulatory compliance. A strong controls and security
position will allow organizations to build trust with their stakeholders.
1.2 Key Features of a Digital Audit
• Digital audit encourages the auditee to embrace the latest technological advancements
and provides confidence to auditee to stay updated in a constantly evolving environment.
• A digital audit improves the quality of opinion. This consequently leads to a more reliable
audit report
• Digital Audit leads to savings in time, cost and human effort which can be utilized
towards more productive tasks. Many of today’s digitally enabled processes can be
orchestrated to operate autonomously 24x7, driving real-time transactions.
• Digital Audit allows to standardize processes and allow controls to be implemented to
mitigate risk.
• The digital audit will help organization gain a more comprehensive overview of end-to-
end processes and how technologies are utilized, controlled and optimized against
standards set.
• The digital audit will help create a future for a digital strategy and paves way for adopting
new technologies such as AI and Robotic, usage of analytics and automation.
• It can help auditee to make informed decisions.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.5
Technology
Advancement
Savings in
More Reliable
time cost and
Audit Report
human effort
Features of a
Digital Audit
End to End Informed
Understanding Decisions
Standardised
Process
1.3 Advantages of Digital Audit
(i) Enhanced Effectiveness & Efficiency: Increased efficiency is one of the key benefits of
digital audit. With the use of tools and automation techniques, auditee can standardize the
processes and routine tasks can be automated like automating a reconciliation process that
previously involved hours increase efficiency and saves time and costs.
(ii) Better Audit Quality: Technology can correctly evaluate massive volumes of data quickly.
This can assist auditors in determining the areas that require more testing, lowering the
chance that serious misstatements or other problems would go unnoticed.
(iii) Lower Costs: By automating processes that were previously done manually, technology can
assist with the cost of auditing. This may shorten the time needed to complete an audit, which
may lower the audit's overall cost.
(iv) Better Analytics: Improved analytics capabilities can aid management and auditors in seeing
trends and patterns that may be challenging to spot manually. For instance, AI can examine
a lot of financial data to spot possible fraud, which is hard for auditors to spot manually.
© The Institute of Chartered Accountants of India
12.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(v) Improved Risk Assessment: Creating a number of automations to assist with the audit
process and streamlined testing improves the risk assessment procedure. Management and
auditors put their testing efforts on sites with a higher risk of material misstatement and make
informed decisions.
1.4 Consideration and Challenges of Digital Audit:
Some considerations that organization should keep in mind while using digital techniques &
automation:
Know what business
Think people first and do not Target the right processes –
benefits the organization
underestimate this is a key for successful
wants to achieve with
change is difficult automation.
automation
Automation introduces new
Automation is not a stand- Ensure the process works challenges for organization.
alone solution and should be and it is standardised before Don’t forget about
part of a broader automating. Bots do not easily governance and data
digitalization strategy. adapt to process change security in the risk
framework.
As auditors will obtain an understanding of management’s implementation and oversight of new
technologies, they also will perform procedures to understand the changes to the company’s
business, including any changes to the information technology environment. Areas of focus could
include understanding of the following:
• New activities or changes to existing processes due to new technology (e.g., new revenue
streams, changes in the roles and responsibilities of entity personnel, automation of manual
tasks, changes in staffing levels that affect an entity’s internal control environment)
• Changes in the way the entity’s systems are developed and maintained and whether these
changes introduce new risks and require new controls to respond to those risks
• The impact the new technology as how the organization obtains or generates and uses
relevant, quality information to support the functioning of internal control.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.7
2. AUDITING DIGITALLY
2.1 What is the concept of auditing digitally?
Auditing Digitally is using advancements in technology for conducting an effective and efficient audit.
With a rapidly growing IT environment it is essential to adapt technology in auditing practices.
Using Sampling Tools for selection of a sample size from a population based on materiality
or using Bot for analysis of statutory payments compliance as part of an audit assignment.
It is time to digitize the way an audit is delivered through automation and innovation. There are new
technologies to help capture data, automate procedures, analyse information and focus on the real
risks of the client. The opportunity is in understanding how technology can help and then applying it
to the auditing challenges.
Expectations from an Auditor
Audit teams need to involve the experts on different software applications and technologies. Having
the right level of expertise of new technology (such as RPA, AI, blockchain technology allows
auditors to provide the highest quality of audit. Investment in digitally upskilling the people is the real
secret to quality technology audit. Investment in technology across the profession has largely been
focused on developing and using tools to automate and enhance existing processes, such as
data analytics and collaboration and sharing tools, which help to drive quality in audits today. While
this will remain core to the role of technology in the audit, there are many opportunities where more
advanced technologies such as AI and drones could have an even bigger impact. Such technologies
may also play a role in evolving the scope of the audit (e.g., in using data analytics and machine
learning to help identify fraud).
A manager on a weekly basis performs a manual control to review if vendor master
additions and changes in the system are done post appropriate approvals.
This control can be tested and reperformed by the auditor using RPA technology – BOTs can
login into the system and generate the report and write the output to an Excel file. Based on the
population the BOT will select the samples of changes to be tested. Further BOT will pull the
correct file with approved changes from SharePoint. Then it will perform the testing wherein it
will populate the details of approvals (date, approved by) and identify if changes made without
approvals. Lastly BOT will summarise the results for all the selected samples in an excel file.
© The Institute of Chartered Accountants of India
12.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The auditor will then review the final results file to check if there are any exceptions (changes made
without approvals) noted in the selected samples.
Due to the usage of BOT manual intervention has been reduced, more accurate results are
populated, it results in saving auditors time as well and exceptions highlighted can be readily
reviewed.
2.2 Key Features or Advantages of Auditing Digitally:
Following are key features or advantages of Auditing Digitally:
(i) Improved Quality of Audits: The impact on quality is evident, through automation, data
analytics techniques we can easily move from sample auditing to full population of
transactions being reviewed or re-performed. This ultimately free up time for audit teams to
analyses the information and better understand the business they audit. Technology requires
an element of upfront investment, and it can be challenging to implement with regards to
resources and people, but the value once it is up and running is undeniable.
(ii) Decreasing human dependency: Using technology minimizes the manual intervention
which ultimately results in reducing the risk of manual errors. Technology helps in
streamlining the process of testing for auditors which decreases the errors which occur from
the judgement of different individuals.
(iii) Increases Transparency: With the technological advancement transparency has been
increased. New ERPs and tools have audit trail feature available to trace the transaction end
to end. It helps the management or auditors to review the details like the date on which any
change is made, who made the change, what has been changed, all such details are captured
and can be used while performing audit.
(iv) Automation and Ease: Automating tasks like recording work in repositories, extracting data
and sampling have improved the quality of audit and reduced the manual error. Using
dashboards (e.g., Power BI) for reporting helps in understanding the position and helps the
auditor to form his opinion.
(v) Improved Efficiency: What used to take weeks to learn and programme using deep experts,
is now easily available to auditors after some simple training and digital upskilling. The result
may be increased efficiency and fewer errors, but the benefits are wider reaching and
personal. This also results in improved retention of talent and confidence.
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DIGITAL AUDITING AND ASSURANCE 12.9
Better risk assessment: With usage of automation and technology in audit, auditor may focus
on the real challenges and assess the potential risk precisely. It gives time to auditors to
focus on the bigger picture rather than being involved with repetitive tasks. Dashboards,
visual presentations and other tools helps in understanding where the risk lies and what all
areas need more attention.
2.3 Considerations in Auditing Digitally
While all industry sectors are affected by the emergence of new technologies it is important to
remember that the auditor’s needs are unique. There are few questions it is important to ask and
answer – at all stages of tech journey:
2.3.1 What problems are you trying to solve?
Continuously evaluate the emerging technologies and latest tools to see what can benefit the audit.
Think about what would make your audit easier or better and how you will measure return on your
investment.
2.3.2 Which technology can help you?
There are a number of tools available and many vendors and start-ups using data acquisition,
manipulation and visualization tools. Consider how comfortably these solutions will integrate into
your current processes and flag any potential implementation issues early on.
2.3.3 How will you upskill your people to make best use of the technology available?
Technology is only as good as the people using it. Training and development are critical to ensure
teams understand how and why they are using the technology. Reluctance to change is obvious,
however continuous training help them to get better.
2.3.4 Range of automated solutions:
There is a range of automation solutions, from low to high sophistication, which helps to standardize
the repeatable tasks and optimize the efforts resulting in doing better. Some of the techinques are
using robotics and automation for data gathering activities, use of data analytics for planning and
budgetting and reporting by dashboards.
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12.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Business Process Robotic Process Intelligent Process
Macros and Scripts
Automation (BPA) Automation (RPA) Automation (IPA)
Rules-based Reengineering Automating labour- • Combining RPA with
automation within a existing business intensive, repetitive artificial intelligence
specific application processes e.g. activities across technologies to
workflows multiple systems identify patterns,
and interfaces learn over time, and
optimize workflows
3. UNDERSTAND THE IT ENVIRONMENT
• Understanding the ways in which the entity relies upon IT and how the IT environment is set
up to support the business. This allows the auditor to better understand where risks might
arise from the entity's use of IT (required as per SA 315).
• Understanding how IT is used by the entity helps in identifying controls over the entity’s IT
processes.
• Assessing the complexity of the IT environment helps the teams consider whether to involve
IT specialists or experts in the planning and/or execution of the audit, including initial
consideration of whether to include specialists in the complexity assessment.
Understand Identify Assess
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 organization structure and governance.
• The policies, procedures and processes followed.
• Extent of IT integration, use of service organizations.
• IT risks and controls.
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DIGITAL AUDITING AND ASSURANCE 12.11
The illustration below is an example of how an auditor can document details of an automated
environment:
Application Used for Database Operating Network Server and
System Storage
SAP ECC/ Integrated Oracle 19c HP-UX LAN, HP Server and
HANA application software WAN NAS
REVS Front Desk, Guest MS-SQL Windows In-house HP Server
Reservations Server 2018 2016 Server developed Internal HDD
KOTS Restaurant and MS-SQL Windows In-house HP Server
Kitchen Orders Server 2018 2016 Server developed Internal HDD
BILLSYS Billing Oracle 12c Windows Packaged HP Server
2016 Server Software Internal HDD
3.1 Key Areas for an Auditor to Understand IT Environment
Key Areas for an Auditor to Understand IT Environment are as follows:
1. Understand the flow of transaction: The auditor's understanding of the IT environment may
focus on identifying and understanding the nature and number of the specific IT applications
and other aspects of the IT environment that are relevant to the flows of transactions and
processing of information in the information system. Changes in the flow of transactions, or
information within the information system may result from program changes to IT applications,
or direct changes to data in databases involved in processing or storing those transactions
or information.
2. Identification of Significant Systems: The auditor may identify the IT applications and
supporting IT infrastructure concurrently with the auditor's understanding of how information
relating to significant classes of transactions, account balances and disclosures flows into,
through and out the entity's information system.
3. Identification of Manual and Automated Controls: An entity's system of internal control
contains manual elements and automated elements (i.e., manual and automated controls and
other resources used in the entity's system of internal control). An entity's mix of manual and
automated elements varies with the nature and complexity of the entity's use of IT. The
characteristics of manual or automated elements are relevant to the auditor's identification
and assessment of the risks of material misstatement.
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12.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. Identification of the technologies used: The need to understand the emerging technologies
implemented and the role they play in the entity's information processing or other financial
reporting activities and consider whether there are risks arising from their use.
Given the potential complexities of these technologies, there is an increased likelihood that
the engagement team may decide to engage specialists and/or auditor's experts to help
understand whether and how their use impacts the entity's financial reporting processes and
may give rise to risks from the use of IT.
Some examples of emerging technologies are:
• Blockchain, including cryptocurrency businesses (e.g., token issuers, custodial
services, exchanges, miners, investors)
• Robotics
• Artificial Intelligence
• Internet of Things
• Biometrics
• Drone
5. Assessing the complexity of the IT environment: Not all applications of the IT environment
have the same level of complexity. The level of complexity for individual characteristics differs
across applications. Complexity is based on the following factors – automation used in the
organization, entity’s reliance on system generated reports, customization in IT applications,
business model of the entity, any significant changes done during the year and
implementation of emerging technologies.
After considering the above factors for each application the over complexity is assessed of
the IT environment.
4. IDENTIFYING THE RISKS ARISING FROM USAGE OF IT
4.1 How to identify the IT Risks?
In identifying the risks arising from the use of IT, the auditor may consider the nature of the identified
IT application.
Applicable risks arising from the use of IT may also be identified related to cybersecurity.
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DIGITAL AUDITING AND ASSURANCE 12.13
It is more likely that there will be more risks arising from the use of IT when the volume or complexity
of automated application controls is higher, and management is placing greater reliance on those
controls for effective processing of transactions or the effective maintenance of the integrity of
underlying information.
4.2 Risks arising from use of IT
• Unauthorized access to data that may result in destruction of data or improper changes to
data, including the recording of unauthorized or non-existent transactions, or inaccurate
recording of transactions. Particular risks may arise where multiple users access a common
database.
• The possibility of IT personnel gaining access privileges beyond those necessary to
perform their assigned duties thereby breaking down segregation of duties. Unauthorized
changes to data in master files.
• Unauthorized changes to IT applications or other aspects of the IT environment.
• Failure to make necessary update IT applications or other aspects of the IT environment.
• Inappropriate manual intervention.
• Data loss or data corruption is a major risk which arises from use of IT. If appropriate
cybersecurity controls and protocols not followed it may lead to loss of sensitive data, hackers
might encrypt your system or illegally break into your system. Risk of fraud can arise if users
alter the information or there is a case of physical security breach or theft of sensitive
information.
• There is a risk of system downtime which is caused by hardware failures, faulty
configurations, cyberattacks or power outage. It means the IT systems will not be operational
or will be unavailable/offline which may hamper the business.
• Since companies uses more than one IT systems to support their business system
integration (means integrating one or more systems) and system compatibility comes
in place. However, system integration and compatibility have some risks. In case of system
failure in one system may also lead to widespread failure in integrated systems. Or if the
integration between two systems is not appropriate the end result would be incorrect. System
compatibility means sharing compatible hardware, software and operating system while
performing the integration. Compatibility risks arises if different versions of same software
are used, if the patches are not upgraded which may lead to bugs.
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12.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• With advancement in usage of IT the risk of regulatory compliances increases. Any change in
the law, order, guidelines or agreements will impact the business, its related costs, investments
etc. A FMCG sector will be subject to different regulatory requirements than a financial
company, however both businesses will need to manage their respective compliance risks.
Performance Issues arises with the way requests are processed in the IT systems. Heavy data load,
network usage impacts the application performance and its responsiveness. To overcome the
performance issues of IT systems, resources or hardware can be added to an existing nodes, which
is known as scaling. However, scaling can be expensive therefore an informed decision should be
made in case of adding a hardware or changing the architecture.
4.3 Know how to identify the IT dependencies impacting the Audit
4.3.1 Why is it important to identify IT dependencies?
Identifying and documenting the entity's IT dependencies in a consistent, clear manner helps to
identify the entity's reliance upon IT, understand how IT is integrated into the entity's business model,
identify potential risks arising from the use of IT, identify related IT General Controls and enables us
to develop an effective and efficient audit approach.
4.3.2 How IT dependencies arise?
IT Dependencies are created when IT is used to initiate, authorize, record, process, or report
transactions or other financial data for inclusion in financial statements.
There are five types of IT dependencies as described below:
Type Description
Automated Automated controls are designed into the IT environment to enforce business
Controls rules. For example,
Purchase order approval via workflow or format checks (e.g., only a particular date
format is accepted), existence checks (e.g., Duplicate customer number cannot
exist), and/or reasonableness checks (e.g., maximum payment amount) when a
transaction is entered.
Reports System generated reports are information generated by IT systems. These reports
are often used in an entity's execution of a manual control, including business
performance reviews, or may be the source of entity information used by us when
selecting items for testing, performing substantive tests of details or performing a
substantive analytical procedure. E.g. (Vendor master report, customer ageing
report)
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DIGITAL AUDITING AND ASSURANCE 12.15
Calculations Calculations are accounting procedures that are performed by an IT system
instead of a person. For example, the system will apply the 'straight-line'
depreciation formula to calculate depreciation of an asset (i.e., cost of the asset,
less the residual value of the asset at the end of its useful life divided by the useful
life of the asset) or the system will calculate the value of the amount invoiced to a
customer by multiplying the item price times the quantity shipped.
Security Security including segregation of duties is enabled by the IT environment to restrict
access to information and to determine the separation of roles and responsibilities
that could allow an employee to perpetrate and conceal errors or fraud, or to
process errors that go undetected.
Interfaces Interfaces are programmed logic that transfer data from one IT system to another.
For example, an interface may be programmed to transfer data from a payroll sub-
ledger to the general ledger.
4.3.3 Understanding and responding to risks arising from IT dependencies
When auditors identify IT dependencies that are relevant to the entity's flow of transactions and
processing of financial information, they need to understand how management responds to the
associated risks that may arise from them.
Management may implement information technology general controls (ITGCs) to address risks related
to IT dependencies.
The illustration below is an overview of the Control Objectives and controls for each area of
General IT Controls:
• Access requests to the application are properly reviewed and authorized
by management
Access Security
• Access of terminated user is removed on a timely basis
Objective: • Access rights to applications are periodically monitored for
To ensure that access to programs and appropriateness
data is authenticated and authorized to • Transactions of administrative and sensitive generic IDs are monitored
meet financial reporting objectives • Security policies are procedures are maintained
• Access to operating system and database is restricted.
• Change Management policy and procedures are maintained.
• Development, testing and production environments are segregated for
Program Change
changes to application configurations
Objective • Changes are adequately tracked and recorded.
To ensure modified systems continue to • Changes to application configurations are adequately tested and approved
meet financial reporting objectives before being migrated into production
• Emergency changes are approved.
• Segregation of duties is mainatined between developer and implementor.
Data Centre and network operations • Policies and procedures for data back and recovery is maintained.
Objective • Data is appropriately backed up and recoverable
To ensure production systems are • Restoration testing is perfomed
appropriately backed up to meet financial • Monitoring and complaince of service level agreements.
reporting objectives • Batch job scheduled are monitored for failures and access is restricted.
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12.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
IT dependencies may also affect the design of the entity's controls and how they are implemented.
Therefore, auditors consider IT dependencies relevant to audit and evaluate the related risks.
Auditor should scope in ITGCs to tests when there are IT dependencies identified in the system. If
the controls around IT environment are not implemented or operating effectively it will result in not
relying on ITGCs which means the IT dependencies could not be relied upon.
5. ASSESSING CYBER RISKS (INCLUDING REMOTE AUDIT)
5.1 What is Cyber Risk:
A cyber-attack is an attempt to gain unauthorized access to a computing system or network with the
intent to cause damage, steal, expose, alter, disable, or destroy data.
Regulators across the globe have placed the topic of cyber risk management under increasing
scrutiny, requiring financial institutions to assess the maturity of their cybersecurity program,
manage cyber risks, and enhance resiliency against cyber-attacks. Most common types of cyber-
attacks are:
• Malware : Malware or malicious software is any program or code that is created with the
intent to do harm to a computer, network or server. Malware is the most common type of
cyberattack, its subsets are ransomware, fileless Malware trojans, viruses etc.
Type Description
Ransomware In a ransomware attack, an adversary encrypts a victim’s data and
offers to provide a decryption key in exchange for a payment.
Ransomware attacks are usually launched through malicious links
delivered via phishing emails, but unpatched vulnerabilities and policy
misconfigurations are used as well.
Fileless Malware Fileless malware is a type of malicious activity that uses native,
legitimate tools built into a system to execute a cyber-attack. Unlike
traditional malware, fileless malware does not require an attacker to
install any code on a target’s system, making it hard to detect.
Trojan A trojan is malware that appears to be legitimate software disguised as
native operating system programs or harmless files like free downloads.
Trojans are installed through social engineering techniques such as
phishing or bait websites.
Mobile Malware Mobile malware is any type of malware designed to target mobile
devices. Mobile malware is delivered through malicious downloads,
operating system vulnerabilities, phishing, smishing, and the use of
unsecured Wi-Fi.
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• Denial-of-Service (DoS) Attacks : A Denial-of-Service (DoS) attack is a malicious, targeted
attack that floods a network with false requests in order to disrupt business operations. In a
DoS attack, users are unable to perform routine and necessary tasks, such as accessing
email, websites, online accounts or other resources that are operated by a compromised
computer or network. While most DoS attacks do not result in lost data and are typically
resolved without paying a ransom, they cost the organization time, money and other
resources in order to restore critical business operations.
• Phishing: Phishing is a type of cyberattack that uses email, SMS, phone, social media, and
social engineering techniques to entice a victim to share sensitive information — such as
passwords or account numbers — or to download a malicious file that will install viruses on
their computer or phone.
Type Description
Spear Phishing Spear-phishing is a type of phishing attack that targets specific
individuals or organizations typically through malicious emails. The
goal of spear phishing is to steal sensitive information such as login
credentials or infect the targets’ device with malware.
Whaling A whaling attack is a type of social engineering attack specifically
targeting senior or C-level executive employees with the purpose of
stealing money or information or gaining access to the person’s
computer in order to execute further cyberattacks.
Smishing Smishing is a type of fraudulent practice of sending text messages
purporting to be from reputable companies in order to induce
individuals to reveal personal information, such as passwords or
credit card numbers.
Vishing Vishing, a voice phishing attack, is the fraudulent use of phone calls
and voice messages pretending to be from a reputable organization
to convince individuals to reveal private information such as bank
details and passwords.
• Spoofing: Spoofing is a technique through which a cybercriminal disguises themselves as a
known or trusted source. In so doing, the adversary is able to engage with the target and
access their systems or devices with the ultimate goal of stealing information, extorting
money or installing malware or other harmful software on the device.
Type Description
Domain Spoofing Domain spoofing is a form of phishing where an attacker
impersonates a known business or person with fake website or
email domain to fool people into the trusting them. Typically, the
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12.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
domain appears to be legitimate at first glance, but a closer look
will reveal subtle differences.
Email Spoofing Email spoofing is a type of cyberattack that targets the businesses
by using emails with forged sender addresses. Because the
recipient trusts the alleged sender, they are more likely to open the
email and interact with its contents, such as a malicious link or
attachment.
• Identity-Based Attacks : When a valid user’s credentials have been compromised and an
adversary is pretend to be that user. For e.g., people often use the same user ID and password
across multiple accounts. Therefore, possessing the credentials for one account may be able to
grant access to other, unrelated account.
• Insider Threats : When current or former employees that pose danger to an organization
because they have direct access to the company network, sensitive data, and intellectual
property (IP), as well as knowledge of business processes, company policies or other
information that would help carry out such an attack.
• DNS Tunneling : DNS Tunneling is a type of cyberattack that leverages domain name system
(DNS) queries and responses to bypass traditional security measures and transmit data and
code within the network. This tunnel gives the hacker a route to unleash malware and/or to
extract data, IP or other sensitive information by encoding it bit by bit in a series of DNS
responses.
• IoT-Based Attacks: An IoT attack is any cyberattack that targets an Internet of Things
(IoT) device or network. Once compromised, the hacker can assume control of the device,
steal data, or join a group of infected devices
5.2 Stages of Cyber Risks:
Following are 3 Stage of cyber risk :
Stage 3 -
Managing the
Stage 2 - cyber risk
Impact of
Stage 1 - cyber risk
Assessing the
cyber risk
1. Stage 1 - Assessing the cyber risk: No organization is completely immune to a cyber risk.
Different clients will have different levels of risks, even with the same industry. Every organization
should consider at least the common threats-
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DIGITAL AUDITING AND ASSURANCE 12.19
• Ransomware disabling their organization (including their plants and manufacturing facilities)
• Common criminals using email phishing and hacks for fraud and theft.
• Insiders committing malicious activities or accidental activities resulting in unintended
discourse of information theft and frauds.
2. Stage 2 - Impact of cyber risk: Cyber-attack can impact one, two or more types of risks. The
impact of the attack would vary from organization to organization and most importantly from an
attack to attack. Some of the indicative areas can be –
• Regulatory costs
• Business interruptions causing an operational challenge for an organization.
• Data loss, reputational loss and litigation.
• Ransomware - more common these days where entire systems are encrypted
• Intellectual property theft which may not only take the competitive advantage, but we may
also result in any impairment/impediment charge because of the loss of IP.
• Incident response cost which could be for investigations & remediations
• Breach of Privacy, if personal data of a consumer is hacked it could have a significant
impact on the organization.
• Fines and penalties
3. Stage 3 - Managing the cyber risk: A strategic approach to cyber risk management can help
an organization to:
• Gain a holistic understanding of the cyber risks, threats facing their organization and other
financial institutions
• Assess existing IT and cybersecurity program and capabilities against the relevant
regulatory requirements
• Align cybersecurity and IT transformation initiatives with strategic objectives and critical
risks
• Understand accepted risks & documented compensating controls
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12.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
5.3 Cyber Security Framework
Cybersecurity framework includes how management is identifying the risk, protecting and
safeguarding its assets (including electronic assets) from the risk. Management preparedness to
detect the attacks, anomalies and responsiveness to the adverse event.
5.3.1 Identify the risk:
Auditor has to determine whether the entity's risk assessment process considers cybersecurity risks.
Entity should conduct a periodic risk assessment & develop a management strategy which
identifies cybersecurity risks around IT system failure affecting the entity's primary business or
potential loss of data or inability to access data as required, Risk of unauthorized access to the IT
network.
The entity should maintain and periodically reviews an inventory of their information assets- i.e.,
Asset Management (e.g., intellectual property, patents, copyrighted material, trade secrets and
other intangibles).
The entity should classify and prioritize protection of their information assets based on sensitivity
and business value and periodically reviews the systems connected to the network on which digital
assets reside.
From the governance perspective management should review how cybersecurity risks affect
internal controls over financial reporting. In case of adverse attack how management is going to
assess the impact on the recoverability of financial data and impact on revenue recognition.
Management needs to identify if any established a risk-based cybersecurity program can be
leveraged e.g. (NIST, ISO etc.)
To determine overall responsibility for cybersecurity in the business environment entity should
establish roles and responsibilities over cybersecurity (CISO, CIO). Further the risk assessment
should be discussed with those charged with governance (e.g., the Audit Committee or Board of
Directors).
5.3.2 Protect the risk
Obtained an understanding of the entity's processes for safeguarding of assets subject to
cybersecurity. Entity monitors whether there has been unauthorized access to electronic assets
and any related impact on financial reporting.
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DIGITAL AUDITING AND ASSURANCE 12.21
Formal training should be conducted to make the teams aware of the risk associated with cyber-
attacks. Entity should implement effective controls for data security. Entity should have a process
& procedures in place for identifying material digital/electronic assets on the balance sheet subject
to cybersecurity risk (e.g., intellectual property, patents, copyrighted material, trade secrets) and
prioritizing their protection based on criticality.
5.3.3 Detect The risk
Entity should have controls and procedures that enable it to identify cybersecurity risks and incidents
and to assess and analyse their impact on the entity’s business, evaluate the significance associated
with such risks and incidents, and consider timely disclosures.
Review entity's processes to monitor and detect security breaches or incidents. If management has
implemented anti-virus in the system to secure it from anomalies or if firewall logs are being
continuously monitored to detect any repetitive attacks. A monitoring process should be established
to review how many such events have been denied by the firewall. Monitoring process should also
include if any upgrades or updates are required to safeguard the systems from vulnerabilities.
5.3.4 Respond to the risk
In case of material cybersecurity or data breach has been identified management should capture
the details of nature of incident and how the incident or data breach was identified. Entity should
have a response planning in place to capture the details of nature of incident and the same needs
to be communicated with those who are ultimately responsible for this framework and with those
charge with governance.
The security incident response plan helps in analysing the impact and severity of the attack and
helps the organisation in taking the appropriate actions. Management should assess Litigation costs,
Regulatory investigation costs and Remediation costs as a part of mitigation process and
improvement management should assess the future action plans that needs to be taken to safeguard
the organisation from such attacks.
5.3.5 Recover from risk
Entity should undertake appropriate actions to recover from the attack and make sure the business
is up and running.
Once the impact evaluated and communicated with the regulators the recovery plan needs to be
implemented to overcome the impact. Necessary improvements – like patch upgrades, better
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12.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
controls, improved technology in terms of firewall, anti-virus, tools etc needs to be implemented to
safeguard the entity.
Develop and implement Develop the
the appropriate activities organizational
to maintain plans for Identify the understanding to
resilience and to restore risk manage
any capabilities or cybersecurity risk to
services that were systems, assets,
impaired due to a data, and
cybersecurity event capabilities
• Recovery Planning Recover • Asset
• Improvements & from risk Protect Management
• Communications from risk • Business
Risk Management Environment
Process • Governance
• Risk
Assessment &
Management
Strategy
Respond to Detect the
the risk risk
Develop and implement
the appropriate activities
to take action regarding a
detected cybersecurity
event
• Response Planning
(incident response Develop and implement the
Develop and implement the appropriate safeguards to ensure
plan) appropriate activities to identify the
• Communications delivery of critical infrastructure
occurrence of a cybersecurity event services
• Analysis
• Mitigation & • Anomalies and Events • Access Control
Improvements • Security Continuous Monitoring & • Awareness and Training
• Detection Processes • Data Security
• Information Protection
Processes and Procedures
TEST YOUR UNDERSTANDING 1
Sukanya, a CA final student, is of the view that cyber risks are issues of IT and result only in
information loss to an entity. She also feels that many cyber-attacks are not directly targeted at
financial systems and do not pose risk of material misstatements to financial statements of an entity.
Is her view proper?
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DIGITAL AUDITING AND ASSURANCE 12.23
Case study
What has happened:
The CEO of a hotel realized their business had become the victim of wire fraud when the accounts
payable executive began to receive insufficient fund notifications for regularly recurring bills.
A review of the accounting records exposed a serious problem. Upon investigating it was noted that
the CEO had clicked on a link in an email that he thought was from the trusted source. However, it
wasn’t and when he clicked the link and entered his credentials, the cyber criminals captured the
CEO’s login information, giving them full access to intimate business and personal details.
Type of Attack: Social engineering, phishing attack.
A phishing attack is a form of social engineering by which cyber criminals attempt to trick individuals
by creating and sending fake emails that appear to be from an authentic source, such as a business
or colleague. The email might ask you to confirm personal account information such as a password
or prompt you to open a malicious attachment that infects your computer with malware.
Result: The hotel’s cash reserves were depleted. The fraudulent transfers amounted to more than
₹1 million. The hotel also contacted a cybersecurity firm to help them mitigate the risk of a repeat
attack.
Impact: The business lost ₹1 million, and the funds were not recovered. Further there was loss of
business reputation too.
Lessons Learned:
− Train the staff about the dangers of clicking on unsolicited email links and attachments, and
the need to stay alert for warning signs of fraudulent emails. Engage in regular email security
training.
− Implement stringent wire transfer protocols and include a secondary form of validation (Multi
Factor Authentication)
− Have a cyber incident response plan ready to implement.
5.4 Control considerations for Cyber Risks:
Apart from having the cyber security policies, procedures, framework and regular assessment in
place, management should have a strong and updated internal controls to ensure they are covered
from cyber risks:
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12.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1) Controls around vendor setup and modifications:
Certain cyber schemes exist in which changes to bank account or other critical vendor
information are requested through email phishing scams by individuals purporting to be
authorized vendor personnel.
Entities have inappropriately dispersed funds to these individuals and therefore
inappropriately reduced the liability owed to the actual vendor, resulting in an impact to the
financial statements (i.e., loss of cash and related expense)
− Who is responsible for making changes to vendor master data? Is the process
centralized or decentralized?
− Are other communication channels, such as email, used to request changes to vendor
master data? (If yes, consider if multi-factor authentication is enabled for email).
− What systems and technologies are used to initiate, authorize and process requests
related to changes to vendor master data?
− Are authentication protocols defined to verify modifications to vendor master data
(e.g., call back procedures, multi-factor authentication)?
2) Controls around electronic transfer of funds:
Wire transfers or electronic funds transfers, similar to vendor changes noted above, cyber
schemes pertaining to fraudulent requests for wire transfers are made relating to business
transactions and vendor payments, as well as fraudulent requests appearing to come from
financial institutions requesting disbursement from customer asset accounts.
− Are personnel responsible for wire transfers educated on the relevant threats and
information related to common phishing scams associated with fraudulent requests for
wire transfers?
− Are authentication protocols defined to verify wire transfer requests (e.g., call back
procedures, dual-authentication procedures)?
− What systems and technologies are used to facilitate the request/initiation,
authorization and release of 0 wire transfers?
3) Controls around patch management:
Cyber and ransomware attacks exploit known security vulnerabilities resulting in the
manipulation or the destruction of data. Exploitations of known security vulnerabilities are
often caused by unapplied patches or upgrades.
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DIGITAL AUDITING AND ASSURANCE 12.25
− Does the entity have a patch management program?
− Does the entity run periodic vulnerability scans to identify missing/unapplied patches?
− How is the entity notified of patches by external vendors (e.g., Microsoft for Windows
patches)?
5.5 Remote Audit
Remote audit or virtual audit is when the auditor uses the online or electronic means to conduct the
audit. It could be partially or completely virtual, auditor engages using technology to obtain the audit
evidence or to perform documentation review with the participation of the auditee.
Audit planning and scoping is crucial in every audit. This includes a discussion of the scope and
schedule, and the ways to conduct audit. The COVID-19 pandemic has changed the entire business
landscape and processes have been adjusted to this new situation, where remote audit is
appreciated by clients as well.
Considerations for remote audit:
Auditors must develop tailored strategies to ensure the remote audit meets the requirements and
deliver results equivalent to traditional onsite audits.
Feasibility and Planning
• Planning should involve agreeing on audit timelines, meeting platform (Zoom calls/ Microsoft
Teams/Google Meet) to be used for audit sessions, data exchange mechanisms, any access
authorization requests. Ensure feasibility is determining what technology may be used, if
auditors and auditees have competencies and that resources are available.
• The execution phases of a remote audit involve video/tele conferencing with auditees. The
documentation for audit evidence should be transferred through a document sharing platform.
Confidentiality, Security and Data Protection
• To ensure data security and confidentiality, access to document sharing platform should be
sufficiently restricted and secured by encrypting the data that is sent across the network. The
information, once reviewed and documented by auditor, is removed from the platform, and
stored according to applicable archiving standards and data protection requirements.
Auditors should take into consideration legislation and regulations, which may require
additional agreements from both sides (e.g., there will be no recording of sound and images,
or authorizations to using people’s images). Auditors should not take screenshots of auditees
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12.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
as audit evidence. Any screenshots of documents or records or other kind of evidence should
be previously authorized by the audited organization. In case of accessing the auditee’s IT
system auditor should use VPN (Virtual private network). VPN is a service which creates safe
and encrypted online connection. It prevents unauthorized users to enter into network and
allows the users to perform work remotely.
Risk assessment
• The communication from auditor as well as auditees need to clear and consistent, and this
becomes crucial during remote audit. The risks for achieving the audit objectives are
identified, assessed and managed. The assessment if remote audit would be sufficient to
achieve the audit objectives should be done and documented for each audit involving all
members of the audit team and the audited organization representative.
Advantages and Disadvantages of remote audit:
ADVANTAGES DISADVANTAGES
Cost and time effective: No travel time and Due to network issues, interviews and meetings
travel costs involved. can be interrupted.
Comfort and flexibility to the audit team as Limited or no ability to visualize facility culture of
they would be working from home the organization, and the body language of the
environment, auditees. Time zone issues could also affect the
efficiency of remote audit session
Time required to gather evidence can spread The opportunity to present doctored documents
over several weeks, instead of concentrated and to omit relevant information is increased. This
into a small period that takes personnel from may call for additional planning, some
their daily activities. additional/different audit procedures,
Security and confidentiality violation.
Auditor can get first-hand evidence directly Remote access to sensitive IT systems may not
from the IT system as direct access may be be allowed. Security aspects related to remote
provided. access and privacy needs to be assessed
Widens the selection of auditors from global Cultural challenges for the auditor. Lack of
network of experts. knowledge for local laws and regulations could
impact audit. Audit procedures like physical
verification of assets and stock taking cannot be
performed.
Remote auditing plays a vital part, and provide assurance when unprecedented circumstances, like
COVID. It provides an opportunity for organisations and auditors to leverage communication
technology tools. In addition, management perception about remote audits is changing as it provides
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DIGITAL AUDITING AND ASSURANCE 12.27
flexibility in terms of time ensuring that day-to-day business activities are not impacted, along with
the reductions in cost.
Auditor should also consider while performing audit using remote means, if access to system and
network is provided post appropriate approvals both to employees who are working remotely and to
auditors who are auditing remotely and if data is transferred through encrypted means to maintain
data privacy. Management should maintain and review the list of people who are working remotely
and make sure they access the system and network through VPN (Virtual Private Network) only and
such accesses should be approved. Further once the employee leaves the organisation or audit is
completed such VPN access should be terminated timely. Auditors can test such controls while
performing remote audit.
6. EMERGING TECHNOLOGIES IN AUDIT
Emerging technologies are altering the financial reporting environment substantially, and this change
is accelerating. Some examples of emerging technologies are – Data analytics (CAATs (ACL,
Alteryx, Power BI, CaseWare), artificial intelligence (AI), robotic process automation, and
blockchain. These are changing the way business gets done, and auditors are leading by
transforming their own processes.
As the use of emerging technologies in the financial reporting process increases, it becomes
important for auditor and the client to upskill on the emerging technologies. Some important
considerations for auditors are to assess the impact of emerging technologies on business and
evaluate whether management is properly assessing the impact of emerging technologies on internal
control over financial reporting.
Data Analytic Techniques
Generating and preparing meaningful information from raw system data using processes, tools, and
techniques is known as Data Analytics. Audit analytics or audit data analytics involves analyzing
large sets of data to find actionable insights, trends, draw conclusions and for informed decision
making. The use of audit analytics enables greater efficiencies and more accurate findings from the
review process.
As a result, businesses will be able to create strategies based on verifiable data and professional
assumptions and auditors can improve the audit quality. It allows auditors to more effectively audit
the large amounts of data held and processed in IT systems in larger clients.
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12.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Audit analytics helps:
• To discover and analyze patterns
• Identifying anomalies
• Extract other useful information in data
The data analytics methods used in an audit are known as Computer Assisted Auditing Techniques
or CAATs. It involves use of multiple data analytical tool or visualization tools that can help the
auditor to deep dive into the problem statement and hence increase the audit quality. This also
minimizes the scope of missing out on key attributes that might be of a higher risk to the organization
and its respective business.
Auditor performing audit analytics can make use of various applications and tools that help them to
analyse large data sets and obtain insights that help them to make the quality of the audit better.
Some of the popular tools used across the industry as part of CAATs are listed below:
1. ACL - Audit Command Language (ACL) Analytics is a data extraction and analysis software
used for fraud detection and prevention, and risk management. It samples large data sets to
find irregularities or patterns in transactions that could indicate control weaknesses or fraud.
ACL (Audit Command Language) is used to analyse and check complete data
sets to perform Trial Balance reconciliations during the Audits. In such case
scenarios, the entity provided the General Ledger dump and system Trial
Balance. Using ACL, the completeness of the data can be ensured as the data set
exceeded beyond the capacity of the excel and basic functions like record count, sum,
pivoting can be performed within ACL where excel could not perform such actions.
2. Alteryx - Alteryx is used to consolidate financial or operational data to assess controls. A
fully transparent audit trail of every action is performed in Alteryx in form of a workflow which
makes it easier for the user to learn as no prior knowledge of coding or scripting is required.
Alteryx can also be leveraged to automate analytics and perform Machine Learning to search
for patterns indicative of fraud or irregularities speed up your processes like accounting close,
tax filings, regulatory reporting, forecast creation etc. It can also be used to automate set
procedures that are performed periodically like reconciliations, consolidations, marketing
workflows, system integrations, continuous audits etc.
Alteryx used for logistics organization to recompute the revenue entries
recorded by the system to match with the financials that showcased the
expected revenue turnover. Due to Alteryx’s processing speed and ease to
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DIGITAL AUDITING AND ASSURANCE 12.29
implement functions, auditors could perform re-computation for all the transactions entry
and noted that the revenue was being understated as the expected revenue was more
than the actual calculated. This was due the fact that the addendum between the logistic
company and the client was not revised in the system and old versions of rates were
used to compute the revenue. Alteryx helped in analysing and recomputing the huge data
set and to focus on actual risk.
3. Power BI – Power Bi is a business intelligence (BI) platform that provides nontechnical
business users with tools for aggregating, analyzing, visualizing and sharing data. From audit
perspective, such visualization tools can be used to find the outliers in the population, it can
also be used for reporting purpose (audit reports) in an interactive dashboard to the higher
management.
Power BI dashboard used for checking the outliers of the apparel company.
Auditors were required to analyse the trends of the sales during the year. By
the use of Power BI, the sales data provided by the client was further
converted into dashboard to analyse the trends and patterns as per the market standards.
In analysis performed on untimely sales, it was noted that sales transactions were
performed during non-business hours. Illustrative charts below which were utilized as
part of the analysis by the auditors.
4. CaseWare – CaseWare is a data analysis software & provide tools that helps in conducting
audit and assurance engagements quickly, accurately and consistently. It shares analytical
insights which help in taking better informed decisions. It helps in streamlining processes and
eliminating the routine tasks. Used by accounting firms, governments and corporations
worldwide, this trusted platform integrates everything you need to conduct assurance and
reporting engagements.
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12.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CaseWare provides the solutions to build accounting software which turns any
document, including financial statements into cost effective client ready report.
It automatically links to client data and securely communicate with the client in
real time. Regardless of location, all authorized users have access to the same
documents. Consistency of data is ensured. Refer screenshot below to illustrate audit,
review and compilation process maintained on-screen.
TEST YOUR UNDERSTANDING 2
CA Y is planning to use CAATs extensively in audit of a company-be it for compliance tests or
substantive tests. Can you list out examples of few situations (in brief) of tests performed by him
using CAATs?
7. AUTOMATED TOOLS IN AUDIT
Enterprises are adopting emerging technologies at a rapid pace to create synergies and harness the
latest technologies.
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DIGITAL AUDITING AND ASSURANCE 12.31
Robotic process automation (RPA), blockchain, machine learning, Internet of Things (IOT) and
artificial intelligence (AI) are some prime examples of automation.
Automation and use of technology often requiring auditors to understand and perform procedures
on a larger group of systems that produce information relevant to the production of financial
statements.
Based on managements and auditors’ independent risk assessment procedures, the audit’s scope
may need to include peripheral systems, as well as testing general IT and application controls
relative to those systems due to the increased use of technology that is relevant to financial
reporting.
7.1 Internet of Things
IoT is the concept of connecting any device (cell phones, coffee makers, washing machines, and so
on) to the internet. Key components of IoT are data collection, analytics, connectivity, and people
and process. IoT not only changes the business model, but also affects the strategic objectives of
the organization. The risk profile of the entity changes with exposure to new laws and regulations.
Connected Cars, connected manufacturing equipment’s, smart home security, (The
options for home security from doorbell cameras or outdoor cameras - users can view
video feeds when they are away from home) or Data from machines can be used to
predict whether equipment will break down, giving manufacturers advance warning to prevent
long stretches of downtime. Or a refrigerator placing an order with a grocery store whenever the
supply of eggs falls below a certain number. Or smart oven works by scanning QR or bar codes
and connecting to Wi-Fi, which it then uses to determine the best temperature and time to cook
the food to avoid undercooking or burning. Researchers uses IoT devices to gather data about
customer preferences and behavior, though that can have serious implications for privacy and
security.
Audit Implications
A shift to connected devices and systems may result in auditors not being able to rely only on manual
controls. Instead, auditors may need to scope new systems into their audit. Audit firms may need to
train and upskill auditors to evaluate the design and operating effectiveness of automated controls.
Consumer-facing tools that connect to business environments in new ways can impact the flow of
transactions and introduce new risks for management and auditors to consider. Consider payment
processing tools that allow users to pay via credit card at a retail location through a mobile device.
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12.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
This could create a new path for incoming payments that may rely, in part, on a new service provider
supplying and routing information correctly. Auditors would need to consider the volume of those
transactions and the processes and controls related to it.
Common risks of IoT:
The key risks associated with IoT, including, device hijacking, data siphoning, denial of service
attacks, data breaches and device theft.
7.2 AI (Artificial intelligence)
Artificial intelligence (AI) refers to a system or a machine that can think and learn. AI systems utilize
data analysis and algorithms to make decisions based on predictive methods. Complex algorithms
are developed to propose decisions based on a pattern or behavior learned over time.
Self-driving cars, manufacturing robots, smart assistants, marketing chatbots, virtual
travel booking agent. The self-deploying robots can determine how much vacuuming
there is to do based on a room’s size, uses AI to scan room size, identify obstacles
and remember the most efficient routes for cleaning.
Siri to help find your Air Pods or told Amazon Alexa to turn off the lights, quick commands to open
a phone camera or start a particular playlist, AI to predict when to book the lowest prices for flights,
hotels, car and vacation home rentals. Using historical flight and hotel data, AI will also recommend
to the user whether the booking has reached its lowest price point or if the user should hold out a
bit longer for the price to drop.
Auditor Implications
Given the invisible nature of algorithms, audits must focus on the logical flow of processes. A review
of AI should ascertain whether unintended bias has been added to the algorithms. Auditors should
assess the effectiveness of algorithms and whether their output is appropriately reviewed and
approved. Because AI is built on software modules, auditors must also consider cybersecurity and
search for possible bugs and vulnerabilities that can be exploited to impact AI functionality. Auditors
should confirm their understanding of how the use of AI affects the entity’s flows of transactions,
including the generation of reports or analytics used by management. Auditors also should consider
whether the AI is making decisions—or being utilized by management as part of the decision-making
process.
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DIGITAL AUDITING AND ASSURANCE 12.33
If management shifts its focus on oversight by relying on AI, auditors should understand what shift
occurred, how new risks might be addressed, and whether existing risks may not be getting the
same level of attention. Understanding these changes could drive changes in the audit approach.
Common risks for AI
AI comes with list of risks. Security is one of the key risks – the more data the system uses, from
more sources, the more entry points and connections are formed and the greater the potential risks.
Inappropriate configuration - AI may also be used to diagnose medical conditions. If it is badly
configured or malfunctions, it could harm people before the problem is spotted. Data privacy - The
data used and shared should have the necessary explicit consent from data providers.
7.3 Blockchain
Blockchain is based on a decentralized and distributed ledger that is secured through encryption.
Each transaction is validated by the blockchain participants, creating a block of information that is
replicated and distributed to all participants. All blocks are sequenced so that any modification or
deletion of a block disqualifies the information.
Despite resistance, the benefits associated with blockchain technology are being recognized across
a variety of other industries.
Bitcoin, cryptocurrency transfer application - Blockchain in money transfer, blockchain
smart contracts.
Audit Implications
Auditors should consider the appropriate governance and security transactions around the
transactions. Although blockchain’s core security premise rests on cryptography, there are risk
factors associated with it. As blockchain interacts with legacy systems and business partners,
concerns related to insecure application programming interfaces (APIs), data confidentiality and
privacy cannot be ignored.
Weak blockchain application development protocols are something auditors cannot overlook.
Similarly, data privacy laws and regulations may be area of concern as data are communicated
across geographic boundaries. Auditors must be able to determine whether the data put on
blockchain will expose the enterprise to liability for noncompliance with applicable laws and
regulations.
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12.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Common risks for blockchain technology
The strengths of blockchain can also be its weaknesses. The inability to reverse transactions and to
access data without the required keys make the system secure, but also mean that organisations
need specific protocols and management processes to ensure that they are not locked out and have
clear contingency plans. Operating through network nodes could also expose the organisation to
cyber-attacks and data hacks, so security issues are important. Auditors should also ensure that the
organisation has the necessary data management processes and complies with regulations. The
regulatory landscape is still evolving for blockchain, so audit teams should check that compliance
managers are following developments constantly and adapting processes accordingly.
7.3.1 NFT (Non-Fungible Token)
NFT means something is unique and cannot be replaced. Unlike physical money and
cryptocurrencies are fungible (means they can be traded or exchanged for one another) NFTs are
non-fungible tokens. NFTs contains the digital signature which make them unique. NFTs are digital
assets, e.g., photos, videos, artwork, sports collectibles etc.
NFTs are tokens used to represent ownership of unique items. NFTs allow their creators to tokenize
things like art, collectibles, or even real estate. They are secured by the blockchain and can only
have one official owner at a time. No one can change the record of ownership or copy/paste a new
NFT into existence.
Key Features of NFT -
• Digital Asset - NFT is a digital asset that represents Internet collectibles like art, music, and
games with an authentic certificate created by blockchain technology that underlies
Cryptocurrency.
• Unique - It cannot be forged or otherwise manipulated.
• Exchange - NFT exchanges take place with cryptocurrencies such as Bitcoin on specialist sites.
Challenges of NFT –
NFTs has its own challenges like ownership and copyright concerns, security risks, market is not
that wide, online frauds etc. NFT audit considerations includes comprehensive code review for
verifying the safety of a token, valid contract, data privacy and potential cyber threat.
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DIGITAL AUDITING AND ASSURANCE 12.35
Case Study
XY Bank, headquartered in New York, offers a broad range of financial services including asset
management, commercial banking, investment banking, and treasury and securities services.
The Five Indian banks in partnership with XY bank, provide a comprehensive range of banking
services and products encompassing retail banking, corporate banking, international banking, and
other financial services. All these banks have been significant contributors to the digitalization of
banking services in India.
Under the pilot programme, the Indian banks will open on-chain Nostro accounts with XY Bank
branch in Gift City. The blockchain-based system is expected to facilitate instant, 24×7 settlement
between the accounts held at the US bank. Essentially, it will create a private intra-correspondent
banking network, redefining the traditional banking hours and enabling seamless money transfer.
Following are the illustrative steps for performing audit of above said block chain:
(a) Obtain a comprehensive understanding of the blockchain-based pilot program, including its
objectives, scope, and key processes involved.
(b) Review the partnership agreements, contracts, and legal documentation governing the
relationship between the Indian banks and XY Bank.
(c) Identify the specific blockchain technology used, its functionalities, and the underlying smart
contracts.
(d) Assess Internal Controls:
Review policies and procedures related to the on-chain Nostro accounts, settlement processes, and
money transfer mechanisms.
Assess the governance framework, risk management practices, and compliance procedures
established by the Indian banks and XY Bank.
(e) Review Security Measures:
Assess encryption methods, cryptographic key management, and secure transmission protocols
used for data protection.
Review measures taken to prevent unauthorized access, cyber threats, and potential vulnerabilities
in the blockchain network.
(f) Test Transaction Validity and Accuracy:
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12.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Validate that transactions are recorded and settled accurately on the blockchain, ensuring
adherence to relevant regulations and contractual obligations.
Perform reconciliations between on-chain Nostro accounts and the corresponding accounts held at
XY Bank to confirm the accuracy of balances and transactions.
(g) Evaluate Compliance and Regulatory Requirements:
Review documentation and procedures related to customer due diligence, transaction monitoring,
and reporting obligations.
Ensure that the pilot program adheres to industry-specific standards and best practices.
(h) Assess Business Continuity and Disaster Recovery:
Evaluate the adequacy of backup and recovery procedures, redundancy measures, and failover
mechanisms to ensure uninterrupted operations.
Test the effectiveness of these plans by conducting simulations or examining historical incidents and
response procedures.
(i) Report Findings and Recommendations:
Provide recommendations for improving internal controls, security measures, compliance
procedures, and overall efficiency and effectiveness of the pilot program.
Communicate the audit results to the relevant stakeholders, highlighting areas of concern and
suggesting remedial actions.
7.4 Robotic Process Automation
RPA is the automation of the repetitive processes performed by users. It is a software technology
that emulate humans’ actions interacting with digital systems and software. Process efficiency,
customer experience and control effectiveness contributed to RPA. Robotic Process Automation
software bots can interact with any application or system the same way people do—except that RPA
bots can operate around the clock, nonstop, much faster and with 100% reliability and precision.
Case Study
A large passenger carrier is having an AI bot for passenger ticket booking with following processes:
User Interaction: The bot interacts with passengers through various channels such as a website,
mobile app, or messaging platforms. Passengers can initiate a conversation with the bot by providing
their travel details, preferences, and other required information.
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DIGITAL AUDITING AND ASSURANCE 12.37
Natural Language Processing (NLP): The bot utilizes natural language processing techniques to
understand and interpret the passenger's queries and requests. It can process text or voice inputs
and extract relevant information to facilitate ticket booking.
Query Handling: The bot responds to passenger queries related to ticket availability, fares, train
schedules, seat preferences, and other relevant information. It can provide real-time updates and
answers to common passenger questions.
Booking Process: Upon receiving a booking request, the bot collects the necessary details from
the passenger, including travel dates, destinations, class preferences, and passenger information.
It validates the inputs, checks seat availability, and calculates fares based on the carrier's pricing
structure.
Integration with Booking Systems: The bot interfaces with the carrier's booking systems to check
seat availability, reserve seats, and process payment transactions. It securely communicates with
the backend systems to initiate the booking process.
Payment Processing: The bot facilitates secure payment transactions, allowing passengers to
provide payment details and complete the booking. It may integrate with various payment gateways
or services to process credit card payments, net banking, or other payment methods.
Confirmation and Ticket Generation: Once the booking is successfully processed, the bot
generates a booking confirmation along with a unique ticket number. It provides the passenger with
the necessary information, including the ticket details, train information, and any other relevant
instructions.
Ancillary Services: The bot may offer additional services such as seat upgrades, meal selection,
travel insurance, or other ancillary offerings. It can provide information and assist passengers in
availing these services during the booking process.
Post-Booking Support: The bot can assist passengers with post-booking support, including
itinerary changes, cancellations, or ticket modifications. It handles these requests, checks the
carrier's policies, and processes the necessary changes as per the passenger's requirements.
Integration with Customer Support: The bot may be integrated with customer support systems to
escalate complex queries or issues to human agents when necessary. It can provide a seamless
transition from automated assistance to human interaction, ensuring a high level of customer
service.
Following are the illustrative steps to audit ticket booking bot system:
• Identify the objectives and goals of auditing the IRCTC ticket booking bot.
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12.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Determine the scope of the audit, including the specific aspects of the bot's functionality and
operations to be evaluated.
• Review relevant regulatory and compliance standards applicable to the ticket booking
process, such as data protection and privacy regulations, payment card industry standards,
and any specific industry guidelines.
• Identify and assess potential risks associated with the ticket booking bot, such as
unauthorized access to customer data, system failures, or inaccurate booking information.
• Develop a comprehensive set of audit procedures to assess the effectiveness, efficiency, and
compliance of the ticket booking bot. This may include:
• Reviewing the system architecture, design, and documentation.
• Evaluating the security measures in place, including authentication, access controls, and
encryption.
• Testing the bot's functionality by simulating booking scenarios and verifying the accuracy of
the results.
• Assessing the performance of the bot, such as response times and scalability.
• Analyzing logs and audit trails to detect any unusual or suspicious activities.
• Examining the data handling processes, ensuring proper encryption, storage, and protection
of customer data.
• Verifying compliance with relevant regulations, policies, and procedures.
• Conducting penetration testing or vulnerability assessments to identify potential weaknesses
in the bot's security.
• Decide on the appropriate sampling methodology to evaluate the bot's performance and
compliance. This may involve selecting a representative sample of booking transactions or
data for analysis.
• Conduct the audit based on the defined procedures, following best practices and professional
audit standards.
• Document your findings, including any issues or areas of improvement identified during the
audit.
• Compile the audit findings into a comprehensive report, detailing the audit objectives, scope,
procedures performed, and results.
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DIGITAL AUDITING AND ASSURANCE 12.39
• Provide recommendations for addressing any identified weaknesses, risks, or non-
compliance issues.
• Present the report to relevant stakeholders, such as management, IT teams, and compliance
officers.
• Track the implementation of recommended actions and ensure appropriate measures are
taken to address any identified weaknesses.
• Periodically review and monitor the bot's performance, security, and compliance to ensure
ongoing effectiveness.
Audit Implications:
It is of utmost importance for auditors to understand RPA processes, which include data extraction,
aggregation, sanitization and cleansing. Unless auditors understand these processes, they will not
be in a position to initiate an audit.
A comprehensive assurance process might demand review of the source code. To perform
substantive testing, auditors must have an understanding of the tools used to develop and maintain
RPA. This will be helpful when auditors review logs, configuration controls, privileged access
controls and the like. General IT controls are applicable as always.
Common Risks of RPA:
Operational and execution risks - Robots are deployed without proper operating model. Buying
the wrong tool, making wrong assumptions, taking shortcuts, and jeopardizing security and
compliance. Assigning proper responsibilities, training and clearly stating about changing roles also
can help you reduce operational risk to a great extent.
Change management risks: Not following the change management implementation lifecycle,
improper and incomplete testing (not covering all scenarios) leads to inaccurate results.
RPA Strategy Risk: Setting wrong expectations, improper KPIs, and unrealistic business goals
creates an environment of uncertainty. Management should discuss, and analyse the complete
working characteristics, potential, and limitations of RPA before drafting a robotic process
automation.
RPA to check IND AS, IFCoFR and Standards on Auditing.
Incorporating Standards on Auditing, IFCoFR, IND AS (para-wise details of | Para reference |
Accounting policy | Relevant data to be captured | Relevant calculation to be made | Presentation in
financial statements | IFCoFR | Audit procedures as per Standards on auditing |) in audit practices
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12.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
ensures accurate financial reporting, effective internal controls, and reliable audit procedures.
Leveraging RPA in conjunction with these frameworks can significantly enhance audit efficiency,
accuracy, and compliance. RPA developers and auditors should collaborate to align RPA workflows
with relevant standards and guidelines, ultimately improving the effectiveness of audits and
enhancing client assurance given below:
Columnar Presentation of IND AS 16 - Property, Plant & Equipment with IFCoFR
and Audit Procedures
Para Accounting Relevant data Relevant Presentation IFCoFR Audit
ref. policy to be calculation to in financial procedures as
captured be made statements per Standards
on auditing
6 Define PPE as Identify PPE Apply Disclose PPE Establish Verify the
tangible items and their recognition items and their internal existence,
assets that cost criteria and carrying controls over ownership,
are held for components. measurement amounts, the valuation, and
use in the principles. depreciation identification, disclosure of PPE
production or methods and recognition, by inspection,
supply of rates, useful measurement, confirmation,
goods or lives, depreciation, vouching,
services, for impairment impairment, analytical
rental to losses, etc. and disclosure procedures, etc.
others, or for of PPE.
administrative
purposes; and
are expected
to be used
during more
than one
period.
7 Recognize an Assess the Apply cost Disclose the Establish Verify the
item of PPE as probability and model or basis of internal recognition
an asset if it is reliability of revaluation recognition controls over criteria and
probable that future model for and the measurement
future economic subsequent measurement assessment of basis of PPE
economic benefits and measurement of PPE items. probability and items by
benefits cost of PPE of PPE items. reliability of inspection,
associated items. future confirmation,
with the item economic vouching,
will flow to the benefits and analytical
entity; and the cost of PPE procedures, etc.
cost of the items.
item can be
measured
reliably.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.41
8 Measure the Identify the Calculate the Disclose the Establish Verify the cash
cost of an item cash price present value cash price internal price equivalent
of PPE as the equivalent and of deferred equivalent and controls over and present
cash price the present payments the present the value of deferred
equivalent at value of using an value of identification payments for
the deferred appropriate deferred and calculation PPE items by
recognition payments for discount rate. payments for of cash price inspection,
date. If PPE items. PPE items. equivalent and confirmation,
payment is present value vouching,
deferred of deferred analytical
beyond payments for procedures, etc.
normal credit PPE items.
terms,
measure the
cost at the
present value
of all future
payments.
9 Include in the Identify the Allocate the Disclose the Establish Verify the
cost of an item directly directly directly internal directly
of PPE any attributable attributable attributable controls over attributable costs
costs directly costs and the costs to PPE costs and the the and non-
attributable to non- items based on non- identification attributable costs
bringing the attributable a rational and attributable and allocation for PPE items by
asset to the costs for PPE consistent costs for PPE of directly inspection,
location and items. basis. Exclude items. attributable confirmation,
condition any non- costs and non- vouching,
necessary for attributable attributable analytical
it to be costs from costs for PPE procedures, etc.
capable of PPE items. items.
operating in
the manner
intended by
management.
Exclude any
costs that are
not directly
attributable to
bringing the
asset to that
location and
condition.
© The Institute of Chartered Accountants of India
12.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
10 Include in the Identify the Allocate the Disclose the Establish Verify the
cost of an item borrowing borrowing borrowing internal borrowing costs
of PPE any costs and the costs to costs and the controls over and qualifying
borrowing qualifying qualifying qualifying the assets for PPE
costs that are assets for PPE assets based assets for PPE identification items by
directly items. on a rational items. and allocation inspection,
attributable to and consistent of borrowing confirmation,
the basis. costs and vouching,
acquisition, qualifying analytical
construction assets for PPE procedures, etc.
or production items.
of a qualifying
asset as part
of the cost of
that asset in
accordance
with Ind AS 23
Borrowing
Costs. A
qualifying
asset is an
asset that
necessarily
takes a
substantial
period of time
to get ready
for its
intended use
or sale.
11 Exclude from Identify the Deduct the Disclose the Establish Verify the trade
the cost of an trade trade trade internal discounts and
item of PPE discounts and discounts and discounts and controls over rebates for PPE
any trade rebates for rebates from rebates for the items by
discounts and PPE items. the cost of PPE items. identification inspection,
rebates PPE items. and deduction confirmation,
of trade vouching,
discounts and analytical
rebates for procedures, etc.
PPE items.
15 Recognize the Identify the Apply the Disclose the Establish Verify the self-
cost of a self- self- same self- internal constructed
constructed constructed principles as constructed controls over assets and their
asset as the assets and for an acquired assets and the costs by
cost of an item their cost asset. their costs. identification inspection,
of PPE. components. and confirmation,
measurement vouching,
of self-
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.43
constructed analytical
assets. procedures, etc.
31 Review the Identify the Assess Adjust the Establish Verify the
residual value, residual value, whether there depreciation internal residual value,
useful life and useful life and is any charge controls over useful life and
depreciation depreciation indication of accordingly the review and depreciation
method of an method of PPE change in and disclose adjustment of method of PPE
asset at least items. expectations the nature and residual value, items by
at each from previous effect of the useful life and inspection,
financial year- estimates. change in depreciation confirmation,
end and, if estimate. method of PPE vouching,
expectations items. analytical
differ from procedures, etc.
previous
estimates,
account for
the change as
a change in an
accounting
estimate in
accordance
with Ind AS 8
Accounting
Policies,
Changes in
Accounting
Estimates and
Errors.
41 Recognize the Identify the Assess the Allocate the Establish Verify the
cost of replacement probability and cost of internal replacement
replacing part parts and their reliability of replacement controls over parts and their
of an item of costs for PPE future parts to PPE the recognition costs for PPE
PPE as an items. economic items and and items by
asset if it is benefits and remove the measurement inspection,
probable that cost of carrying of replacement confirmation,
the future replacement amount of parts for PPE vouching,
economic parts. replaced parts. items. analytical
benefits Disclose the procedures, etc.
embodied replacement
within the part parts and their
will flow to the costs for PPE
entity; and the items.
cost of the
item can be
measured
reliably.
Derecognize
the carrying
© The Institute of Chartered Accountants of India
12.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
amount of the
replaced part.
57 Derecognize Identify the Calculate the Recognize the Establish Verify the
an item of disposed or gain or loss on gain or loss on internal disposed or
PPE on retired PPE derecognition derecognition controls over retired PPE items
disposal or items and their as the in profit or loss. the and their gain or
when no carrying difference Disclose the identification loss on
future amounts. between net disposed or and calculation derecognition by
economic disposal retired PPE of gain or loss inspection,
benefits are proceeds and items and their on confirmation,
expected from carrying gain or loss on derecognition vouching,
its use or amount. derecognition. of PPE items. analytical
disposal. Gain procedures, etc.
or loss arising
from
derecognition
is included in
profit or loss
when the item
is
derecognized.
8. CONTROL CONSIDERATIONS OR OBJECTIVES OF
AUDITING DIGITALLY
Emerging technologies can bring great benefits, but they also come with a varied set of substantial
risks.
The strength of the auditing profession is the assessment of risks and controls. As they address the
challenge of assessing technology risk, auditors can and should focus on the following control
considerations:
1. Auditors should gain a holistic understanding of changes in the industry and the
information technology environment to effectively evaluate management’s process for
initiating, processing, and recording transactions and then design appropriate auditing
procedures.
2. Auditors, as appropriate, should consider risks resulting from the implementation of new
technologies and how those risks may differ from those that arise from more traditional,
legacy systems.
3. Auditors should consider whether digital upskilling or specialists are necessary to
determine the impact of new technologies and to assist in the risk assessment and
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.45
understanding of the design, implementation, and operating effectiveness of controls. E.g.,
cybersecurity control experts, IT specialists in the team etc.
Some examples of technology risks where auditors should test the appropriate controls
for relying on the digital systems
• Reliance on systems or programs that are inaccurately processing data, processing
inaccurate data, or both
• Unauthorized access to data that might result in destruction of data or improper
changes to data, including the recording of unauthorized or non-existent transactions
or inaccurate recording of transactions (specific risks might arise when multiple users
access a common database)
• The possibility of information technology personnel gaining access privileges beyond
those necessary to perform their assigned duties, thereby leading to insufficient
segregation of duties
• Unauthorized or erroneous changes to data in master files
• Unauthorized changes to systems or programs
• Failure to make necessary or appropriate changes to systems or programs
• Inappropriate manual intervention
• Potential loss of data or inability to access data as required
• Risks introduced when using third-party service providers
• Cybersecurity risks
8.1 Key Steps for Auditors in a Changing Technology Environment
As auditors obtain an understanding of the impact of technology on a company’s business, its
systems of internal control, and its financial reporting, some important reminders include the
following:
• Maintain sufficient professional skepticism when reviewing management’s risk assessment
for new systems.
• Understand the direct and indirect effects of new technology and determine how its use by
the entity impacts the auditor’s overall risk assessment.
© The Institute of Chartered Accountants of India
12.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Understand how the technologies impact the flow of transactions, assess the completeness
of the in-scope ICFR systems, and design a sufficient and appropriate audit response.
• Assess the appropriateness of management’s processes to select, develop, operate, and
maintain controls related to the organization’s technology based on the extent the technology
is used.
TEST YOUR UNDERSTANDING 3
A company is planning to use Robotics process automation (RPA) to streamline its hiring process.
Earlier, the company used to hire from campuses of various management institutes leading to high
recruitment costs, inefficient hire yield and resultant lack of diversity. How RPA can be used to
automate the hiring process? List out tentative few such steps. What could be likely benefits of using
RPA in hiring process?
9. NEXT GENERATION AUDIT
The Next Generation Audit is human-led, tech-powered and data-driven. It is based on combining
emerging technologies to redefine how audits are performed.
Next Generation Audit aims to the following:
We live in an era of fast technological progress, with new digital devices, applications, and tools
being developed almost on a daily basis. 3D printing, augmented reality (AR) and virtual reality (VR),
biotechnology, auditing through drones (also known as an ‘Unmanned Aerial Vehicle’ (UAV)and
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.47
quantum technology are some of the most rapidly advancing areas, with many implications for
society.
Drone Technology: Using drone technology in the remote locations for stock
counts. Drones have great payload capacity for carrying sensors and cameras, thus
they can photograph and physically examine the count of large quantities of fixed
assets and inventory.
Drone captured audit information can be combined with various alternative sources of information
such as QR code readers, handheld bar scanners, manual counts etc. to optimise quality of
deliverables, consolidate audit information and enhance the execution speed while ensuring
correctness and completeness of data.
Drone Technology: Using drone technology in the remote locations for stock counts. Drones have
great payload capacity for carrying sensors and cameras, thus they can photograph and physically
examine the count of large quantities of fixed assets and inventory.
Drone captured audit information can be combined with various alternative sources of information
such as QR code readers, handheld bar scanners, manual counts etc. to optimise quality of
deliverables, consolidate audit information and enhance the execution speed while ensuring
correctness and completeness of data.
Augmented reality: The technology allows users to view the real-world environment with
augmented (added) elements, generated by digital devices.
One famous example was Pokémon Go, a game for mobile devices in which players chase imaginary
digital creatures (visible on their mobile phones) around physical locations.
Virtual reality: VR goes a step forward and replaces the real world entirely with a simulated
environment, created through digitally generated images, sounds, and even touch and smell. Using
special equipment, such as a custom headset, the user can explore a simulated world or simulate
experiences such as flying or skydiving.
Examples of augmented and virtual reality? In architecture and engineering businesses, AR and
VR allow architects to see their building plans come to life before being built. In the business sector,
these technologies allow products to be previewed or customised, thus improving productivity and
offering new marketing possibilities.
In the health sector, AR can provide surgeons with additional information when operating on a
patient, such as heartbeat and blood pressure monitoring and virtual x-rays. Vision Pro is essentially
© The Institute of Chartered Accountants of India
12.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
an augmented-reality (AR) headset that “seamlessly” blends the real and digital worlds. The device
can switch between augmented and full virtual reality (VR) using a dial.
Metaverse: The metaverse is the emerging 3-D digital space that uses virtual reality, augmented
reality, and other advanced internet technology to allow people to have lifelike personal and business
experiences online. It represents a convergence of digital technology to combine and extend the
reach and use of Cryptocurrency, Artificial Intelligence (AI), Augmented Reality (AR) and Virtual
Reality (VR)
The internet offers many experiences today, but tomorrow’s Metaverse will feel more interconnected
than ever before. We are heading towards mature landscape of virtual spaces with transferable
identities and assets enabled by blockchains (NFTs) that are interoperable or interchangeable. It
further includes highly automated systems, immersive interfaces, hyperconnected networks and
digital reflections.
Some considerations for future –
• Beyond cryptocurrencies, coins, and exchanges, players in the Metaverse will need to
consider how to build digital monetary systems and apply economic principles to things like
digital land.
• Governance models will become ever more difficult to balance openness and user
contribution with strategic direction and innovation.
• Identity in the digital world has historically been different based on the platform utilized. The
practical challenge of identity will also have to be considered in the Metaverse (e.g., KYC)
• Synchronicity is the ability for aspects of the Metaverse to be multiplayer, simultaneous, and
real-time. This includes transactions and actions happening in the Metaverse and are
dependent on the infrastructure of digital economies, networking and computing power
required to operate a digital world.
Case scenarios to illustrate the potential application of the metaverse in the financial domain:
• Virtual Banking and Transactions: A forward-thinking financial institution, establishes a
presence in the metaverse to offer virtual banking services. Users can create virtual bank
accounts, access personalized financial dashboards, and perform transactions using virtual
currencies. Customers can seamlessly transfer funds, make virtual purchases, and engage
in virtual commerce, all within the immersive environment of the metaverse. XYZ Bank
leverages the metaverse to provide a convenient and interactive banking experience,
attracting tech-savvy customers who value digital innovation.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.49
• Digital Asset Management: A digital asset management company, recognizes the growing
popularity of virtual assets in the metaverse. They launch a virtual asset trading platform
within the metaverse, allowing users to buy, sell, and trade NFTs and other digital assets.
Investors can diversify their portfolios, participate in virtual auctions, and even showcase their
virtual art collections in virtual galleries. Crypto Investments Ltd. leverages the metaverse's
decentralized and secure infrastructure to facilitate transparent and efficient transactions of
virtual assets.
• Virtual Financial Education and Training: A Financial Learning Academy aims to enhance
financial literacy using the metaverse. They create a virtual classroom environment where
participants can attend interactive financial education sessions. Students can engage in
simulated investment activities, learn about budgeting and financial planning, and gain hands-
on experience through virtual trading simulations. Financial Learning Academy leverages the
immersive nature of the metaverse to provide an engaging and practical financial education
platform, preparing individuals for real-world financial challenges.
• Virtual Meetings and Conferences: For a leading industry even an organisation hosts a
virtual conference within the metaverse. Participants from around the world can access the
conference through their virtual avatars. They can attend keynote speeches, panel
discussions, and networking events in virtual conference halls. Attendees can interact with
industry experts, explore virtual exhibition booths, and establish valuable connections in the
financial sector. Global Finance Summit leverages the metaverse to create a global and
inclusive conference experience, fostering collaboration and knowledge sharing.
• Data Visualization and Analytics: A company utilizes the metaverse to offer advanced data
visualization and analytics tools to financial professionals. Their virtual analytics platform
allows users to visualize complex financial data in interactive and immersive 3D
environments. Users can explore data trends, conduct simulations, and analyze financial
performance through intuitive interfaces within the metaverse. Analytics Solutions Inc.
leverages the metaverse's immersive capabilities to enhance data-driven decision-making,
enabling financial professionals to gain deeper insights into market trends and make informed
investment decisions.
Common Risks associated:
Beyond their potential, these technologies also come with challenges such as public safety,
cybersecurity, data privacy, data protection, lack of standards and technical challenges. Since they
often track movements and data, massive amounts of data are generated about the whereabouts of
users. It also raises questions about taxation, jurisdiction, and customer protection. Regulators and
© The Institute of Chartered Accountants of India
12.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
auditors have to think of the controls around privacy, data security, governance to make it more
regulated.
10. CONCLUSION
Emerging technologies bring opportunities to organizations, but they also expose the enterprise to
new risk. Auditors are expected to identify the right balance between cost and benefit of internal
controls for mitigating these risk factors. This includes understanding how technology integrates with
business, how it is governed, which activities are automated and how they are controlled, what the
business impacts are as a result of this automation, and how negative impacts are controlled and
monitored. Though auditors are not expected to be experts in every technology, they should be able
to identify the risk inherent with these technologies. This includes understanding the technology
architecture, the internal control framework embedded in the technology and its integration with
business.
Integrated Case Scenario:
Consider the following five situations: -
[A] Safe Health Insurance Limited is a company working in field of health insurance sector. It is
now using a claim management system where incoming claims can be immediately identified on the
website itself. A form is issued to the customer who signs it. The details are verified by the system
against data present in it. Such a system has allowed faster processing of claims, error-free data
validation and increased customer satisfaction.
[B] During the course of audit of a company, it is noticed that a cyber attack took place on the
data in which files were encrypted and computers got locked. The hacker then demanded a booty
for decryption of files which was to be paid in bitcoins.
[C] CA X, auditor of a company, is looking into cyber security risks of the company. He is making
inquiries regarding processes and controls relating to privileged account access, patch management
program, vendor risk management program. He has also performed external network penetration testing.
[D] “Verificatory” is an entity which can stamp e-mails or any files. It simplifies certifying of e-
mails by just e-mailing to them to an e-mail specifically created for each customer. Many law firms
can use this service to certify documents. The information is secured by networks of thousands of
computers distributed across the globe. It uses cryptographic algorithms. The information can be
verified from anywhere in the world. Its hashing and time stamping is of significant evidentiary value.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.51
[E] CA X is planning for audit of an entity. The timelines are agreed in a meeting with key
management person on an electronic meeting platform. The entity also agrees to provide data
electronically. Video-conference meetings are to be held from time to time with the client.
Keeping in view above situations, answer the following questions: -
1 In respect of situation regarding working of insurance company in health insurance sector,
which of following technologies has likely been used?
(a) Internet of things
(b) Data analytics
(c) Robotic process automation
(d) Power BI
2. Which type of cyber attack is referred to situation described in para [B]?
(a) Ransomware
(b) Trojan
(c) Denial of service attacks
(d) Fileless Malware
3. In situation described at [C] above, which is not part of risk assessment procedures to assess
cyber security risks?
(a) Making inquiries regarding processes and controls relating to privileged account
access
(b) Making inquiries regarding processes and controls relating to patch management
program
(c) Making inquiries regarding processes and controls relating to vendor risk management
program
(d) Performing external network penetration testing
4. The kind of services being provided by an entity described at [D] above, are example of use
of: -
(a) Blockchain technology
(b) Internet of things
© The Institute of Chartered Accountants of India
12.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) Ethical hacking
(d) Cyber attestation
5. Which of following is false in an audit described at para [E]?
(a) The opportunity to present doctored documents and to omit relevant information is
decreased.
(b) Remote access to sensitive IT systems may not be allowed.
(c) It provides comfort and flexibility to the audit team as they would be working from their
office/home environment.
(d) Time zone issues could also affect the efficiency of audits.
Key Takeaways
A digital audit improves the quality of opinion. This consequently leads to a more reliable
audit report. It leads to savings in time, cost and human effort which can be utilized towards
more productive tasks.
Auditing digitally is using the advancements in technology for conducting an effective and
efficient audit. With a rapidly growing IT environment it is essential to adapt technology in
auditing practices.
It is necessary for an auditor to understand key areas of automated environment. Such key
areas include understanding flow of transaction, identification of significant systems,
identification of manual and automated controls and identification of technologies used.
It is also imperative upon an auditor to identify the risks arising from the use of IT. The
auditor may consider the nature of the identified IT application.
Applicable risks arising from the use of IT may also be identified related to cybersecurity. It
is more likely that there will be more risks arising from the use of IT when the volume or
complexity of automated application controls is higher, and management is placing greater
reliance on those controls for effective processing of transactions or the effective
maintenance of the integrity of underlying information.
Cyber risks have to considered like a business risk. It is necessary for an auditor to
understand cyber risk strategy of an entity. It should include gaining some knowledge about
cybersecurity framework of an entity.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.53
Cybersecurity framework includes how management is identifying the risk, protecting and
safeguarding its assets (including electronic assets) from the risk, management preparedness
to detect the attacks, anomalies and responsiveness to the adverse event.
Apart from having the cyber security policies, procedures, framework and regular assessment
in place, management should have a strong and updated internal controls to ensure they are
covered from cyber risks. Such controls could include controls over vendor setup, electronic
fund transfer and patch management etc.
Emerging technologies in business are also transforming auditing landscape. Data analytics,
artificial intelligence (AI), robotic process automation, and blockchain are some of such
technologies.
Auditing digitally also has to assess technology risk considerations like relying upon programs
which are inaccurately processing the data, issue of technological personnel gaining access
privileges beyond those necessary to perform their duties, inability to access data as required,
cybersecurity risks etc.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Briefly describe the advantages and challenges of Auditing digitally.
2. What are the stages involved in understanding the IT environment and what key
considerations auditor should consider?
3. Auditor should scope in ITGCs to tests when there are IT dependencies identified in the
system. Briefly describe the types of IT dependencies.
4. What does cyber risk explain it with some examples.
5. Briefly describe the cyber security Framework.
6. What are the advantages and disadvantages of remote audit?
7. 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. In view of above you are required to briefly discuss
the meaning of data analytics and example of such data analytics techniques.
© The Institute of Chartered Accountants of India
12.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
8. Enterprises are adopting emerging technologies at a rapid pace to create synergies and harness
the latest technologies. Give 3 examples of automated tools used as a part of emerging
technologies along with the risk and audit considerations associated with these tools.
9. Emerging technologies can bring great benefits, but they also come with a varied set of
substantial risks. Give some examples of technology risks of digital system and the control
considerations to consider while assessing technology risk.
10. Give example of emerging technologies available for Next Generation Audit along with the
risks associated with it.
Answers to Test Your Understanding Questions
1. The cyber risks are not an issue of IT alone. Rather, it is a business risk and has an effect on
whole business organization. It affects entity’s reputation and can lead to many other
consequences which are listed below: -
• Regulatory costs
• Business interruptions causing an operational challenge for an organization.
• Data loss, reputational loss and litigation.
• Ransomware - more common these days where entire systems are encrypted
• Intellectual property theft which may not only take the competitive advantage, but we
may also result in any impairment/impediment charge because of the loss of IP.
• Incident response cost which could be for investigations & remediations
• Breach of Privacy, if personal data of a consumer is hacked it could have a
significant impact on the organization.
• Fines and penalties
It may happen that many cyber attacks are not directly targeted at financial systems.
However, the access gained by the attackers may provide them the ability to:
• Manipulate or modify financial records
• Modify key automated business rules
• Modify automated controls relied upon by the management.
Further, auditor should consider whether cyber risk (like other business risks) represents a
risk of material misstatement to the financial statement as part of the audit risk assessment
activities. Focus should be on understanding the cyber risks affecting the entity and the
actions being taken to address these risks.
© The Institute of Chartered Accountants of India
DIGITAL AUDITING AND ASSURANCE 12.55
2. (i) Identify exceptions: Identify exceptional transactions based on set criteria. For
example, cash transactions above ` 10,000.
(ii) Identify errors: Identify data, which is inconsistent or erroneous. For e.g.: account
number which is not numeric.
(iii) Verify calculations: Re-perform various computations in audit software to confirm the
results from application software confirm with the audit software. For e.g.: TDS rate
applied as per criteria.
(iv) Existence of records: Identify fields, which have null values. For example: invoices
which do not have vendor name.
(v) Data completeness: Identify whether all fields have valid data. For example: null
values in any key field such as date, invoice number or value or name.
(vi) Data consistency: Identify data, which are not consistent with the regular format. For
example: invoices which are not in the required sequence.
(vii) Duplicate payments: Establish relationship between two or more tables as required.
For example, duplicate payment for same invoice.
(viii) Accounts exceeding authorized limit: Identify data beyond specified limit. For
example, transactions entered by user beyond their authorized limit or payment to
vendor beyond amount due or overdraft allowed beyond limit.
3. RPA can be used to streamline hiring process in a company. The tentative steps could include: -
Place advertisements on social media/career advice sites.
Link redirects candidate to a career site.
Career site pulls information of candidate.
An algorithm scans applicants for desired and suitable roles.
Selected candidates may be asked to play online games to assess their skills.
A certain percentage of those applicants are called for a video interview using an
interview software.
The automated hiring process will reduce full time effort involvement, provide with a wider assessment
range, reduce the impact of recruiter biases, increase the efficiency of mapping of interested
candidates, reduce recruiting costs, increase hire yield, reduce time to hire, increase diversity.
© The Institute of Chartered Accountants of India
12.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Integrated Case Scenario:
1. (c)
2. (a)
3. (d)
4. (a)
5. (a)
Hints /Answers to Theoretical Questions:
1. Advantages – Improved efficiency, better quality, lower costs, improved risk assessment.
Challenges – Reluctance to change, challenges with data security and governance, choosing
the right tool and automating the right process, ensuring standardisation and correct
configurations to avoid error and bias, evaluating business benefits the organization wants to
achieve with automation and the roadmap for digital strategy.
For details refer Para 2.
2. The stages involved in understanding of IT environment are: Understand – Identify – Assess.
Key considerations - Understand the flow of transaction, Identification of Significant Systems,
Identification of Manual and Automated Controls, Identification of the technologies used and.
Assessing the complexity of the IT environment.
For details refer Para 3.
3. For details refer para 4.
4. For details refer para 5.1.
5. For details refer para 5.3.
6. For details refer para 5.5
7. For details refer para 6
8. For details refer para 7
9. For details refer para 8
10. For details refer para 9
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
© The Institute of Chartered Accountants of India
CHAPTER 13
7
GROUP AUDITS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the concept of Audit of Consolidated Financial Statements.
Identify the responsibility of Parent and Auditor in Consolidation of
Financial Statements.
Gain the knowledge of Audit Considerations during the Audit of
Consolidated Financial Statements.
Recognise the manner of Permanent Consolidation Adjustment and
Current Period Consolidation Adjustments.
Learn the reporting requirements as per the given circumstance and
understand audit of group financial statements including the work of
component auditors.
Understand and interpret SA 600-“Using the Work of Another Auditor”
© The Institute of Chartered Accountants of India
13.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Parent Co.
Responsibility of
Auditor
Permanent Consolidation
Adjustments
Audit Considerations
& Consolidation
Current Period
Audit of CFS
Consolidation Adjustments
Management
Representation
Reporting
SA 600 "Using the work of
another auditor"
CA. Vikram is statutory auditor of a manufacturing company whose financial statements are
required to be prepared in accordance with requirements of Ind AS. At the time of planning
of audit of current year, it is noticed by him that said company, of which he is auditor, has
purchased shares of another company located in USA. He further inquired from the
management and found that all shares of US based company were purchased by Indian
company.
Section 129 of Companies Act immediately came to his mind. Whether provisions regarding
consolidation of financial statements would apply in such a case? Since Indian company has
acquired all shares of another company, aren’t its financial statements required to be
consolidated? Gathering further insight, it became clear to him that financial statements of
Indian company are required to be consolidated as it has a wholly owned subsidiary now.
He had another recurring anxiety in his mind. Whether foreign subsidiaries are covered within
scope of consolidated financial statements? Exhaustive reading of Ind AS 110 on
“Consolidated financial statements” came to his help and it became clear to him that a parent
which presents consolidated financial statements should consolidate all subsidiaries,
domestic as well as foreign. The management of the company was informed to prepare the
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.3
groundwork for the preparation of consolidated financial statements in accordance with
statutory provisions and applicable accounting standards.
While consolidating financial statements, management was caught in a dilemma. The
financial statements were going to be consolidated for the first time. However, the Indian
parent company had acquired all shares in foreign subsidiary in the month of June. The
question arose as to from which date consolidation is required. Is it required for the whole
year or from the date of acquiring shares in foreign subsidiary? The management turned to
Ind AS 110 for help. It became clear that the results of the operations of a subsidiary are
included in the consolidated financial statements from the date on which the parent gained
control of the subsidiary.
The consolidated financial statements were made ready by management by combining like
items of assets, liabilities, income and expenses of the parent with that of a foreign
subsidiary. There was no minority interest involved.
While auditing such group financial statements prepared by the management, it came to the
fore that accounts of foreign subsidiary were unaudited. CA Vikram was caught in a Catch-
22 situation. How should he proceed? What are the implications for unaudited accounts of a
component included in group financial statements? What considerations would play in such
a case?
1. INTRODUCTION
Consolidated Financial Statements are the financial statements of a group in which the assets,
liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented
as those of a single economic entity. In other words, consolidated financial statements present the
financial position of an entire group including the parent and its group companies. Whereas separate
financial statements present the financial position of a single entity for which the financial statements
are prepared. Consolidated financial statements provide a complete overview of the operations and
profitability of the entire group which is controlled by the parent.
Financial Statements of
Subsidiaries
Financial Statements
of Parent Company (ABC Ltd. and XYZ Ltd.)
(MNO Ltd.)
Consolidated Financial
Statements of the group
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13.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In the above diagram there is one parent company (MNO Ltd.) having two subsidiaries (ABC Ltd.
and XYZ Ltd.) The auditor of MNO Ltd. is SS Maheshwari & Co. while the auditor of ABC Ltd. and
XYZ Ltd. is RT & Associates. Further, it was decided that SS Maheshwari & Co. will act as the
principal auditor (i.e., auditor with reporting responsibilities with respect to the consolidated financial
statements of the group). Now the management of all the three companies is responsible for
preparation of their respective standalone financial statements which shall then be audited by the
respective auditors. Thereafter, the parent company shall prepare the consolidated financial
statements for the group. Once the consolidated financial statements are prepared, such financial
statements are audited by the principal auditor. Now, we need to consider the following points.
♦ The responsibility of the parent company in consolidation of financial statements. (MNO Ltd.)
♦ Manner of permanent adjustment and current period consolidation adjustment.
♦ The principal auditor’s procedures. (SS Maheshwari & Co.)
♦ Coordination and division of responsibility between both the auditors.
♦ Reporting requirements.
Consolidated financial statements are presented, to the extent possible, in the same format as
adopted by the parent for its separate financial statements. The formats for preparation of balance
sheet, statement of profit and loss and a statement of change in equity (if applicable) are prescribed
under the Schedule III of the Companies Act, 2013.
Consolidated Financial
Statements include
Consolidated
Any explanatory
Consolidated Consolidated statement of
Consolidated notes annexed
statement of cash flow change in equity
balance sheet to, or forming
profit and loss statement (if applicable)
part thereof
and
An entity which prepares the consolidated financial statements, either under any law or regulation
governing the entity or suo motu, might be required to or otherwise engage the auditor for conducting
the audit of consolidated financial statements. However, a law or regulation governing the entity may
require the consolidated financial statements to be audited by the statutory auditor of the entity (i.e.
the auditor who audits standalone financial statements of the entity). The Guidance Note on Audit
of Consolidated Financial Statements provides guidance on the specific issues and audit procedures
to be applied in an audit of consolidated financial statements. This Guidance Note can also be used
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GROUP AUDITS 13.5
while auditing consolidated financial statements prepared for special purpose, to the extent
applicable but it does not deal with accounting matters arising on consolidation of financial
statements.
Accounting Standard (AS) 21 ‘Consolidated Financial Statements’ and Indian Accounting Standard
(Ind AS) 110, ‘Consolidated Financial Statements’ lay down principles and procedures for
preparation and presentation of consolidated financial statements under AS and Ind AS respectively.
In other words, whenever a parent decides to or is required to prepare and present consolidated
financial statements, it should do so in accordance with the requirements of applicable Accounting
Standards under the relevant financial reporting framework
1.1 Consolidation of Financial Statements - Mandatory under Companies
Act, 2013
According to Section 129(3) of the Companies Act, 2013, where a company has one or more
subsidiaries, including associate company and joint venture, it shall, in addition to its own financial
statements prepare a consolidated financial statement of the company and of all the subsidiaries in
the same form and manner as that of its own. Further, section 129(4) of the said Act, provides that
the provisions applicable to the preparation, adoption and audit of the financial statements of a
holding company shall, mutatis mutandis, also apply to its the consolidated financial statements.
The consolidated financial statements shall also be approved by the Board of Directors before they
are signed on behalf of the Board, along with its standalone financial statements and shall also be
laid before the annual general meeting of the company along with the laying of its standalone
financial statement.
The company shall also attach along with its financial statement, a separate statement containing
the salient features of the financial statement of its subsidiary(ies) in Form AOC-1.
According to the Companies (Accounts) Rules, 2014, the consolidation of financial statements of the
company shall be made in accordance with the provisions of Schedule III to the Act and the
applicable accounting standards. However, a company which is not required to prepare consolidated
financial statements under the Accounting Standards, it shall be sufficient if the company complies
with provisions of consolidated financial statements provided in Schedule III of the Act.
However, the requirement related to preparation of consolidated financial statements shall
not apply to a company 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
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13.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
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 India 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.
As per sub-section 6 of the section 129 of the Companies Act, 2013, 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 companies from complying with any of the requirements of section 129 or the rules
made thereunder, if it is considered necessary to grant such exemption in the public interest and
any such exemption may be granted either unconditionally or subject to such conditions as may be
specified in the notification.
Thus, the companies having subsidiaries, which have previously never prepared the consolidated
financial statements, must prepare their consolidated financial statements in adherence with this
mandatory requirement. This will provide the holding companies’ stakeholders more transparency
about the companies’ businesses.
Further, an investment entity need not present consolidated financial statements if it is required, in
accordance with paragraph 31 of Ind AS 110, to measure all of its subsidiaries at fair value through
profit or loss. A parent shall determine whether it is an investment entity.
An investment entity is an entity that:
(a) obtains funds from (b) commits to its (c) measures and
one or more investors investor(s) that its evaluates the
for the purpose of business purpose is to performance of
providing those invest funds solely for substantially all of its
investor(s) with returns from capital investments on a fair
investment appreciation, value basis.
management investment income, or
services; both; and
However, as per paragraph 33 of Ind AS 110, the parent of an investment entity shall consolidate all
entities that it controls, including those controlled through an investment entity subsidiary, unless
the parent itself is an investment entity.
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GROUP AUDITS 13.7
Case Study - Consolidation of Financial Statement of a Subsidiary
1. Parent Ltd acquired 51% shares of Child Ltd during the year ended 31-3-2021. During the
financial year 2021-22, 20% shares of Child Ltd were sold by Parent Ltd. Parent Ltd while
preparing the financial statements for the year ended 31-3-2021 and 31-3-2022 did not
consider the financial statements of Child Ltd for consolidation. As a statutory auditor how
would you deal with it?
Provisions & Explanation: As per Ind AS 110, there is no such exemption for ‘temporary control’,
or “for operation under severe long-term funds transfer restrictions” and consolidation is mandatory
for Ind AS compliant financial statement in this case.
However, as per section 129(3) of the Companies Act, 2013 where a company having subsidiary,
which is not required to prepare consolidated financial statements under the applicable Accounting
Standards, it shall be sufficient if the company complies with the provisions of consolidated financial
statements provided in Schedule III to the Act.
Conclusion: In the given case, Parent Ltd acquired 51% shares of Child Ltd during the year ended
31.03.2021 and sold 20% shares during the year ended 31.03.2022. Parent Ltd did not consolidate
the financial statements of Child Ltd for the year ended 31.03.2021 and 31.03.2022.
The intention of Parent Ltd is quite clear that the control in Child Ltd is temporary as the former
company disposed off the acquired shares in the next year of its purchase. Parent Ltd is required to
prepare Consolidated Financial Statements in accordance with Ind AS 110 as exemption for
‘temporary control’, or “for operation under severe long-term funds transfer restrictions” is not
available under Ind AS 110. Paragraph 20 of Ind AS 110 states that “Consolidation of an investee
shall begin from the date the investor obtains control of the investee and cease when the investor
loses control of the investee”.
2. RESPONSIBILITY OF PARENT
The responsibility for the preparation and presentation of consolidated financial statements, among
other things, is that of the management of the parent. This includes:
(a) identifying components, and including the financial information of the components to be
included in the consolidated financial statements;
(b) where appropriate, identifying reportable segments for segmental reporting;
(c) identifying related parties and related party transactions for reporting;
© The Institute of Chartered Accountants of India
13.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) obtaining accurate and complete financial information from components;
(e) making appropriate consolidation adjustments;
(f) harmonization of accounting policies and accounting framework; and
(g) GAAP conversion, where applicable.
Apart from the above, the parent ordinarily issues instructions to the management of the component
specifying the parent’s requirements relating to financial information of the components to be
included in the consolidated financial statements. The instructions ordinarily cover the accounting
policies to be applied, statutory and other disclosure requirements applicable to the parent, including
the identification of and reporting on reportable segments, and related parties and related party
transactions, and a reporting timetable.
3. RESPONSIBILITY OF THE AUDITOR OF THE
CONSOLIDATED FINANCIAL STATEMENTS
Section 129(4) of the Companies Act, 2013 requires that 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.
Besides other matters, the principal auditor of the consolidated
financial statements is responsible for expressing an opinion on
whether the consolidated financial statements are prepared, in all
Fig.: Responsibility of Auditors∗
material respects, in accordance with the financial reporting
framework under which the parent prepares the consolidated financial statements in addition to
reporting on the additional matters as required under the Companies Act, 2013 and any other statute
to the extent applicable.
Therefore, the auditor's objectives in an audit of consolidated financial statements are:
(a) to satisfy himself that the consolidated financial statements have been prepared in
accordance with the requirements of the applicable financial reporting framework;
(b) to enable himself to express an opinion on the true and fair view presented by the
consolidated financial statements;
(c) to enquire into the matters as specified in section 143(1) of the Companies Act, 2013; and.
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.9
(d) to report on the matters given in the clauses (a) to (i) of section 143(3) of the Companies Act,
2013 for other matters under section 143(3)(j) read with rule 11 of the Companies (Audit and
Auditors) Rules, 2014, to comment on the matters specified in sub-rule (a),(b), (c), (d), (e),
(f) and (g) 1 to the extent applicable;
(e) The auditor should also validate the requirement of preparation of CFS for the company as
per applicable financial reporting framework.
Standards on Auditing, Statements and Guidance Notes on auditing matters issued by the Institute
of Chartered Accountants of India (ICAI) apply in the same manner to audit of consolidated financial
statements as they apply to audit of standalone financial statements. It means that the auditors,
while conducting the audit of consolidated financial statements are, inter alia, expected to:
(a) plan their work to enable them to conduct an effective audit in an efficient and timely manner;
(b) obtain an understanding of the accounting and internal control systems including IT system
like consolidation tool, sufficient to plan the audit and determine the nature, timing and extent
of his audit procedures. Such an understanding would help the auditors to develop an
effective audit approach;
(c) use professional judgement to assess audit risk and to design audit procedures to ensure
that the risk is reduced to an acceptable level, etc.
4. AUDIT CONSIDERATIONS
The following features of consolidated financial statements have an impact on the related
audit procedures:
(a) The consolidated financial statements are prepared on the basis of separate financial
statements of the parent and its components, using the consolidation procedures prescribed
by Accounting Standards 2 under applicable financial reporting framework; and
1 The auditor of the consolidated financial statements generally report on the matters pertaining to the component, on the
basis of auditors’ report of the respective component.2 Accounting Standard (AS) 21, Consolidated Financial Statements,
Accounting Standard (AS 23)- Accounting for Investments in Associates in Consolidated Financial Statements and
Accounting Standard (AS) - 27, Financial Reporting of Interests in Joint Ventures OR Indian Accounting Standard (Ind
AS) 110 – Consolidated Financial Statements, Indian Accounting Standard (Ind AS) 111- Joint Arrangements, Indian
Accounting Standard (Ind AS) 112 –Disclosure of Interests in Other Entities and Indian Accounting Standard (Ind AS) 28
– Investments in Associates and Joint Ventures.
2 Accounting Standard (AS) 21, Consolidated Financial Statements, Accounting Standard (AS 23)- Accounting for
Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) - 27, Financial Reporting
of Interests in Joint Ventures OR Indian Accounting Standard (Ind AS) 110 – Consolidated Financial Statements, Indian
© The Institute of Chartered Accountants of India
13.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) The auditor of the consolidated financial statements may use the work of other auditors as
per requirement of Standards on Auditing unless the auditor of consolidated financial
statements is also the auditor of the other components of the group.
The consolidated financial statements (including the intermediate consolidated financial statements
prepared internally) 3 are prepared using the separate financial statements of the parent and its
components and also other financial information, which might not be covered by the separate
financial statements of these entities. The ‘other financial information’ would include disclosures to
be made in the consolidated financial statements about the components, proportion of items included
in the consolidated financial statements to which different accounting policies have been applied
where permitted, adjustments made for the effects of significant transactions or other events that
occur between the financial statements of parent and its components, as the case may be, etc. Thus,
this ‘other financial information’ would be required to be additionally disclosed.
When an auditor accepts the audit of consolidated financial statements, the auditor should assess
whether based on his work alone he would be able to express an opinion on the true and fair view
presented by the consolidated financial statements. If the auditor is of the view that his own
participation may not be enough or sufficient, he should consider using the work of ‘other auditors’.
Consolidation – Example
♦ Group consists of entity A and its subsidiaries B and C
♦ B has a loan with A of 100
A B C Total Eliminations Group
PPE 100 50 30 180 180
Shares in subsidiaries 500 - - 500 -500- -
Intercompany receivables 100 - - 100 -100 -
Receivables - 400 300 700 - 700
Intercompany debt - -100 - -100 100 -
Debt -100 -50 -130 -280 -280
Equity -600 -300 -200 -1,100 500 -600
Accounting Standard (Ind AS) 111- Joint Arrangements, Indian Accounting Standard (Ind AS) 112 –Disclosure of Interests
in Other Entities and Indian Accounting Standard (Ind AS) 28 – Investments in Associates and Joint Ventures.
3 Intermediate consolidated financial statements are the consolidated financial statements of an intermediate parent, e.g.,
Company A has one subsidiary Company B. Company B has a subsidiary Company C. In this case, Company B is the
intermediate parent and the consolidated financial statements prepared by Company B will be intermediate consolidated
financial statements.
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GROUP AUDITS 13.11
Such ‘other auditors’ might be the statutory auditors of the separate financial statements of one or
more of the components or the auditors appointed specifically for assisting the auditor of the
consolidated financial statements (the principal auditor).
Where the statutory auditors of one or more of the components of the parent are also requested to
assist the principal auditor, the work to be performed by such statutory auditors for use by the
principal auditor would constitute an assignment separate from the assignment to conduct the
statutory audit of the respective component.
Standard on Auditing (SA) 600, ‘Using the Work of Another Auditor’ establishes standards when
an auditor, reporting on the financial statements of an entity (the group—in the case of consolidated
financial statements), uses the work of another auditor on the financial information of one or more
components included in the financial statements of the entity (Paragraph 2 of SA 600). The principal
auditor, if he decides to use the work of another auditor in relation to the audit of consolidated
financial statements, should comply with the requirements of SA 600.
In carrying out the audit of the standalone financial statements, the computation of materiality for
the purpose of issuing an opinion on the standalone financial statements of each component would
be done component-wise on a standalone basis. However, with regard to determination of materiality
during the audit of consolidated financial statements (CFS), the auditor should consider the
following:
• The auditor is required to compute the materiality for the group as a whole. This materiality
should be used to assess the appropriateness of the consolidation adjustments (i.e.
permanent consolidation adjustments and current period consolidation adjustments) that are
made by the management in the preparation of CFS.
• The parent auditor can also use the materiality computed on the group level to determine
whether the component's financial statements are material to the group to determine whether
they should scope in additional components and consider using the work of other auditors
as applicable.
• The principal auditor also computes the materiality for each component and communicates
to the component auditor, if he believes is required for a true and fair view on CFS.
• The principal auditor also obtains certain confirmations from component auditors like
independence, code of ethics, certain information required for consolidation and disclosure
requirements etc.
However, while considering the observations (for instance modification and /or emphasis of matter
in accordance with SA 705/706) of the component auditor in his report on the standalone financial
statements, the principles of SA 600 need to be considered. ICAI issued an announcement dated
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13.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
May 25, 2017 which amended paragraph 17 of Guidance Note and states that while considering the
observations (for instance modification and /or emphasis of matter/other matter in accordance with
SA 705/706) of the component auditor in his report on the standalone financial statements, the
parent auditor should comply with the requirements of SA 600, “Using the Work of Another Auditor”.
Therefore, the concept of materiality would be considered while considering the observations of the
component auditor.
5. AUDITING THE CONSOLIDATION
Before commencing an audit of consolidated financial statements, the auditor should plan his work
to enable him to conduct an effective audit in an efficient and timely manner.
The auditor should make plans, among other things, for the following:
(a) Understanding of the group structure and group-wide controls including assessment of
Information Technology (IT) system and related general and applications IT related
controls (manual and automated) for consolidation process;
(b) understanding of accounting policies of the parent and its components as well as of the
consolidation process including the process of translation of financial statements of foreign
components;
(c) determining and programming the nature, timing, and extent of the audit procedures to be
performed based on the assessment of the risk of material misstatement in consolidation
process;
(d) determining the extent of use of other auditor’s work in the audit; and
(e) coordinating the work to be performed.
A parent which presents consolidated financial statements is required to consolidate all its
components in the consolidated financial statements other than those for which exceptions have
been provided in the relevant accounting standards under the applicable financial reporting
framework.
The auditor should obtain a listing of all the components included in the consolidated financial
statements and review the information provided by the management of the parent identifying the
components. The auditor should verify that all the components have been included in the
consolidated financial statements unless these components meet criterion for exclusion.
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.13
In respect of completeness of this information, the auditor should perform the following
procedures:
(a) review his working papers for the prior years for the known components;
(b) review the parent’s procedures for identification of various components;
(c) make inquiries of the management to identify any new components or any component
which goes out of consolidated financial statements;
(d) review the investments of parent as well as its components to determine the shareholding
in other entities;
(e) review the joint ventures and joint arrangements as applicable;
(f) review the other arrangements entered into by the parent that have not been included in
the consolidated financial statements of the group;
(g) review the statutory records maintained by the parent, for example registers under
section 186, 190 of the Companies Act, 2013;
(h) Identify the changes in the shareholding that might have taken place during the reporting
period.
The auditor should document procedures performed for assessing completeness of the components
to be consolidated.
There would be various means by which control, joint control or significant influence can be obtained.
In this regard, the auditor may verify the Board’s minutes, shareholder agreements entered into by
the parent, agreements with the entities to which the parent might have provided any technology or
know how, enforcement of statute, as the case may be, etc. The auditor may also review the minutes
of the meetings of the Board of Directors subsequent to the year-end to understand if there has been
any liquidation of investments or any further investments have been made as these may provide
further evidence to understand if the control was meant to be temporary in nature or otherwise.
Where a component is excluded from the consolidated financial statements, the auditor should
examine the reasons for exclusion and whether such exclusion is in conformity with the applicable
financial reporting framework, for example, under the Companies (Accounting Standards) Rules,
2006, there could be two reasons for exclusion of a subsidiary, associate or jointly controlled entity-
one, that the relationship of parent with the subsidiary, associate or jointly controlled entity is
intended to be temporary or the subsidiary, associate or joint venture operates under severe long-
term restrictions which significantly impair its ability to transfer funds to the parent. Similarly, under
the Companies Act, 2013, intermediate subsidiary in India is not required to present consolidated
financial statements, if a company meets the following conditions:
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13.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(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 India 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.
Ind AS 110 also prescribes certain criteria where consolidated financial statements are not required.
In such cases, the auditor should satisfy himself that the exclusion made by the management falls
within these categories, example in the case of an entity which is excluded from consolidation on
the ground that the relationship of parent with the other entity as subsidiary, associate or joint
venture is temporary, the auditor should verify that the intention of the parent, to dispose off the
subsidiary, investment in associate or interest in jointly controlled entity, in the near future, existed
at the time of acquisition of the subsidiary, making investment in associate or jointly controlled entity.
The auditor should also verify that the reasons for exclusion are given in the consolidated financial
statements. If an entity is excluded from the consolidated financial statements for reasons other than
those allowed by the applicable financial reporting framework, the auditor should consider its effect
on the auditor’s report to be issued.
The auditor should also examine whether there is any change in the status of a component (e.g.,
subsidiary to associate, JV to associate or vice – versa). The auditor, in such cases, should examine
whether these changes have been appropriately accounted for in the consolidated financial
statements as required by the relevant accounting standards/Ind AS under the applicable financial
reporting framework.
(a) In preparing consolidated financial statements in accordance with the Companies
(Accounting Standards) Rules, 2006, the financial statements of the parent and its
subsidiaries are combined on a line-by-line basis by adding together like items of assets,
liabilities, income, expenses and cash flows and then certain calculations like
determination of goodwill or capital reserve, minorities interest and adjustments like
elimination of intra group transactions, balances and unrealised profits etc. are made in
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.15
accordance with the requirements of Accounting Standard (AS) 21, “Consolidated
Financial Statements”. Investments in associates are accounted for using the Equity
Method as prescribed in Accounting Standard (AS) 23, “Accounting for Investments in
Associates in Consolidated Financial Statements”. A parent that has an interest in a
jointly controlled entity, reports its interest in the consolidated financial statements using
proportionate consolidation method in accordance with Accounting Standard (AS) 27,
“Financial Reporting of Interests in Joint Ventures”. Many of the procedures appropriate
for the application of equity method and the proportionate consolidation method are
similar to the consolidation procedures set out in Accounting Standard (AS) 21,
“Consolidated Financial Statements”.
(b) For consolidation of subsidiaries in accordance with the Companies (Indian
Accounting Standards) Rules, 2015:
• the financial statements of the parent and its subsidiaries are combined as per
Ind AS 110, “Consolidated Financial Statements” on a line-by-line basis by adding
together like items of assets, liabilities, income, expenses and cash flows;
• related goodwill/ capital reserve (or gain on bargain purchase) and non-controlling
interest is determined as per Ind AS 103;
• business combinations involving entities or businesses under common control
shall be accounted for using the pooling of interest method in accordance with Ind
AS 103;
• adjustments like elimination of intra-group transactions, balances, unrealised
profits and deferred tax etc. are made in accordance with the requirements of Ind
AS 110;
• investments in associates and joint ventures are accounted for using the Equity
Method as prescribed in Indian Accounting Standard (Ind AS) 28, “Investments in
Associates and Joint Ventures”. Interests in assets, liabilities, revenues and
expenses in a joint operation are accounted for as part of separate financial
statements of the entity in accordance with Indian Accounting Standard (Ind AS)
111, “Joint Arrangements”;
• in a business combination achieved in stages, the acquirer shall remeasure its
previously held equity interest in the acquiree at its acquisition-date fair value and
recognise the resulting gain or loss, if any, in profit or loss or other comprehensive
income, as appropriate in accordance with Ind AS 103.
The auditor should verify that the adjustments warranted by the relevant accounting standards under
the applicable financial reporting framework have been made wherever required and have been
properly approved by the management of the parent. The preparation of consolidated financial
statements gives rise to permanent consolidation adjustments and current period consolidation
adjustments. The auditor should also pay attention to off balance sheet entities which sometimes do
not qualify for the definition of subsidiary, however, parent might have transferred risks of various
business ventures to these entities. Further, de-facto control should also be considered.
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13.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
De facto control means an investor with less than the majority of the voting rights has the
practical ability to direct the relevant activities unilaterally.
TEST YOUR UNDERSTANDING 1
CA. Mukund is in the second year of his term as statutory auditor of Style Marks Limited (Holding
company), its subsidiaries and joint ventures. At the time of planning audit, he wants to be sure that
all the components have been included in the consolidated financial statements. List out some
procedures he should perform to verify completeness of this information.
6. SPECIAL CONSIDERATIONS
6.1 Permanent Consolidation Adjustments
Permanent consolidation adjustments are those adjustments that are made only on the first occasion
or subsequent occasions in which there is a change in the shareholding of a particular entity which
is consolidated. Permanent consolidation adjustments are:
(a) Determination of (b) Determination of
goodwill or capital reserve amount of equity
as per applicable attributable to minority/
accounting standards. non- controlling interests.
The auditor should verify that the above calculations have been made appropriately.
♦ The auditor should pay particular attention to the determination of pre-acquisition reserves of
the components. Date(s) of investment in components assumes importance in this regard.
♦ The auditor should also examine whether the pre-acquisition reserves have been allocated
appropriately between the parent and the minority interests/ non-controlling interests of the
subsidiary.
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GROUP AUDITS 13.17
♦ The auditor should also verify the changes that might have taken place in these permanent
consolidation adjustments on account of subsequent acquisition of shares in the components,
disposal of the components in the subsequent years.
It may happen that while working out the permanent consolidation adjustments, in the case of one
subsidiary, goodwill arises and in the case of another subsidiary, capital reserve arises. The parent
may choose to net off these amounts to disclose a single amount in the consolidated balance sheet
where permitted by the applicable financial reporting framework. In such cases, the auditor should
verify that the gross amounts of goodwill and capital reserves arising on acquisition of various
subsidiaries have been disclosed in the notes to the consolidated financial statements to reflect the
excess/shortage over the parents’ portion of the subsidiary’s equity.
XYZ Ltd. is a company engaged in the manufacture of tyres for four wheelers and two
wheelers through its subsidiaries ABC Ltd. and MNO Ltd. The company has invested
70% in ABC Ltd. During the FY 2021-22, the company reduced the control over ABC
Ltd. from 70% to 55%. Consequently, certain adjustments were made to the accounts for the
change in share of equity held in XYZ Ltd. whose financials are being consolidated. Such kind of
adjustments are known as permanent consolidation adjustments.
6.2 Current Period Consolidation Adjustments
Current period adjustments are those adjustments that are made in the accounting period for which
the consolidation of financial statements is done.
Consolidation – Elimination of inter-company purchases as sales
Sale 120
Cost 100
Sale 100
GM 20
Cost 60
GM 40 B 3rd party
A
What happened?
Sale 90 C Sale 120
Cost 55 Cost 60
GM 35 GM 60
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13.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Current period consolidation adjustments primarily relate to the elimination of intra-group
transactions and account balances including:
(a) intra-group interest paid and received, or management fees, etc.;
(b) unrealised intra-group profits on assets acquired/ transferred from/ to other subsidiaries;
(c) record deferred taxes on unrealised intercompany profits elimination in accordance with Ind
AS 12;
(d) intra-group indebtedness;
(e) adjustments related to harmonising the different accounting policies being followed by the
parent and its components;
(f) adjustments to the financial statements (of the parent and the components being
consolidated) for recognized subsequent events or transactions that occur between the
balance sheet date and the date of the auditor’s report on the consolidated financial
statements of the group.
There are two types of subsequent events:
(i) The first type of subsequent events consists of events or transactions that provide
additional evidence about conditions that existed at the date of the financial
statements, including the estimates inherent in the process of preparing financial
statements (i.e. adjusting events).
(ii) The second type of subsequent events consists of events that provide evidence about
conditions that did not exist at the date of the financial statements but arose
subsequent to that date (i.e. non-adjusting events).
Events occurring after balance sheet date which do not require adjustments would not
normally require disclosure, although they may be of such significance that they may require
a disclosure in the report of approving authority in the case of accounting standards and in
the financial statements in case of Ind AS. For such events, the following shall be disclosed:
(i) The nature of the event; and
(ii) An estimate of its financial effect or a statement that such an estimate cannot be made.
(g) adjustments for the effects of significant transactions or other events that occur between the
date of the components balance sheet and not already recognised in its financial statements
and the date of the auditor’s report on the group’s consolidated financial statements when
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GROUP AUDITS 13.19
the financial statements of the component to be used for consolidation are not drawn upto
the same balance sheet date as that of the parent;
(h) In case of a foreign component, adjustments to convert a component’s audited financial
statements prepared under the component’s local GAAP to the GAAP under which the
consolidated financial statements are prepared;
(i) determination of movement in equity attributable to the minorities interest/non-controlling
interest since the date of acquisition of the subsidiary. It should also be noted that under Ind
AS, non-controlling interest can also result in negative balance. Unlike earlier AS, as per
paragraph 28 of Ind AS 27, if the net worth of subsidiary is negative, non-controlling interest
could have deficit balance;
(j) adjustments of deferred tax on account of temporary differences arising out of elimination of
profit and losses resulting from intragroup transactions and undistributed profits of the
component in case of consolidated financial statements prepared under Ind AS.
The adjustments required for preparation of consolidated financial statements are made in
memorandum records kept for the purpose by the parent. The auditor should review the
memorandum records to verify the adjustment entries made in the preparation of consolidated
financial statements.
Apart from reviewing the memorandum records, the auditor should inter alia:
(a) verify that the intra group transactions and account balances have been eliminated;
(b) verify that the consolidated financial statements have been prepared using uniform
accounting policies for like transactions and other events in similar circumstances;
(c) verify that adequate disclosures have been made in accordance with AS 21 in the
consolidated financial statements of application of different accounting policies in case, it was
impracticable to harmonize them. Applying a requirement is impracticable when the entity
cannot apply it after making every reasonable effort to do so 4 but while preparing CFS under
Ind AS, auditors should ensure that appropriate adjustments are made to that group
member’s financial statements in preparing the consolidated financial statements to ensure
conformity with the group’s accounting policies in accordance with Ind AS 110;
4 AS 21/ AS 23/ AS 27 permit application of different accounting policies, if it is impractical to use uniform accounting
policies, that fact should be disclosed together with the proportion of the items in the consolidated financial statements
to which the different accounting policies have been applied. Ind AS 28 permits that financial statement of an associate
can be prepared using different accounting policies if it is impractical to do so however adjustment shall be made to make
the accounting policies confirm to those of parent when the financial statements are used by parent in applying the equity
method.
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13.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) verify the adjustments made to harmonise the different accounting policies including
adjustments made by management to convert a component’s financial statements prepared
under the component’s GAAP to the GAAP under which the consolidated financial statements
are prepared;
(e) verify the calculation of minorities/non-controlling interest;
(f) verify adjustments relating to deferred tax on account of temporary differences arising out of
elimination of profit and losses resulting from intergroup transactions (where the parent’s
accounts are maintained in Ind AS);
(g) verify that income and expenses of the subsidiary are included in consolidated financial
statements from the date it gains control until the date when the entity ceases to control the
subsidiary and further such income and expenses are based on the amounts of the assets
and liabilities recognised in consolidated financial statements at the acquisition date 5.
The auditor should gain an understanding of the procedures adopted by the management of the
enterprise to make the above mentioned adjustments. This helps the auditor in reducing the audit
risk to an acceptably low level.
One of the important adjustment that may be required in the current period is determination of
impairment loss that might exist for goodwill arising on consolidation. Goodwill arising on
consolidation is carried at the value determined at the date of acquisition of the component, and the
same is to be tested for impairment loss at every balance sheet date.
The auditor should examine whether any impairment loss has been determined by the parent. If yes,
the auditor should examine the procedure followed for determination of impairment loss. The auditor
should satisfy himself that the amount of impairment loss determined is fair. In case the impairment
loss in goodwill of a component has been determined in foreign currency, the auditor should verify
if any amount of loss in local currency need to be adjusted from currency translation reserve on
account of movement in the exchange rate from the date when the goodwill was first accounted for
in the consolidated financial statement of parent, to the date of determination of impairment loss.
The auditor should also perform audit procedures to understand and verify whether intragroup losses
are indicating an impairment loss that requires recognition in the consolidated financial statements.
Apart from verifying that the calculation and disclosures regarding minorities/non-controlling interest
have been made appropriately, the auditor also determines, in cases where the minority interests’
share of the losses exceed the minority/non-controlling interests’ share of the equity, the excess,
and any further losses applicable to the minority interest, have been accounted for in accordance
with the relevant accounting standards.
5 Where the consolidated financial statements are prepared under Indian Accounting Standards.
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GROUP AUDITS 13.21
The financial statements of the components used in the consolidation should be drawn up to the
same reporting date as that of the parent. If it is not practicable to draw up the financial statements
of one or more components to such date and, accordingly, those financial statements are drawn up
to different reporting dates, adjustments should be made for the effects of significant transactions or
other events that occur between those dates and the date of the parent’s financial statements. In
any case, the difference between reporting dates should not be more than six months in case of
financial statements under AS and three months in case of financial statements under Ind AS. The
auditor of the consolidated financial statements should review other components’ results between
its financial reporting date and that of the parent for significant transactions or other events that have
taken place during the period and, therefore, need to be reflected in the consolidated financial
statements. Recognition should be given by disclosure or otherwise to the effect of intervening
events which materially affect the financial position, results of operations or cash flows.
The fundamental accounting assumption of “consistency” requires the auditor of the consolidated
financial statements to consider whether the length of the reporting periods and any difference in
financial year-ends are the same from period to period. If there have been any changes in the
respective reporting periods of the components included in the consolidated financial statements
that have a material effect on the financial statements, the auditor should ensure that the entity
discloses such changes and the manner of treatment in the financial statements.
The Ministry of Corporate Affairs has issued a Circular number 39/2014 dated October 14, 2014
stating that Schedule III to the Act read with the applicable Accounting Standards does not envisage
that a company while preparing its consolidated financial statements merely repeats the disclosures
made by it under separate financial statements being consolidated. In the consolidated financial
statements, the company would need to give all disclosures relevant to consolidated financial
statements only.
Further, Accounting Standard (AS) 21 also lays down certain principles that should be observed
while giving the information which is part of the separate financial statements of the Components
but that need not be reported in the notes and other explanatory material of the consolidated financial
statements.
The auditor should:
(a) examine that the notes required by the applicable standards which are necessary for
presenting a true and fair view of the consolidated financial statements have been included
in the consolidated financial statements as an integral part thereof; and
© The Institute of Chartered Accountants of India
13.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) examine that additional statutory information disclosed in the separate financial statements
of the subsidiary and/or a parent having bearing on the true and fair view of the consolidated
financial statements have been disclosed in the consolidated financial statements.
In addition, the information required pursuant to Schedule III to the Companies Act, 2013 (‘general
instructions for the preparation of consolidated financial statements’) should be disclosed.
Example 2. Following information is also required to be disclosed in the consolidated financial
statements separately for the parent and each of its components (including foreign component)
which has been consolidated:
(i) amount of net assets and net assets as a percentage of consolidated net assets;
(ii) amount of share in profit or loss and the percentage share in profit or loss as a percentage
of consolidated profit or loss;
(iii) amount in other comprehensive income (OCI) and the percentage of OCI as a percentage of
Consolidated OCI. 6
As regards consolidation adjustments (including elimination of intra group transactions), it should be
ensured that these are either disclosed as a single line item separately or adjusted in the information
(e.g. net assets) disclosed for the parent and its each component.
The Ind AS 110 does not give a list of information which is part of the separate financial statement
of the components but that need not be reported in the notes and other explanatory material of the
consolidated financial statements, however, based on section 129(4) and MCA circular 39/2014 as
referred above, it can be construed that, even in consolidated financial statements under Ind AS,
only those disclosures should be given which are relevant to consolidated financial statements.
Based on the above discussion, in case of companies, the information such as the following given
in the notes to the separate financial statements of the parent and/or the subsidiary, need not be
included in the consolidated financial statements.
(i) Source from which bonus shares are issued, e.g., capitalisation of profits or reserves or from
securities premium account.
(ii) Disclosure of all unutilised monies out of the issue indicating the form in which such unutilised
funds have been invested.
(iii) Disclosure required under Micro, Small and Medium Enterprises Development Act, 2006.
6 For companies which are covered by Ind AS.
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GROUP AUDITS 13.23
(iv) A statement of investments (whether shown under “financial assets or non-financial assets
as stock-in-trade) separately classifying trade investments and other investments, showing
the names of the bodies corporate (indicating separately the names of the bodies corporate
under the same management) in whose shares or debentures, investments have been made
(including all investments, whether existing or not, made subsequent to the date as at which
the previous balance sheet was made out) and the nature and extent of the investment so
made in each such body corporate.
(v) Value of imports calculated on C.I.F. basis by the company during the financial year in respect
of:
(a) raw materials;
(b) components and spare parts;
(c) capital goods.
(vi) Expenditure in foreign currency during the financial year on account of royalty, know-how,
professional and consultation fees, interest, and other matters.
(vii) Value of all imported raw materials, spare parts and components consumed during the
financial year and the value of all indigenous raw materials, spare parts and components
similarly consumed and the percentage of each to the total consumption.
(viii) The amount remitted during the year in foreign currencies on account of dividends, with a
specific mention of the number of non-resident shareholders, the number of shares held by
them on which the dividends were due and the year to which the dividends related.
(ix) Earnings in foreign exchange classified under the following heads, namely:
(a) export of goods calculated on F.O.B. basis;
(b) royalty, know-how, professional and consultation fees;
(c) interest and dividend;
(d) other income, indicating the nature thereof.
However, notwithstanding the above, the auditor needs to ensure compliance with disclosure
requirements of applicable accounting standards and other applicable laws for consolidated financial
statements.
© The Institute of Chartered Accountants of India
13.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
7. MANAGEMENT REPRESENTATIONS
SA 580, “Written Representations” requires the auditor to obtain written representations from
management and, where appropriate, those charged with governance. The auditor of the
consolidated financial statements should obtain evidence that the management of the parent
acknowledges its responsibility for a true and fair presentation of the consolidated financial
statements in accordance with the financial reporting framework applicable to the parent and that
parent management has approved the consolidated financial statements. In addition, the auditor of
the consolidated financial statements obtains written representations from parent management on
matters material to the consolidated financial statements.
Examples of such representations include:
(a) Completeness of components included in the CFS;
(b) Identification of reportable segments for segmental reporting;
(c) Identification of related parties and related party transactions for reporting;
(d) Appropriateness and completeness of permanent and current period
consolidation adjustments, including the elimination of intra-group
transactions.
8. REPORTING
There could be two situations in an audit of consolidated financial statements–-when the parent’s
auditor is also the auditor of all the components to be included in the consolidated financial
statements and when the parent’s auditor is not the auditor of one or more components and
therefore, uses the work of other auditors in the audit. The auditor should, while preparing the report,
consider the requirements of Standard on Auditing (SA) 700, “Forming an Opinion and Reporting on
Financial Statements”, SA 705, “Modifications to the Opinion in the Independent Auditor’s Report
and SA 706, “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent
Auditor’s Report. Where, the auditor uses the work of other auditors in the audit of consolidated
financial statements, the requirements of SA 600, “Using the Work of Another Auditor” should also
be considered.
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.25
Reporting
When the
Component(s) When the
When the When the Auditor Reports Component(s)
Parent’s Parent’s on Financial Auditor Reports
Auditor is also Auditor is not Statements under an Components
the Auditor of the Auditor of under an Auditing Not Audited.
all its its Accounting Framework
Components. Components. Framework different than
different than that of the
that of the Parent.
Parent.
8.1 When the Parent’s Auditor is also the Auditor of all its Components
While drafting the audit report, the auditor should report:
♦ Whether principles and procedures for preparation and presentation of consolidated financial
statements as laid down in the relevant accounting standards have been followed.
In case of any departure or deviation, the auditor should consider the requirements given in
SA 705, Modifications to the Opinion in the Independent Auditor’s reports in the audit report
so that users of the consolidated financial statements are aware of such deviation.
♦ Auditor should issue an audit report expressing opinion whether the consolidated financial
statements give a true and fair view of the state of affairs of the Group as on balance sheet
date and as to whether consolidated profit and loss statement gives true and fair view of the
results of consolidated profit or losses of the Group for the period under audit.
♦ Where the consolidated financial statements also include a cash flow statement, the auditor
should also give his opinion on the true and fair view of the cash flows presented by the
consolidated cash flow statements.
8.2 When the Parent’s Auditor is not the Auditor of all its Components
In a case where the parent’s auditor is not the auditor of all the components included in the
consolidated financial statements, the auditor of the consolidated financial statements should also
consider the requirement of SA 600.
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13.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
As prescribed in SA 706, if the auditor considers it necessary to make reference to the audit of the
other auditors, the auditor’s report on the consolidated financial statements should disclose clearly
the magnitude of the portion of the financial statements audited by the other auditor(s).
This may be done by stating aggregate rupee amounts or percentages of total assets, revenues and
cash flows of components included in the consolidated financial statements not audited by the
parent’s auditor.
Total assets, revenues and cash flows not audited by the parent’s auditor should be presented
before giving effect to permanent and current period consolidation adjustments.
Reference in the report of the auditor on the consolidated financial statements to the fact that part
of the audit of the group was made by other auditor(s) is not to be construed as a qualification of the
opinion but rather as an indication of the divided responsibility between the auditors of the parent
and its subsidiaries.
8.3 When the Component(s) Auditor Reports on Financial Statements
under an Accounting Framework Different than that of the Parent
The parent may have components located in multiple geographies outside India applying an
accounting framework (GAAP) that is different than that of the parent in preparing its financial
statements. Foreign components prepare financial statements under different financial reporting
frameworks, which may be a well-known framework (such as US GAAP or IFRS) or the local GAAP
of the jurisdiction of the component. Local component auditors may be unable to report on financial
statements prepared using the parent’s GAAP because of their unfamiliarity with such GAAP.
When a component’s financial statements are prepared under an accounting framework that is
different than that of the framework used by the parent in preparing group’s consolidated financial
statements, the parent’s management perform a conversion of the components’ audited financial
statements from the framework used by the component to the framework under which the
consolidated financial statements are prepared. The conversion adjustments are audited by the
principal auditor to ensure that the financial information of the component(s) is suitable and
appropriate for the purposes of consolidation.
A component may alternatively prepare financial statements on the basis of the parent’s accounting
policies, as outlined in the group accounting manual, to facilitate the preparation of the group’s
consolidated financial statements. The group accounting manual would normally contain all
accounting policies, including relevant disclosure requirements, which are consistent with the
requirements of the financial reporting framework under which the group’s consolidated financial
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GROUP AUDITS 13.27
statements are prepared. The local component auditor can then audit and issue an audit report on
the components financial statements prepared in accordance with “group accounting policies”.
When applying the approach of using group accounting policies as the financial accounting
framework for components to report under, the principal/parent auditors should perform procedures
necessary to determine compliance of the group accounting policies with the GAAP applicable to
the parent’s financial statements. This ensures that the information prepared under the requirements
of the group accounting policies will be directly usable and relevant for the preparation of
consolidated financial statements by the parent entity, eliminating the need for auditing by the
auditor, the differences between the basis used for the component’s financial statements and that
of the consolidated financial statements. The Principal auditor can then decide whether or not to rely
on the components’ audit report and make reference to it in the auditor’s report on the consolidated
financial statements.
8.4 When the Component(s) Auditor Reports under an Auditing
Framework Different than that of the Parent
Normally, audits of financial statements, including consolidated financial statements, are performed
under auditing standards generally accepted in India (“Indian GAAS”).
In order to maintain consistency of the auditing framework and to enable the parent auditor to rely
and refer to the other auditor’s audit report in their audit report on the consolidated financial
statements, the components’ financial statements should also be audited under a framework that
corresponds to Indian GAAS.
8.5 Components Not Audited
Generally, the financial statements of all components included in consolidated financial statements
should be audited or subjected to audit procedures in the context of a multi-location group audit.
Such audits and audit procedures can be performed by the auditor reporting on the consolidated
financial statements or by the components’ auditor.
Where the financial statements of one or more components continue to remain unaudited, the auditor
reporting on the consolidated financial statements should consider unaudited components in
evaluating a possible modification to his report on the consolidated financial statements. The
evaluation is necessary because the auditor (or other auditors, as the case may be) has not been
able to obtain sufficient appropriate audit evidence in relation to such consolidated
amounts/balances. In such cases, the auditor should evaluate both qualitative and quantitative
factors on the possible effect of such amounts remaining unaudited when reporting on the
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13.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
consolidated financial statements using the guidance provided in SA 705, “Modifications to the
Opinion in the Independent Auditor’s Report”.
TEST YOUR UNDERSTANDING 2
CA. Kajal is nearing completion of audit of consolidated financial statements of Rubic Paints and
Chemicals Limited. She requires written representations from the parent’s management on matters
material to the consolidated financial statements. What specific matters such written representations
can include?
TEST YOUR UNDERSTANDING 3
CA.M is auditor of consolidated financial statements of “D and D Limited” for year 2022-23. The
consolidated financial statements consist of financial statements and financial information of 8
subsidiaries audited by other auditors. Such financial statements, financial information and auditor’s
reports of subsidiaries have been furnished by management of the “D and D Limited” to him.
Following further information is also available in respect of these 8 subsidiaries for year 2022-23: -
Total assets ` 1500 crore
Total revenues ` 1000 crore
Net cash outflows ` 10 crore
Two of these subsidiaries are located outside India whose financial statements have been prepared
in accordance with accounting principles generally accepted in their respective countries and which
have been audited by other auditors under generally accepted auditing standards applicable in their
respective countries.
Where and how such information should be included in independent auditor’s report on consolidated
financial statements of company? Also draft a suitable para by making necessary assumptions.
Integrated Case Scenario
While auditing consolidated financial statements of YK Industries Limited for the year 2022-23, a
manufacturing company whose financial statements are required to be prepared in accordance with
Division II of Schedule III of Companies Act, 2013, CA. Palash Shah notices as under: -
(A) The notes to accounts in respect of consolidated financial statements disclose additional
information pertaining to the holding company and its subsidiaries. It provides disclosure regarding
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GROUP AUDITS 13.29
percentages of consolidated net assets, of consolidated profit and loss and of total comprehensive
income along with their respective amounts pertaining to holding company and its subsidiaries.
(B) It is noticed by him that financial statements of one foreign subsidiary included in consolidated
financial statements are drawn up to 31St December, 2022 in accordance with legal requirements in
US. He feels it to be weird and is of the view that consolidated financial statements of group could
present a distorted picture. The management, in turn, informs him that it is not practicable to draw
the financial statements of foreign subsidiary to 31st March, 2023.
(C) During the year 2022-23, goodwill of Rs.50 crore had arisen on account of the acquisition of a
subsidiary during the year and there is no impairment loss as on the balance sheet date. Besides,
adjustments have been made in consolidated financial statements with respect to intra-group
indebtedness and those related to harmonizing different accounting policies being adopted by parent
and its subsidiaries.
(D) It is noticed by him that one subsidiary was acquired on 15.6.22. He is in a dilemma as regards
to the correctness of consolidation of its financial statements in group financial statements.
Besides, he is also in the process of finalising audit report including matters to be reported under
CARO, 2020 in respect of consolidated financial statements. However, he is in a fix in respect of
manner of reporting under CARO,2020 relating to consolidated financial statements.
Based upon above information and description, answer the following questions:-
1. Considering disclosure of additional information in consolidated financial statements as
stated in para (A) of case study, which of the following statements is correct?
(a) The said disclosure is not proper as percentage of consolidated revenue from
operations along with respective amount pertaining to holding company and its
subsidiaries is also required.
(b) The said disclosure is not proper as percentage of other comprehensive income along
with respective amount pertaining to holding company and its subsidiaries is also
required.
(c) The said disclosure is not proper as percentages of consolidated revenue from
operations as well as other comprehensive income along with their respective amounts
pertaining to holding company and its subsidiaries are also required.
(d) The said disclosure is proper.
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13.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. What should be auditor’s proper course of action pursuant to situation highlighted in para [B]
relating to financial statements of a foreign subsidiary?
(a) The auditor should insist for drawing up of financial statements of foreign subsidiary
to 31St March,2023. The reason for impracticality is a mere excuse. In case of failure
to redraw, he can modify his opinion in accordance with SA 705.
(b) The auditor can accept management’s version.
(c) The auditor can accept management’s version. However, it is his duty to verify
adjustments made for effects of significant transactions or events occurring between
1st January 2023 and 31st March,2023.
(d) The auditor should modify his opinion by quantifying the financial effects of such an
inconsistency.
3 Which of the following statements is correct in respect of goodwill and other matters described
in the case scenario?
(a) Goodwill represents current period consolidation adjustments. Adjustments relating to
intra-group indebtedness and those relating to harmonizing different accounting
policies being adopted by the parent and its subsidiaries represent permanent
consolidation adjustments.
(b) Adjustments relating to goodwill, intra-group indebtedness and those relating to
harmonizing different accounting policies being adopted by parent and its subsidiaries
represent current period consolidation adjustments.
(c) Goodwill represents permanent consolidation adjustments. Adjustments relating to
intra-group indebtedness and those relating to harmonizing different accounting
policies being adopted by the parent and its subsidiaries represent current-period
consolidation adjustments.
(d) Goodwill and adjustments relating to harmonizing different accounting policies being
adopted by the parent and its subsidiaries represent permanent consolidation
adjustments. Adjustments relating to intra-group indebtedness represent current-
period consolidation adjustments.
4. Which of the following statements is most appropriate regarding consolidation of financial
statements of a subsidiary acquired on 15.6.22?
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GROUP AUDITS 13.31
(a) The auditor should verify that income and expenses of subsidiary are included in
consolidated financial statements from the date it gains control of subsidiary and
further such income and expenses are based on the amounts of the assets and
liabilities recognized in consolidated financial statements at the acquisition date.
(b) The auditor should verify that income and expenses of subsidiary are included in
consolidated financial statements for the complete financial year and further such
income and expenses are based on the amounts of the assets and liabilities
recognized in consolidated financial statements at the preceding reporting date.
(c) The auditor should verify that income and expenses of subsidiary are included in
consolidated financial statements from the date it gains control of subsidiary and
further such income and expenses are based on the amounts of the assets and
liabilities recognized in consolidated financial statements at the preceding reporting
date.
(d) The auditor should verify that income and expenses of subsidiary are included in
consolidated financial statements for the complete financial year and further such
income and expenses are based on the amounts of the assets and liabilities
recognized in consolidated financial statements at the acquisition date.
5. As regards reporting under reporting CARO,2020 in respect of consolidated financial
statements, which of the following is in accordance with requirements of law?
(a) A separate report providing Clause by Clause reporting under CARO,2020 is required
in respect of specified matters pertaining to parent and all subsidiaries incorporated in
India.
(b) It would be sufficient if report under CARO,2020 in respect of standalone financial
statements is supplemented with additional information in respect of all subsidiaries
incorporated in India.
(c) A separate report under CARO, 2020 in respect of all subsidiaries incorporated in India
together is required. It should be annexed with report under CARO,2020 in respect of
standalone financial statements.
(d) Reporting of details of subsidiaries together with paragraph numbers of reports under
CARO, 2020 of auditors of such companies incorporated in India containing
qualifications or adverse remarks would serve the purpose.
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13.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Key Takeaways
Whenever a parent decides to or is required to prepare and present consolidated financial
statements, it should do so in accordance with the requirements of applicable Accounting
Standards under the relevant financial reporting framework.
Accounting Standard (AS) 21 ‘Consolidated Financial Statements’ and Indian Accounting
Standard (Ind AS) 110, ‘Consolidated Financial Statements lay down principles and
procedures for preparation and presentation of consolidated financial statements under AS
and Ind AS respectively.
Consolidated financial statements are presented, to the extent possible, in the same format
as adopted by the parent for its separate financial statements.
According to Section 129(3) of the Companies Act, 2013, where a company has one or more
subsidiaries, including associate company and joint venture, it shall, in addition to its own
financial statements prepare a consolidated financial statement of the company and of all the
subsidiaries in the same form and manner as that of its own.
Section 129(4) of the said Act, provides that the provisions applicable to the preparation,
adoption and audit of the financial statements of a holding company shall, mutatis mutandis,
also apply to its the consolidated financial statements.
The responsibility for the preparation and presentation of consolidated financial statements,
among other things, is that of the management of the parent.
The principal auditor of the consolidated financial statements is responsible for expressing
an opinion on whether the consolidated financial statements are prepared, in all material
respects in accordance with the financial reporting framework under which the parent
prepares the consolidated financial statements in addition to reporting on the additional
matters as required under the Companies Act, 2013 and any other statute to the extent
applicable.
Standards on Auditing, Statements and Guidance Notes on auditing matters issued by the
Institute of Chartered Accountants of India (ICAI) apply in the same manner to audit of
consolidated financial statements as they apply to audit of standalone financial statements.
When an auditor accepts the audit of consolidated financial statements, the auditor should
assess whether based on his work alone he would be able to express an opinion on the true
and fair view presented by the consolidated financial statements. If the auditor is of the view
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GROUP AUDITS 13.33
that his own participation may not be enough or sufficient, he should consider using the work
of ‘Other auditors’.
Before commencing an audit of consolidated financial statements, the auditor should plan his
work to enable him to conduct an effective audit in an efficient and timely manner.
Special considerations like Permanent consolidation adjustments and current period
consolidation adjustments need to be taken into account while auditing group financial
statements.
Permanent consolidation adjustments are those adjustments that are made only on the first
occasion or subsequent occasions in which there is a change in the shareholding of a
particular entity which is consolidated. Examples are determination of goodwill or capital
reserve, equity attributable to minority shareholders.
Current period adjustments are those adjustments that are made in the accounting period for
which the consolidation of financial statements is done like elimination of intra-group
transactions and account balances.
There could be two situations in an audit of consolidated financial statements–-when the
parent’s auditor is also the auditor of all the components to be included in the consolidated
financial statements and when the parent’s auditor is not the auditor of one or more
components and therefore, uses the work of other auditors in the audit.
The auditor should, while preparing the report, consider the requirements of Standard on
Auditing (SA) 700, “Forming an Opinion and Reporting on Financial Statements”, SA 705,
“Modifications to the Opinion in the Independent Auditor’s Report and SA 706, “Emphasis of
Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report. Where,
the auditor uses the work of other auditors in the audit of consolidated financial statements,
the requirements of SA 600, “Using the Work of Another Auditor” should also be considered.
Where the financial statements of one or more components continue to remain unaudited,
the auditor reporting on the consolidated financial statements should consider unaudited
components in evaluating a possible modification to his report on the consolidated financial
statements. The evaluation is necessary because the auditor (or other auditors, as the case
may be) has not been able to obtain sufficient appropriate audit evidence in relation to such
consolidated amounts/balances.
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13.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Whether preparation of consolidated financial statements is mandatory? If yes, please
elaborate on the requirements under the statute.
2. Please elaborate on the situations wherein the requirement related to preparation of
consolidated financial statements may not apply.
3. While doing the audit of Consolidated Financial Statements, which current period
consolidation adjustments are to be taken into account?
4. Write a short note on:
(a) Responsibility of holding company for preparation of Consolidated Financial
Statements.
(b) Permanent Consolidated Adjustments.
5. R Ltd. owns 51% voting power in S Ltd. It however, holds and discloses all the shares as
"Stock-in-trade" in its accounts. The shares are held exclusively with a view to their
subsequent disposal in the near future. R Ltd. represents that while preparing Consolidated
Financial Statements, S Ltd. can be excluded from the consolidation. As a Statutory Auditor,
how would you deal?
6. A Ltd. holds the ownership of 10% of voting power and control over the composition of Board
of Directors of B Ltd. While planning the statutory audit of A Ltd., what factors would be
considered by you as the statutory auditors of A Ltd for the audit of its consolidated financial
statements prepared under Ind AS?
7. You are appointed as an auditor of Nawab Limited, a listed company who is a main supplier
to the UK building and construction market. With a turnover of ` 2.9 billion, the company
operates through 11 business units and has nearly 180 branches across the countries .
As an auditor, how will you draft the report in case:
(a) When the Parent’s Auditor is also the Auditor of all its Components?
(b) When the Parent’s Auditor is not the Auditor of all its Components?
(c) When the Component(s) Auditor Reports on Financial Statements under an
Accounting Framework Different than that of the Parent?
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.35
(d) When the Component(s) Auditor Reports under an Auditing Framework Different than
that of the Parent?
(e) Where the financial statements of one or more components is not audited?
8. M Ltd. acquired 51 % shares of S Ltd. on 01-04-2019 and sold 25% of these shares during
the financial year 2019-20. M Ltd. did not prepare Consolidated Financial Statements for the
financial year 2019-20 on the plea that the control was only temporary. Do you agree with the
view of M Ltd.? Decide, assuming, that M Ltd. is required to prepare its financial statements
under Ind AS.
9. H Limited is an Investment Company preparing its Financial Statements in accordance with
Ind AS. The Company obtains funds from various investors and commits its performance for
fair return and capital appreciation to its investors. During the year under audit, it had been
observed that the Company had invested 25% in S1 Ltd., 50% in S2 Ltd. and 60% in S3 Ltd.
of the respective share capitals of the Investee Companies. When checking the investment
schedule of the Company, an issue cropped as to whether there would arise any need to
consolidate accounts of any such investee companies with those of H Limited in accordance
with section 129(3) of the Companies Act, 2013 which contains no exclusion from
consolidation. Analyse the issues involved and give your views.
10. Venus Ltd. is a company engaged in the manufacture of stainless steel items. The company
operates through 5 business units and has 35 branches across India. Manglam & Associates
are being appointed as the principal auditor of the company. While accepting the audit
assignment as the principal auditor, what will be the points of consideration for the principal
auditor of the company?
11. Venus Ltd. is a curtain manufacturing company having its corporate office in Punjab. The
company is in the process of expansion and has acquired four companies during the year.
Pradyuman & Co.is the principal auditor of the company while the audit of all the companies
acquired during the year is being conducted by Jha & Jha Associates. During the course of
audit, CA Pradyuman, the engagement partner asked the management of Venus Ltd. at the
corporate office that in order to conduct the audit of the consolidated financial statements,
his audit firm is required to conduct audit of the financial statements of all the components
also (Companies acquired during the year). To this, the management asked CA Pradyuman
to consider the audit reports of the component auditor already provided to his audit team and
to communicate with the component auditor for any discussion they wish to have. CA
Pradyuman contended that for the purpose of audit of consolidated financial statements either
© The Institute of Chartered Accountants of India
13.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
his firm is required to conduct an audit of all the component’s financial statements or he needs
the working papers of the component auditors. Is the contention of CA Pradyuman correct?
12. Kukreja & Associates is the principal auditor of MN Ltd. The company is engaged in the
manufacture of sports items and operates through its 14 branches all over India. With respect
to the audit of branches, the company has appointed seven Chartered Accountant firms, each
firm conducting the audit of two branches. The audit reports in respect of accounts of
branches have already been sent to the principal auditor. While analysing the work of the
branch auditors, CA Kukreja, the engagement partner, asked the branch auditors to share
with him a summary of the audit procedures and findings in respect of the accounts of the
branches examined by them. CA Kukreja also asked one of the branch auditor to share his
working paper with respect to the two branches examined by that branch auditor for his review
and return. Is the principal auditor correct in asking the branch auditors for sharing the
summary and the working papers for his review.
Answers to Test your Understanding.
1. The auditor should verify that all the components have been included in the consolidated
financial statements unless these components meet criterion for exclusion. In respect of
completeness of this information, the auditor should perform the following procedures:
(a) review his working papers for the prior years for the known components
(b) review the parent’s procedures for identification of various components
(c) make inquiries of management to identify any new components or any component
which goes out of consolidated financial statements
(d) review the investments of parent as well as its components to determine the
shareholding in other entities
(e) review the joint ventures and joint arrangements as applicable
(f) review the other arrangements entered into by the parent that have not been included
in the consolidated financial statements of the group
(g) review the statutory records maintained by the parent, for example registers under
section 186, 190 of the Companies Act, 2013
(h) also identify the changes in the shareholding that might have taken place during the
reporting period.
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.37
2. The auditor of the consolidated financial statements should obtain written representations
from parent‘s management on matters material to the consolidated financial statements.
Examples of such representations include:
(a) Completeness of components included in the consolidated financial statements;
(b) Identification of reportable segments for segment reporting
(c) Identification of related parties and related party transactions for reporting
(d) Appropriateness and completeness of permanent and current period consolidation
adjustments, including the elimination of intra-group transactions.
3. In a case where the parent‘s auditor is not the auditor of all the components included in the
consolidated financial statements, then as prescribed in SA 706, if the auditor considers it
necessary to make reference to the audit of the other auditors, the auditor’s report on the
consolidated financial statements should disclose clearly the magnitude of the portion of the
financial statements audited by the other auditors. This may be done by stating aggregate
rupee amounts or percentages of total assets, revenues and cash flows of components
included in the consolidated financial statements not audited by the parent‘s auditor.
It should be included in Other Matter paragraph of independent auditor’s report. The draft
“Other Matter Paragraph” is as under: -
Other Matter Paragraph
We did not audit the financial statements and other financial information, in respect of eight
(8) subsidiaries, whose financial statements include total assets of Rs.1500 crores as at
March 31, 2023, and total revenues of Rs.1,000 crores and net cash outflow of Rs. 10 crores
for the year ended on that date. These financial statements and other financial information
have been audited by other auditors and such financial statements, other financial information
and auditor’s reports have been furnished to us by the management of the Holding Company.
Our opinion on the consolidated financial statements, in so far as it relates to the amounts
and disclosures included in respect of these subsidiaries and joint ventures, and our report
in terms of sub-sections (3) of Section 143 of the Act, in so far as it relates to the aforesaid
subsidiaries is based solely on the reports of such other auditors.
Two of these subsidiaries are located outside India whose financial statements and other
financial information have been prepared in accordance with accounting principles generally
accepted in their respective countries and which have been audited by other auditors under
© The Institute of Chartered Accountants of India
13.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
generally accepted auditing standards applicable in their respective countries. The Holding
Company’s management has converted the financial statements of such subsidiaries from
accounting principles generally accepted in their respective countries to accounting principles
generally accepted in India.
We have audited these conversion adjustments made by the Holding Company’s
management. Our opinion in so far as it relates to the balances and affairs of such
subsidiaries is based on the report of other auditors and the conversion adjustments prepared
by the management of the Holding Company and audited by us. Our opinion on the
consolidated financial statements, and our report on Other Legal and Regulatory
Requirements is not modified in respect of the above matters with respect to our reliance on
the work done and the reports of the other auditors and the financial statements and other
financial information certified by the Management.
Answer to Integrated Case Scenario
1. (b)
2. (c)
3. (c)
4. (a)
5. (d)
Answers to Theoretical Questions
1. Refer Para 1.1
2. The requirement related to preparation of consolidated financial statements shall not apply to
a company 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 India or outside India; and
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.39
(iii) its ultimate or any intermediate holding company files consolidated financial
statements with the Registrar which are in compliance with the applicable Accounting
Standards.
3. Refer Para 6.2
4. (a) Refer Para 2
(b) Refer Para 6.118
5. Consolidation of Financial Statement: As per Ind AS 110, there is no such exemption for
‘temporary control’, or “for operation under severe long-term funds transfer restrictions” and
consolidation is mandatory for Ind AS compliant financial statement in this case. Paragraph
20 of Ind AS 110 states that “Consolidation of an investee shall begin from the date the
investor obtains control of the investee and cease when the investor loses control of the
investee”.
However, as per Section 129(3) of the Companies Act, 2013 read with rule 6 of the
Companies (Accounts) Rules, 2014, where a company having subsidiary, which is not
required to prepare consolidated financial statements under the Accounting standards, it shall
be sufficient if the company complies with the provisions on consolidated financial statements
provided in Schedule III to the Act.
In the given case, R Ltd’s intention is to dispose off the shares in the near future as shares
are being held as stock in trade and it is quite clear that the control is temporary, Therefore,
R Ltd. is required to prepare Consolidated Financial Statements in accordance with Ind AS
110 as exemption for ‘temporary control’ is not available under Ind AS 110.
6. 10% Voting Power and Control over the composition of Board of Directors: In this case,
A Ltd. holds only 10 percent of the voting power but has control over the composition of the
Board of Directors of B Ltd.
In such a case, A Ltd shall be considered as a parent of B Ltd and, therefore, it would
consolidate B Ltd in its consolidated financial statements as a subsidiary.
The auditor should verify A Ltd’s management’s assessment of having control in B Ltd despite
having only 10% voting power as per the requirements of Ind AS 110. Auditor would need to
verify as to how A Ltd controls the composition of the Board of Directors or corresponding
governing body of B Ltd.
© The Institute of Chartered Accountants of India
13.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
There can be various means by which such kind of control can be established. In this regard,
the auditor may verify the minutes of Board meetings, shareholder agreement entered into
by the parent, agreements with B Ltd to which the parent might have provided any technology
or know how, enforcement of statute, etc.
Further, the auditor should verify that the adjustments warranted by Ind AS 110 have been
made wherever required and have been properly authorised by the management of the
parent. The preparation of consolidated financial statements gives rise to permanent
consolidation adjustments and current period consolidation adjustments. The auditor should
make plan, among other things, for the understanding of accounting policies of the A Ltd and
B Ltd and determining and programming the nature, timing, and extent of the audit procedures
to be performed etc.
Further, the duties of an auditor with regard to reporting of transactions with any other related
parties are given in SA 550 on Related Parties. As per SA 550 on, “Related Parties”, the
auditor should review information provided by the management of the entity identifying the
names of all known related parties. A person or other entity that has control or significant
influence, directly or indirectly through one or more intermediaries, over the reporting entity
are considered as Related Party.
In forming an opinion on the financial statements, the auditor shall evaluate whether the
identified related party relationships and transactions have been appropriately accounted for
and disclosed in accordance with Ind AS 110 and Schedule III and whether the effects of the
related party relationships and transactions prevent the financial statements from achieving
true and fair presentation (for fair presentation frameworks) or cause the financial statements
to be misleading (for compliance frameworks).
7. Refer Para 8
8. Consolidation of Financial Statement: As per Ind AS 110, there is no such exemption for
‘temporary control’, or “for operating under severe long-term funds transfer restrictions” and
consolidation is mandatory for Ind AS compliant financial statement in this case.
Ind AS 110 states that “Consolidation of an investee shall begin from the date the investor
obtains control of the investee and cease when the investor loses control of the investee”.
In the given case, M Ltd acquired 51% shares of S Ltd on 01.04.2019 and sold 25% shares
during the year ended 2019-20. M Ltd did not consolidate the financial statements of S Ltd
for the year ended 31.03.2020 on the plea that control was only temporary. The intention of
© The Institute of Chartered Accountants of India
GROUP AUDITS 13.41
M Ltd. is quite clear that the control in S Ltd. is temporary as the former company disposed
off the acquired shares in the same year of its purchase.
However, even though the intention of M Ltd. is for temporary holding of shares in S Ltd. as
per Ind AS, M Ltd is required to prepare Consolidated Financial Statements in accordance
with Ind AS 110 as exemption for ‘temporary control’ is not available under Ind AS 110.
However, “Consolidation of an investee shall begin from the date the investor obtains control
of the investee and cease when the investor loses control of the investee”. Here, due to sale
of investment in S Ltd. up to 25%, M Ltd. loses control of S Ltd.
Accordingly, M Ltd., is required to prepare consolidated statement till the date of disposal of
the 25% shares to comply with the same.
9. Consolidated Financial Statements: According to Section 129(3) of the Companies Act,
2013, where a company has one or more subsidiaries, including associate company and joint
venture, it shall, in addition to its own financial statements prepare a consolidated financial
statement of the company and of all the subsidiaries in the same form and manner as that of
its own.
Further, as per Companies (Accounts) Rules, 2014, the consolidation of financial statements
of the company shall be made in accordance with the provisions of Schedule III to the Act
and the applicable accounting standards. However, a company 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.
However, an investment entity need not present consolidated financial statements if it is
required, in accordance with Ind AS 110‘Consolidated Financial Statements’, to measure all
of its subsidiaries at fair value through profit or loss. A parent shall determine whether it is an
investment entity.
(An investment entity is an entity that(a) obtains funds from one or more investors for the
purpose of providing those investor(s) with investment management services; (b) commits to
its investor(s) that its business purpose is to invest funds solely for returns from capital
appreciation, investment income, or both; and (c) measures and evaluates the performance
of substantially all of its investments on a fair value basis.)
In the given case, H Limited is an investment company preparing its financial statements in
accordance with Ind AS and the company had invested 25% in SI Ltd., 50% in S2 Ltd. and
© The Institute of Chartered Accountants of India
13.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
60% in S3 Ltd. of the respective share capitals of the investee companies. In view of
provisions discussed in Ind AS 110, the Company is not required to prepare consolidated
financial statements however, for the compliance of Companies (Accounts) Rules, 2014, it
shall be sufficient if the company complies with provisions on consolidated financial
statements provided in Schedule III of the Act.
Thus, it can be concluded that ultimate authority on consolidation is AS / Ind AS as prescribed
by law and if they give some exemption it should be followed. If out of exemption some
subsidiaries are not consolidated, then list should be disclosed in notes to accounts with
reason.
10. Acceptance as Principal Auditor :The principal auditor, Manglam & Assocaites, should
consider whether their own participation is sufficient to be able to act as the principal auditor.
For this purpose, the auditor would consider:
(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.
11. As per SA 600, “Using the work of Another auditor”, the principal auditor is normally entitled
to rely upon the work of component 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. 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.
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
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GROUP AUDITS 13.43
information of the components. He may also decide that supplemental tests of the records or
the financial statements of the component are necessary. Such tests may, depending upon
the circumstances, be performed by the principal auditor or the other auditor.
Accordingly, CA Pradyuman, can perform the above mentioned audit procedures. However,
the audit of the component’s financial statements by the principal auditor is not required.
So, the contention of CA Pradyuman that for the purpose of audit of consolidated financial
statements he is required to conduct an audit of the components financial statements is not
correct.
Further, SA 230 issued by ICAI on Audit Documentation, and “Standard on Quality Control
(SQC) 1, 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.
Accordingly, it is the discretion of the component auditor as the working papers with respect
to the components examined by the component auditor are the property of the component
auditor.
So, the contention of CA Pradyuman is not correct.
12. In terms of SA 600 “Using the Work of Another auditor”, 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. 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 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 Institute of Chartered Accountants of India
13.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Accordingly, CA Kukreja is correct in asking the branch auditors to share with him the
summary of their audit procedures and findings in respect of the accounts of the branches
examined by them.
Further, CA Kukreja has asked one of the branch auditors to share with him the working
papers with respect to the branches examined by such branch auditor for the former’s review
and return.
SA 230 issued by ICAI on Audit Documentation, and “Standard on Quality Control (SQC) 1,
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.
Accordingly, it is the discretion of the branch auditor as the working papers with respect to
the branches examined by the branch auditor are the property of the branch auditor.
So, CA Kukreja is not correct in asking the branch auditor to share with him the working
papers with respect to the branches examined by the branch auditor.
© The Institute of Chartered Accountants of India
CHAPTER 14
7
SPECIAL FEATURES OF AUDIT
OF BANKS & NON-BANKING
FINANCIAL COMPANIES
UNIT 1 – SPECIAL FEATURES OF AUDIT OF BANKS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Gain the knowledge of legal framework, form and content of financial
statements of the banks.
Know the feature of audit of accounts and auditor’s report.
Understand CRR, SLR and Capital Adequacy etc.
Understand the prescribed procedure to be followed while doing
verification of assets and liabilities of the bank.
Acquire the knowledge of Concurrent Audit and types of activities to be
covered in it.
Know the role of audit committee in audit of banks.
© The Institute of Chartered Accountants of India
14.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
UNIT OVERVIEW
Regulatory Framework
Form and Content of F.S.
Format of Audit Report
Audit of Accounts
LFAR
Auditor's Report
Coducting an Audit
Reporting to RBI,
Regulators etc.
Overview
Internal Control in Certain Selected
Areas
Assets and Balances
Verfication
Capital and Liabilities
Scope & its covered Activities
Coverage of Business/Branches
Concurrent Audit
Appointment of Auditors and its
accountability
Audit Committee
Audit Report
Viraj & Associates, an auditing firm of long standing and experience, has been appointed as one
of Statutory Central Auditors of a nationalized bank. Trying to gain understanding of working of
the bank including its internal control along with joint auditors, CA. Mansukh is also involved in
reviewing treasury operations of the bank as part of gaining insight in bank’s working.
Why are treasury operations of a bank significant from point of view of an auditor? Treasury
operations are responsible for processing of all financial market transactions and play a crucial
role in managing risks. Investments and forex & derivatives form two main components of
treasury. In view of regulatory prudential norms on investments, audit of investments becomes
very important as non-compliance with regulations could have a direct and material effect on
© The Institute of Chartered Accountants of India
SPECIAL FEATURES OF AUDIT OF BANKS & NON-BANKING 14.3
FINANCIAL COMPANIES
financial statements of the bank. He is also trying to gain understanding of General IT controls
and system application controls relating to these as investment function is automated in Bank.
He is also gaining knowledge of various types of deposit products of the bank (like CASA and
term deposits) and process of determination of interest rates and other charges of these deposits
as per rules laid down by bank. Going through bank policy on customer acceptance, procedures
to verify compliance of KYC norms are in offing. Apart from it, planned verification of application
of rate of interest to every deposit product on sample basis is also on the table. Verification of
movement of interest expenses is also in audit plan arsenal.
He is also considering to go through complaints lodged by bank customers. What is necessity to
plan procedures in this respect? Does auditor of a bank have anything to do with customer
complaints? Certainly. It is due to the reason that such complaints may result into material liability
or contingent liability.
CA. Piyush, Partner of P K S D & Associates (joint auditor) is in the process of familiarising himself
with credit recovery policy of the Bank and guidelines of RBI regarding accounting and income
recognition in this respect. He is also considering extent of automation of process relating to
accounting of recovery of credit portfolio of the Bank. Besides, he wants to ensure consistency
in income recognition process relating to order of recovery and its synchronization with internal
policy of the Bank. He is also planning procedures to ensure upgradation of NPAs during the year
in accordance with RBI norms.
Review of activities of Credit monitoring and restructuring department of Bank also falls in
domain of his responsibilities. Why such a review is important for him as an auditor? It is due to
the reason this department is responsible for implementing Bank’s policies relating to credit
monitoring and restructuring. Credit monitoring policy helps in managing credit risks in a
systematic and effective manner. Further, this department may also be responsible for
sanctioning of restructuring of stressed advances in accordance with RBI guidelines.
CA. Gopal, Partner of GSK & Co. (joint auditor) is verifying internal/office accounts of the bank
including sundry/suspense accounts. Why does such verification assume importance? Such
accounts can be used to commit frauds and malpractices like unauthorized opening and
operation of such accounts for affording credits to certain borrower accounts to prevent them
from slipping into NPAs. Opening of such accounts as well as their periodic reconciliation
becomes too significant for Statutory Central Auditors to ignore.
© The Institute of Chartered Accountants of India
14.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1. INTRODUCTION
The banking industry is the pivot of any economy and its financial system. Banks are one of the
foremost agents of financial intermediation in an economy like
India and, therefore, development of a strong and resilient
banking system is of utmost importance. The banking
institutions in the country are working in a competitive
environment and their regulatory framework is aligned with the
international best practices. Thus, financial deepening has
taken place in India and continues to be in progress with a focus
on orderly conditions in financial markets while sustaining the
growth momentum.
Banks have certain characteristics distinguishing them from most other commercial enterprises.
Example
Custody of large volumes of monetary items, including cash and negotiable instruments,
whose physical security has to be ensured. This applies to storage and the transfer of
monetary items, making banks vulnerable to misappropriation and fraud, necessitating
establishment of formal operating procedures, well-defined limits for individual discretion
and rigorous systems of internal control.
Engagement in a large volume and variety of transactions in terms of number and value
which necessarily require complex accounting and internal control systems and
widespread use of Information Technology (IT).
Operation through a wide network of geographically dispersed branches and departments
necessitating a greater decentralization of authority and dispersal of accounting and
control functions, with consequent difficulties in maintaining uniform operating practices
and accounting systems, particularly when the branch network transcends national
boundaries.
Assumption of significant commitments without any transfer of funds. These items, called
'off-balance sheet' items, may at times not involve accounting entries and the failure to
record such items may be difficult to detect.
Engagement in transactions that are initiated at one location, recorded at a different
location and managed at yet another location.
© The Institute of Chartered Accountants of India
SPECIAL FEATURES OF AUDIT OF BANKS & NON-BANKING 14.5
FINANCIAL COMPANIES
Direct Initiation and completion of transactions by the customer without any intervention
by the bank’s employees. For example, over the Internet or mobile or through automatic
teller machines (ATMs).
Integration and linkages of national and international settlement systems could pose a
systemic risk to the countries in which they operate.
Regulatory requirements by governmental authorities often influence accounting and
auditing practices in the banking sector.
Special audit considerations arise in the audit of banks because of:
• the particular nature of risks associated with the
transactions undertaken;
• the scale of banking operations and the resultant
significant exposures which can arise within short
period of time;
• the extensive dependence on IT to process
transactions;
• the effect of the statutory and regulatory requirements;
• the continuing development of new products and services and banking practices which may
not be matched by the concurrent development of accounting principles and auditing practices.
Evolution of technology and providing services through Net Banking and Mobiles has exposed
banks to huge operational and financial risk.
The auditor should consider the effect of the above factors in designing his audit approach. It is
imperative for Branch Auditors and SCAs (Statutory Central Auditors) to have detailed knowledge
of the products offered and risks associated with them, and appropriately address them in their
audit plan to the extent they give rise to the risk of material misstatements in the financial
statements.
In today’s environment, the banks use different applications to carry out different transactions
which may include data flow from one application to other application; the auditor while designing
his plans should also understand interface controls between the various applications.
© The Institute of Chartered Accountants of India
14.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. LEGAL FRAMEWORK
There is an elaborate legal framework governing the functioning of banks in India. The principal
enactments which govern the functioning of several types of banks are:
Banking
Co-operative Regulation Act,
Societies Act, 1912 1949 State Bank of India
for Co-operative Act, 1955
Banks
Payment and
Reserve Bank of
Settlement
India Act, 1934
Systems Act, 2007
Credit Information
Companies Companies Act,
(Regulation) Act, 2013
2005 Legal Framework for Banks in
India
Securitisation and Banking
Reconstruction of Companies
Financial Assets (Acquisition and
and Enforcement Transfer of
of Security Interest Undertakings) Act,
Act, 2002 1970
Prevention of
Regional Rural
Money Laundering
Banks Act, 1976
Act, 2002 Banking
Companies
Information
(Acquisition and
Technology Act,
Transfer of
2000
Undertakings) Act,
1980
© The Institute of Chartered Accountants of India
SPECIAL FEATURES OF AUDIT OF BANKS & NON-BANKING 14.7
FINANCIAL COMPANIES
Further, the Reserve Bank of India Act, 1934 gives wide powers to the RBI to give directions to
banks which also have considerable effect on the functioning of banks
3. FORM AND CONTENT OF FINANCIAL STATEMENTS
Every banking company is required to prepare a Balance Sheet and a Profit and Loss Account in
the forms set out in the Third Schedule to the Act or as near thereto as the circumstances admit.
Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of Balance
Sheet and Form B contains the form of Profit and Loss Account.
Every banking company needs to comply with the disclosure requirements under the various
Accounting Standards, as specified under section 133 of the Companies Act, 2013, read with Rule
7 of the Companies (Accounts) Rules 2014, in so far as they apply to banking companies or the
Accounting Standards issued by the ICAI. It may be noted that implementation of Indian
Accounting Standards (Ind AS) has been deferred by RBI for all scheduled commercial banks
presently.
It is pertinent to state that preparation of balance sheet of a bank usually involves preparation of
standalone financial statements and consolidated financial statements. Preparation of Standalone
financial statements involve consolidation of branch accounts and incorporation of various
verticals/departments of bank in case of a nationalized bank/public sector bank. The detailed
procedures in this regard may vary from bank to bank. In case of private banks, the processes of
accounting are centralized and there is no concept of mandatory branch audit in accordance with
RBI guidelines.
Public sector banks and private banks are listed on recognized stock exchange and are required
to comply with SEBI regulations including LODR.
3.1 Audit of Accounts & Appointment of Auditor
Sub-section (1) of section 30 of the Banking Regulation Act requires that the balance sheet and
profit and loss account of a banking company should be audited by a person duly qualified under
any law for the time being in force to be an auditor of companies.
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14.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Most banks, especially those in nationalised banks or public sector, appoint four or more
(depending upon their size and Board decision, as per RBI guidelines) firms of chartered
accountants to act jointly as statutory central auditors (SCAs).
The appointment letter sent by banks in connection with the appointment of SCAs
typically contains the following:
• Period of appointment.
• Particulars of other central auditors.
• Particulars of previous auditors.
• Procedural requirements to be complied with in accepting the assignment.
Example 1. Letter of acceptance (the letter usually contains, inter alia, averment as to
absence of disqualification for appointment, way in which the audit has to be conducted
and confirmation of present name, constitution and address of the auditor), declaration
of fidelity and secrecy, restriction on accepting other assignments from the bank, etc.
• A statement of division of work and review and reporting responsibilities amongst joint
auditors in case of nationalised banks (Generally this is decided at a later stage)
• Scope of assignment which includes any special reports or certificates to be given by the
SCAs in addition to the main report.
• In case of statutory branch auditors (SBAs), appointment letter is given on similar lines
except in regard to particulars of other auditors and statement of division of work.
However, it is to be noted that statutory branch audit is carried out by a single firm of
chartered accountants.
Authority appointing the Auditors - As per the provisions of the relevant enactments, the auditor
of a banking company is to be appointed at the annual general meeting of the shareholders,
whereas the auditor of a nationalised bank is to be appointed by the concerned bank acting
through its Board of Directors.
In either case, approval of the Reserve Bank is required before the appointment is made.
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4. CONDUCTING AN AUDIT
The audit of banks or of their branches involves the following stages –
Initial Considerations Understanding Risk Assessment Execution Reporting
• Acceptance & • Understanding the • Identifying and • Engagement Team • Independent
Continuance Bank and Its Assessing the Discussions Auditor’s
• Declaration of Environment Risks of Material • Prepare response Report
Indebtedness including Internal Misstatements to the Assessed • Long Form
• Internal Assignments in Control • Assess the Risk of Risks Audit Report
Banks by Statutory • Understand the Fraud including • Establish the • Report any
Auditors Bank’s Accounting Money Laundering Overall Audit other matters
• Terms of Audit Process • Assess Specific Strategy to Bank,
Engagements • Understanding the Risks • Audit Planning Regulator or
• Communication with Risk Management • Risk Associated Memorandum Government
Previous Auditor Process with Outsourcing • Determine Audit
• Planning of Activities Materiality
• Establish Engagement • Consider Going
Team Concern
Stage I: Initial Considerations
Acceptance & Continuance: The assessment of engagement risk is a critical part of the audit
process and should be done prior to the acceptance of an audit engagement since it affects the
decision of accepting the engagement and in planning decisions if the audit is accepted.
Declaration of Indebtedness: The RBI has advised that the banks, before appointing their statutory
central//branch auditors, should obtain a declaration of indebtedness i.e., a written confirmation that
auditor/firm/partners/f/family members have not been declared as wilful defaulters by any
bank/financial institution This is in addition to the declaration regarding absence of disqualifications
stipulated in Section 141 of the Companies Act 2013 which includes borrowing above stipulated
amount. Students may refer Chapter 12 of CA Intermediate Auditing and Assurance Study Material.
Internal Assignments in Banks by Statutory Auditors: The RBI decided that the audit firms
should not undertake statutory audit assignment while they are associated with internal assignments
in the bank during the same year.
Terms of Audit Engagements: SA 210, “Terms of Audit Engagements” requires that for each period
to be audited, the auditor should agree on the terms of the audit engagement with the bank before
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14.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
beginning significant portions of fieldwork. It is imperative that the terms of the engagement are
documented, to prevent any confusion as to the terms that have been agreed in relation to the audit
and the respective responsibilities of the management and the auditor, at the beginning of an audit
relationship. This is usually done in the form of engagement letter which is written by the auditor and
acknowledged by the bank.
Communication with Previous Auditor: As per Clause (8) of the Part I of the First Schedule to the
Chartered Accountants Act, 1949, a chartered accountant in practice cannot accept position as
auditor previously held by another chartered accountant without first communicating with him/her in
writing.
Planning: The audit plan needs to be properly documented with respect to timing, extent of
checking, audit procedures to be followed at assertion level and should be flexible and updated or
changed, as and when necessary.
Establish the Engagement Team: The assignment of qualified and experienced professionals is
an important component of managing engagement risk. The size and composition of the engagement
team would depend on the size, nature, and complexity of the bank’s operations.
Stage II : Understanding
Understanding the Bank and Its Environment including Internal Control: An understanding of
the bank and its environment, including its internal control, enables the auditor:
• to identify and assess risk;
• to develop an audit plan to determine the operating effectiveness of the controls, and to address
the specific risks.
Understand the Bank’s Accounting Process: The accounting process produces financial and
operational information for management’s use and it also contributes to the bank’s internal control.
Thus, understanding of the accounting process is necessary to identify and assess the risks of
material misstatement whether due to fraud or not, and to design and perform further audit
procedures.
Understanding the Risk Management Process: Management develops controls and uses
performance indicators to aid in managing key business and financial risks. An effective risk
management system in a bank generally requires the following:
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Oversight by those Identification,
Reliable information
charged with measurement and Control activities Monitoring activities
systems
governance monitoring of risks
• Those charged • Risks that could • A bank should • Risk management • Banks require
with governance significantly have appropriate models, reliable
(BOD/Chief impact the controls to methodologies information
Executive Officer) achievement of manage its risks, and assumptions systems that
should approve bank’s goals including effective used to measure provide adequate
written risk should be segregation of and manage risk financial,
management identified, duties should be operational and
policies. The measured and (particularly, regularly compliance
policies should be monitored against between front and assessed and information on a
consistent with pre-approved back offices), updated. This timely and
the bank’s limits and criteria accurate function may be consistent basis.
business measurement and conducted by the Those charged
objectives and reporting of independent risk with governance
strategies, capital positions, management unit. and management
strength, verification and require risk
management approval of management
expertise, transactions, information that is
regulatory reconciliation of easily understood
requirements and positions and and that enables
the types and results, setting of them to assess
amounts of risk it limits, reporting the changing
regards as and approval of nature of the
acceptable. exceptions, bank’s risk profile.
physical security
and contingency
planning.
Stage III : Risk Assessment
Identifying and Assessing the Risks of Material Misstatements: SA 315 requires the auditor to
identify and assess the risks of material misstatement at the financial statement level and the
assertion level for classes of transactions, account balances, and disclosures to provide a basis for
designing and performing further audit procedures.
Assess the Risk of Fraud including Money Laundering: As per SA 240 “The Auditor’s
Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor’s objective is to
identify and assess the risks of material misstatement in the financial statements due to fraud, to
obtain sufficient appropriate audit evidence on those identified misstatements and to respond
appropriately. The attitude of professional scepticism should be maintained by the auditor to
recognise the possibility of misstatements due to fraud.
The RBI has framed specific guidelines that deal with prevention of money laundering and “Know
Your Customer (KYC)” norms. The RBI has from time to time issued guidelines (“Know Your
Customer Guidelines – Anti Money Laundering Standards”), requiring banks to establish policies,
procedures and controls to deter and to recognise and report money laundering activities.
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Assess Specific Risks: The auditors should identify and assess specific risks of material
misstatement at the financial statement level which refers to risks that relate to the banking industry
and the use of IT therein.
Risk Associated with Outsourcing of Activities: The modern-day banks make extensive use of
outsourcing as a means of both reducing costs as well as making use of services of an expert not
available internally. There are, however, certain risks associated with outsourcing of activities by
banks and therefore, it is quintessential for the banks to effectively manage those risks.
Stage IV: Execution
Engagement Team Discussions: The engagement team should hold discussions to gain better
understanding of bank and its environment, including internal control, and to assess the potential for
material misstatements of the financial statements.
Response to the Assessed Risks: SA 330 “The Auditor’s Responses to Assessed Risks” requires
the auditor to design and implement overall responses to address the assessed risks of material
misstatement at the financial statement level. The auditor should design and perform further audit
procedures whose nature, timing and extent are based on and are responsive to the assessed risks
of material misstatement at the assertion level.
Establish the Overall Audit Strategy: SA 300 “Planning an Audit of financial Statements’’ states
that the objective of the auditor is to plan the audit so that it will be performed in an effective manner.
For this purpose, the audit engagement partner should:
• establish the overall audit strategy, prior to the commencement of an audit; and
• involve key engagement team members and other appropriate specialists while establishing
the overall audit strategy, which depends on the characteristics of the audit engagement.
Audit Planning Memorandum: The auditor should summarise the team’s audit plan by preparing
an audit planning memorandum in order to:
• Describe the expected scope and extent of the audit procedures to be performed by the
auditor.
• Highlight all significant issues and risks identified during their planning and risk assessment
activities, as well as the decisions concerning reliance on controls.
• Provide evidence that they have planned the audit engagement appropriately and have
responded to engagement risk, pervasive risks, specific risks, and other matters affecting the
audit engagement.
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Determine Audit Materiality: The auditor should consider the relationship between the audit
materiality and audit risk when conducting an audit. The determination of audit materiality is a matter
of professional judgment and depends upon the knowledge of the bank, assessment of engagement
risk, and the reporting requirements for the financial statements. Judgments about materiality are
made in light of surrounding circumstances and are affected by the size or nature of a misstatement,
or combination of both.
Consider Going Concern: In obtaining an understanding of the bank, the auditor should consider
whether there are events and conditions which may cast significant doubt on the bank’s ability to
continue as a going concern.
Stage V: Reporting
Students should refer to the reporting requirements explained in heading 8. Auditor’s Report of this
Chapter.
[Note: For detailed understanding of stages involved for conducting an audit, as discussed above,
students may refer Guidance Note on Audit of Banks.]
4.1 Special Considerations in IT Environment
The advent of working in CBS environment in banks coupled with changes in technology, use of
different payment systems and integration of Aadhar for cardless transactions have changed the
way banking used to be in earlier times. However, the technological developments have brought
new challenges for auditors as audit is required to be conducted through the system. Considering
the importance of IT systems in preparation and presentation of financial statements, it is imperative
that bank should share detailed information with auditors like: -
• Overall IT policy, structure and environment of Bank’s IT system
• Data processing and data interface under various systems
• Data integrity and data security
• Business Continuity plans and disaster control plans
• Accounting manual and critical accounting entries, their processes and involvement of IT systems
• Controls over key aspects, use of various account heads, expense booking, overdue identification
etc.
• Controls on recording of various e-banking and internet banking products and channels
• MIS reports being generated and their periodicity
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14.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Major exception reports and process of generation including embedded logic
• Process of generating various information related to various disclosures in financial statements
and involvement of IT systems
Overall review of IT environment and computerized accounting system has to be taken at head office
level. The branch auditors generally do not have access to IT policy and processes implemented by
the bank. Hence, based upon guidance and information received from Statutory central auditors,
branch auditors need to ensure that data review and analysis through CBS is carried out and tests
of controls and substantive checking of sample transactions is carried out at branch level and results
are shared with statutory central auditors.
It is responsibility of statutory central auditors to obtain understanding of IT environment and
various controls put in place by management and evaluate whether controls are operating
effectively. The methodology adopted by the bank in implementing and monitoring controls
should be discussed with head of IT department and based on this understanding, audit
procedures can be designed. The key security control aspects that an auditor needs to address
when undertaking audit in a computerised bank include:
• Ensure that authorised, accurate and complete data is made available for processing.
• Ensure that in case of interruption due to power, mechanical or processing failures, the
system restarts without distorting the completion of the entries and records.
• Ensure that the system prevents unauthorised amendments to the programmes.
• Verify whether “access controls” assigned to the staff-working match with the
responsibilities as per manual. It is important for the auditor to ensure that access and
authorisation rights given to employees are appropriate.
• Verify that segregation of duties is ensured while granting system access to users and
that the user activities are monitored by performing an activities log review.
• Verify that changes made in the parameters or user levels are authenticated.
• Verify that charges calculated manually for accounts when function is not regulated
through parameters are properly accounted for and authorised.
• Verify that exceptional transaction reports are being authorised and verified on a daily
basis by the concerned officials. It is important for auditor to understand the nature of
exception and its impact on financials.
• Verify that the account master and balance cannot be modified/amended/altered except
by the authorised personnel.
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• Verify that all the general ledger accounts codes authorised by Head Office are in
existence in the system.
• Verify that balance in general ledger tallies with the balance in subsidiary book. .
4.2 Internal Audit and Inspection
Central audit and inspection department in Banks is a combination of centralized function with some
level of decentralization which is usually headed by a Chief Audit Executive. It is responsible for
undertaking risk-Based Internal Audit (RBIA) as per the framework as stipulated by RBI. It is also
responsible for identification of branches for revenue audit, appointment of concurrent auditors,
deciding their scope, meeting the concurrent auditors, discussing their issues, conducting trainings
if needed, and review of work of concurrent auditors. The primary function is to ensure that the audit
function is handled smoothly, effectively & efficiently.
Risk-based Internal audit is conducted based upon the risk assessment of business and control risks
of branches. The risk assessment process includes: -
• Identification of inherent business risks in various activities undertaken by branches
(Business risk)
• Assessment of effectiveness of control systems for monitoring inherent risks of business
activities of branch (Control risk)
• Making an assessment of level and direction of various risk areas and assess level and
direction of overall business risk and control risk
• Drawing up of risk matrix taking into account factors viz. Risk of branch
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14.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
5. INTERNAL CONTROL IN CERTAIN SELECTED AREAS
System of Internal Control in Banks: Banks are required to implement and maintain a system of
internal controls for mitigating risks, maintain good governance and to meet the regulatory
requirements. Given below are examples of internal controls that are typically implemented in a
bank:
Area of Focus Examples of Internal Controls in a Bank
General • The staff and officers of a bank should be shifted from one position to
another frequently and without prior notice.
• The work of one person should always be checked by another person
(usually by an officer) in the normal course of business.
• The arithmetical accuracy of the books should be proved
independently every day.
• All bank forms (e.g. Cheque books, demand draft/pay order books,
travelers’ cheques, foreign currency cards etc.) should be kept in the
possession of an officer, and another responsible officer should verify
the issuance and stock of such stationery.
• The mail should be opened by a responsible officer. Signatures on all
the letters and advices received from other branches of the bank or
its correspondence should be checked by an officer with the signature
book.
• The signature book and the telegraphic code book should be kept with
responsible officers and access should be allowed only to authorised
officers.
• The bank should take out insurance policies against loss due to all the
risks such as fire, natural calamities, theft and employees’ infidelity.
• The financial powers of officers of different grades should be clearly
defined.
• There should be surprise inspection of head office and branches at
periodic interval by the internal audit department. The irregularities
pointed out in the inspection reports should be promptly rectified.
Cash • Cash should be kept in the joint custody of two responsible officers.
• In addition to normal checking by the chief cashier, cash should be
test-checked daily and counted in full occasionally by a responsible
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officer other than those handling the cash. Actual cash in hand should
agree with the balance shown by the Day Book every day.
• The cashier should have no access to the customer’s ledger accounts
and the Day Book. This is an important safeguard as the Bank
managements are often tempted to use cashiers because of their
shorter working hours as ledger clerks in the absence of regular staff
etc. This can result in substantial losses to the bank.
• The counterfoil of cash receipt vouchers (e.g. counterfeits of pay-in-
slips lodged by the depositors) should be signed by an officer in Cash
Department, in addition to the receiving cashier.
• Payments should be made only after the vouchers (e.g. cheques,
demand drafts etc.) have been passed for payment by the authorised
officer and have been entered in the customer’s account.
• Receipt and payment scrolls or their totals should be compared with
the cash column of the Day-Book by independent persons.
• High value cash receipts and payments should be verified by a higher
officer/ branch manager and the excess cash balance should be remitted
to currency chest according to branch’s retention limit on daily basis.
Clearings • Under the Cheque Truncation System (CTS) implemented by RBI, an
electronic image of the cheque is transmitted to the paying branch
through the clearing house, along with relevant information like data on
the MICR band, date of presentation, presenting bank, etc. This
effectively eliminates the associated cost of movement of the physical
cheques, reduces the time required for their collection.
• As per RBI guidelines, the branch is required to either call the customer
or email him for any cheque received for the amount of ` 5 lakh and
above in respect of inward clearings. The Auditor may verify the
compliance on test check basis.
• The Auditor is to check whether signature of the drawer of the cheque
is being verified by the staff or not as else there will be liability of the
paying bank under all circumstances.
• The unpaid cheques received in outward clearing should be either sent
to the customers at their recorded address or the customers be
informed to collect the same from bank branch.
Bills for • All the documents accompanying the bills should be received and
Collection entered in the Register by a responsible officer. At the time of dispatch,
the officer should also see that all the documents are sent along with
the bills.
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• The accounts of customers or principals should be credited only after
the bills have been collected or an advice to that effect received from
the bank branch or agent to which they were sent for collection.
• It should be ensured that bills sent by one branch for collection to
another branch of the bank, are not taken in the bills for collection twice
in the amalgamated balance sheet of the bank. For this purpose, the
receiving branch should reverse the entries regarding such bills at the
end of the year for closing purposes.
Bills • At the time of purchase of the bills, an officer should verify that all the
Purchased documents of title are properly assigned to the bank.
• Sufficient margin should be kept while purchasing or discounting a bill
to cover any decline in the value of the security etc.
• If the bank is unable to collect a bill on the due date, immediate steps
should be taken to recover the amount from the drawer against the
security provided.
• All irregular outstanding account/s should be reported to the Head
Office.
• In the case of bills purchased outstanding at the close of the year the
discount received thereon should be properly apportioned between the
two years.
Loans and • The bank should make advances only after satisfying itself as to the
Advances creditworthiness of the borrowers and after obtaining sanction from the
proper authorities of the bank.
• All the necessary documents (e.g., agreements, demand promissory
notes, letters of hypothecation, etc.) should be executed by the parties
before advances are made.
• Sufficient margin should be kept against securities taken to cover any
decline in the value thereof and to comply with Reserve Bank directives.
Such margins should be determined by the proper authorities of the
bank as a general policy or after detailed scrutiny for specific accounts.
• All the securities should be received and returned by responsible
officer. They should be kept in the Joint custody of two such officers.
• All securities requiring registration should be registered in the name of
the bank or otherwise accompanied by the documents sufficient to give
title of the bank.
• All accounts should be kept within both the drawing power and the
sanctioned limit as per prescribed norms. Additional temporary limit
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may be sanctioned, for a maximum of 20% of existing limit and 90 days
maximum tenure.
• All the accounts which exceed the sanctioned limit or drawing power or
are against unapproved securities or are otherwise irregular should be
brought to the notice of the Management/Head Office regularly.
• The operation (in each advance account) should be reviewed at least
once every year.)
Demand Drafts • The signatures on a demand draft should be checked by an officer with
the Signature Book.
• All the D.Ds. sold/ issued by a branch should be immediately confirmed
by an advice to the paying branch.
• If the paying branch does not receive proper confirmation of any D.D.
from the issuing branch or does not receive credit in its account with
that branch, it should take immediate steps to ascertain the reasons.
Inter Branch • The accounts should be adjusted only on the basis of advices (and not
Accounts on the strength of entries found in the statement of account) received
from other branches,
• Prompt action should be taken preferably by central authority, if any
entries (particularly debit entries) are not responded to by any branch
within a reasonable time.
Credit Card • There should be effective screening of applications with reasonably
Operations good credit assessments.
• There should be strict control over storage and issue of cards.
• There should be a system whereby a merchant confirms the status of
unutilised limit of a credit-card holder from the bank before accepting
the settlement, in case the amount to be settled exceeds a specified
percentage of the total limit of the card holder.
• There should be a system of prompt reporting by the merchants of all
settlements accepted by them through credit cards.
• Reimbursement to merchants should be made only after verification of
the validity of merchant’s acceptance of cards.
• All the reimbursement (gross of commission) should be immediately
charged to the customer’s account.
• There should be a system to ensure that statements are sent regularly
and promptly to the customer.
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• There should be a system to monitor and follow-up customers’
payments.
• Payments overdue beyond a reasonable period should be identified
and attended to carefully. For defaulting customers, credit should be
stopped by informing the merchants through periodic bulletins, as early
as possible, to avoid increased losses.
• There should be a system of periodic review of credit card holders’
accounts. On this basis, the limits of customers may be revised, if
necessary. The review should also include determination of doubtful
amounts and the provisioning in respect thereof.
Example 2
While doing the audit of a branch of XYZ bank for the year ended 31st March 23, it was seen
that the stock statements with the same figures are submitted by borrowers month after
month with a change in the month at the top. These are just filed for formal compliance. Such
things happen because a responsible official does not check the stock statements and get
them entered in in the system, which is a lapse in internal control. Due to such a lapse, neither
the borrower nor bank staff take it sincerely, thus posing a risk of loss to bank.
6. COMPLIANCE WITH CRR AND SLR REQUIREMENTS
(i) Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers,
which commercial banks have to hold as reserves either in cash or as deposits with the central bank.
One of the important determinants of cash balances to be maintained by banking companies and
other scheduled banks is the requirement for maintenance of a certain minimum cash reserve.
While the requirement for maintenance of cash reserve by banking companies is contained in the
Banking Regulation Act, 1949, corresponding requirement for scheduled banks is contained in the
Reserve Bank of India Act, 1934.
The RBI, from time to time, reviews the evolving liquidity situation and accordingly decides the rate
of CRR required to be maintained by scheduled commercial banks. Therefore, the auditor needs to
refer to the master circular issued from time to time in this regard to ensure the compliance of CRR
requirements.
(ii) Statutory Liquidity Ratio (SLR) Requirements – SLR is the requirement that every
scheduled commercial bank in India is required to maintain in the form of certain liquid assets such
as gold, cash and government approved securities before providing credit to the customers. The
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Reserve Bank of India requires statutory central auditors of banks to verify the compliance with SLR
requirements of 12 odd dates in different months of a fiscal year not being Fridays. The objective of
maintaining SLR is to have an amount in the form of liquid assets which can be used to handle a
sudden increase in demand for the amount from the depositors. The resultant report is to be sent to
the top management of the bank and to the Reserve Bank.
Correctness of the compilation of Maintenance of liquid assets
DTL (Demand and Time Liabilities) as prescribed u/s 24 of
position; and Banking Regulation Act.
Audit Approach and Procedure:
Area of Focus Suggested Audit Procedures
Compliance • Obtain an understanding of the relevant circulars/ instructions of the
with CRR and RBI, particularly regarding composition of items of DTL.
SLR
requirements • Request the branch auditors to send their weekly trial balance as on
Friday and these are consolidated at the head office. Based on this
consolidation, the DTL position is determined for every reporting
Friday. The statutory central auditor should request the branch
auditors to verify the correctness of the trial balances relevant to the
dates selected by him/her. The branch auditors should also be
specifically requested to examine the cash balance at the branch on
the selected dates.
• Examine, on a test basis, the consolidations regarding DTL position
prepared by the bank with reference to the related returns received
from branches. The auditor should examine whether the valuation of
securities done by the bank is in accordance with the guidelines
prescribed by the RBI.
• While examining the computation of DTL, specifically examine that
items have been excluded from liabilities as per RBI guidelines. Some
of these items are:-
• Paid up capital, reserve, any credit balance in profit & loss account of
bank, amount of loan taken from RBI and amount of refinance taken
from EXIM bank, NHB, SIDBI and NABARD
o Part amounts of recoveries from the borrowers in respect of
debts considered bad and doubtful of recovery.
o Amounts received in Indian currency against import bills and
held in sundry deposits pending receipts of final rates.
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14.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
o Un-adjusted deposits/balances lying in link branches for
agency business like dividend warrants, interest warrants,
refund of application money, etc., in respect of
shares/debentures to the extent of payment made by other
branches but not adjusted by the link branches.
o Margins held and kept in sundry deposits for funded facilities.
• Similarly, specifically examine that the items have been included in
liabilities as per RBI guidelines. Some of these items are:-
o Net credit balance in branch adjustment accounts.
o Borrowings from abroad by banks in India needs to be
considered as ‘liabilities to other’ and thus, needs to be
considered at gross level unlike ‘liabilities towards banking
system in India’, which are permitted to be netted off against
‘assets towards banking system in India’. Thus, the adverse
balances in Nostro Mirror Account needs to be considered as
‘Liabilities to other’.
o The reconciliation of Nostro accounts (with Nostro Mirror
Accounts) needs to be scrutinized carefully to analyze and
ascertain if any inwards remittances are received on behalf of
the customers / constituents of the bank and have remained
unaccounted and / or any other debit (inward) entries have
remained unaccounted and are pertaining to any liabilities for
the bank.
• Examine whether the consolidations prepared by the bank include the
relevant information in respect of all the branches.
• It may be noted that, even though interest accrues daily, it is recorded
in the books only at periodic intervals. Thus, examine whether such
interest accrued but not accounted for in books is included in the
computation of DTL.
• The auditor at the central level should apply the audit procedures
listed above to the overall consolidation prepared for the bank as a
whole. Where such procedure is followed, the central auditor should
adequately describe the same in the report.
• While reporting on compliance with SLR requirements, the auditor
should specify the number of unaudited branches and state that
he/she has relied on the returns received from the unaudited branches
in forming an opinion. Recently, there has been introduction of
Automated Data Flow (ADF) for CRR & SLR reporting and the auditors
should develop necessary audit procedures around this.
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7. VERIFICATION OF ASSETS
Before beginning verification of assets and balances, the auditor should obtain an accurate schedule
of accounts in the prescribed format. The following are the steps involved in verification of assets
and balances. -
I. CASH, BANK BALANCES AND MONEY AT CALL AND SHORT NOTICE - The Third
Schedule to the Banking Regulation Act, 1949, requires disclosures to be made in the balance
sheet regarding cash, balances with Reserve Bank of India, balances with other banks and
money at call and short notice. Audit approach and audit procedures in respect of these
items is discussed as under: -
Balances with
Balances with Money at Call and
Cash Reserve Bank of
Other Banks Short Notice
India
Audit approach: The auditor’s basic objective in verification of these items is their existence
and completeness as on date of balance sheet and audit procedures have to be tailored to
meet these. Remember that cash would be appearing in balance sheet of almost all
branches. However, in most of the branches of a bank, there will be no bank account requiring
reporting except in branches with treasury operations. Similarly, activity pertaining to money
at call and short notice is handled by treasury department of the bank at head office level.
Banks have a robust system of internal controls pertaining to cash like joint custody of two
responsible officers, checking of cash at periodic intervals etc due to higher risk of
misappropriation. Similarly, the balance with other banks (in case of applicable branches) are
reconciled periodically. The auditor has to be satisfied about effective operation and
implementation of internal controls in this area.
Audit Procedures:
Area of Focus Suggested Audit Procedures
Cash • Carry out the physical verification of cash (including foreign
currency, if any, cash at ATM and cash at cash deposit
machines) as close to the balance sheet date as possible.
• The cash balance as physically verified should be agreed
with the balance shown in the cash register/balance in
CBS.
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14.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Balance with • Verify the ledger balances in each account with reference to
Reserve Bank of the bank confirmation certificates and reconciliation
India statements as at the year-end.
• Review the reconciliation statements, paying special
attention to the following items appearing in the
reconciliation statements:
o Cash transactions remaining unresponded;
o Revenue items requiring adjustments/write-offs; and
o Other credit and debit entries originated in the
statement provided by RBI remaining unresponded
for more than 15 days.
Balance with Apart from the procedures described above in examining the
Other Banks balances with Reserve Bank of India, while reviewing the
(Other than reconciliation statements, the auditor should pay particular attention
Reserve Bank of to the following.
India)
• Examine that no debit for charges or credit for interest is
outstanding and all the items which ought to have been taken
to revenue for the year have been so taken.
• Examine that no cheque sent or received in clearing is
outstanding.
• Examine that all bills or outstation cheques sent for collection
and outstanding as on the closing date have been credited
subsequently.
• Examine large transactions in inter-bank accounts to ensure
that no transactions have been put through for window-
dressing particularly towards the close of year.
The balances with banks outside India should also be verified in the
manner described above. These balances should be converted into
the Indian currency at the exchange rates prevailing on the balance
sheet date
Money at Call and • Examine whether there is a proper system of authorisation,
Short Notice general or specific, for lending of the money at call or short
notice. Compliance with the instructions or guidelines laid
down in this behalf by the head office or controlling office of
the branch, including the limits on lending’s in inter-bank call
money market should also be examined.
• Call loans should be verified with the certificates of the
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borrowers and the call loan receipts held by the bank.
• Examine whether the aggregate balances comprising this
item as shown in the relevant register tally with the control
accounts as per the general ledger.
• Examine subsequent repayments received from borrowing
banks to verify the amounts shown under this head as at the
year-end. It may be noted that call loans made by a bank
cannot be netted-off against call loans received.
• Verify that the interest has been properly accrued and
accounted for on year-end outstanding balances of call/
short notice money.
II. INVESTMENTS
Audit approach:
The auditor’s primary objective in audit of investments is to satisfy himself as to their existence,
ownership and valuation. Examination of compliance with statutory and regulatory requirements is
also an important objective in audit of investments in as much as non-compliance may have a direct
and material effect on the financial statements. The latter aspect assumes special significance in
the case of banks where investment transactions should be carried out within the numerous
parameters laid down by the relevant legislation and directions of the RBI. The auditor should keep
this in view while designing audit procedures relating to investments. Every bank has their own
investment policy, which is drawn strictly in conjunction with RBI Master circular on investments.
The entire compliance needs to be evaluated in terms of requirements of investment policy read with
master circular RBI
Audit Procedures:
Area of Focus Suggested Audit Procedures
Internal Control • Review the investment policy of the bank to ascertain that the
Evaluation and policy conforms, in all material respects, to the RBI’s
Review of Investment guidelines as well as to any statutory provisions applicable to
Policy the bank.
• It should clearly outline the broad investment objectives
separately for the investments on its own account and
investments on behalf of customers.
Separation of • Check the segregation of duties within the bank staff in terms
Investment Functions of executing trades, settlement and monitoring of such trades,
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14.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
and accounting of the same (generally termed as front office,
middle office and back-office functions’ segregation).
Examination of • Examine the reconciliation of the investment account,
Reconciliation physically verify the securities on hand, obtain confirmations
from counter-party banks for Bank Receipts (BRs) issued by
such banks and on hand, obtain confirmation of Subsidiary
General Ledger (SGL) balances with the Public Debt Office
(PDO), and examine the control and reconciliation of BRs
issued by the bank.
Examination of • Ascertain whether the investments made by the bank are
Documents within its authority.
• Ensure that any other covenants or conditions which restrict
qualify or abridge the right of ownership and/or disposal of
investments, have been complied with by the bank.
• The acquisition/disposal of investments should be verified
with reference to the broker’s contract note, bill of costs,
receipts and other similar evidence.
Physical Verification • Verify the investment scrips physically at the close of
business on the date of the balance sheet.
• Verify investments held with public debt office of RBI,
custodians and depository with the statement of holdings as
on date of balance sheet. Independent balance confirmation
requests can be made in accordance with SA-505. In case
independent confirmations are not received back, alternative
audit procedures like getting bank personnel to download
investment statement from E-Kuber for government securities
(E-Kuber is CBS platform of RBI) in auditor’s presence can
be designed.
• In respect of BRs issued by other banks and on hand with the
bank at the year-end, the auditor should examine
confirmations of counterparty banks about such BRs. Where
any BRs have been outstanding for an unduly extended
period, the auditor should obtain written explanation from the
management for the reasons thereof. The auditor should
examine the reconciliation of BRs issued by the bank. BRs
should not be issued in respect of transactions in government
securities for which SGL facility is available.
• If certain securities are held in the names of nominees, the
auditor should examine whether there are proper transfer
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deeds signed by the holders and an undertaking from them
that they hold the securities on behalf of the bank.
Examination of • Examine that entire investment portfolio of bank is classified
classification and under three categories i.e.HTM, HFT and AFS and shifting of
shifting securities is as per regulatory norms and laid down policy.
• Examine whether the shifting of the investments from
‘available for sale’ to ‘held to maturity’ is duly approved by the
Board of Directors of the bank.
Examination of • Examine whether the method of accounting followed by the
Valuation bank in respect of investments, including their year-end
valuation, is appropriate.
• Examine whether the investments have been properly
classified into the three categories at the time of acquisition
based on such intention as evidenced by the decision of the
competent authority such as Board of directors, Asset Liability
Committee (ALCO) or Investment Committee.
• Examine compliance by the bank with the guidelines of the
RBI relating to valuation of investments.
• Verify that investments are classified as non-performing
investments (NPI) as per applicable RBI guidelines. (Non-
performing investments are those where interest/principal is
in arrears and remains unpaid for more than 90 days). In such
cases, banks have not to reckon income on securities and are
required to make provisions for depreciation in value of
investment.
• Examine whether income from investments is properly
accounted for. This aspect assumes special importance in
cases where the bank has opted for receipt of income through
the electronic/on line medium.
• Verify whether adequate disclosure of any change in method
of valuation of investment is made.
• Examine whether the profit or loss on sale of investments has
been computed and accounted for properly.
• Verify that there is a proper system for recording and
maintenance of TDS certificates received by the bank.
Dealings in Securities • Examine whether prior approvals for carrying out such
on Behalf of Others dealings have been obtained.
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14.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Examine whether bank’s income from such activities has
been recorded and is fairly stated in the bank’s financial
statements.
• Consider whether the bank has any material undisclosed
liability from a breach of its fiduciary duties, including the
safekeeping of assets.
Special-purpose • Examine whether the bank is maintaining separate accounts
Certificates Relating for the investments made by it on their own Investment
to Investments Account, on PMS clients’ account, and on behalf of other
constituents (including brokers).
• As per the RBI guidelines, banks are required to get their
investments under PMS separately audited by external
auditors.
Audit, Review and Reporting: Banks should undertake half-yearly reviews (as of 30th September
and 31st March) of their investment portfolio. These half yearly reviews should not only cover the
operational aspects of the investment portfolio but also clearly indicate amendments made to the
investment policy and certify the adherence to laid down internal investment policy and procedures
and RBI guidelines.
The internal auditors are required to separately conduct the concurrent audit of treasury transactions
and the results of their report should be placed before the CMD once every month. Banks need not
forward copies of the internal audit report to RBI. However, major irregularities observed in these
reports and position of compliance thereto may be incorporated in the half yearly review of the
investment portfolio.
III. ADVANCES
The Third Schedule to the Act requires classification of advances made by a bank from three
different angles, viz., nature of advance (like cash credit, overdrafts or term loans or bills purchased
and discounted), nature and extent of security(like secured by tangible assets or covered by
bank/govt guarantees), and and place of making advance (i.e. Whether in India or outside India).
Further, advances in India are also to be classified also on sectoral basis (like priority sector or
public sector).
Audit Approach: Advances generally constitute the major part of the assets of the bank. There are
substantial number of borrowers to whom variety of advances are granted. The audit of advances
requires the major attention from the auditors. The auditor is primarily concerned with obtaining
evidence about the following while carrying out audit of advances:-
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• Amounts included in the balance sheet in respect of advances are outstanding at the date of
balance sheet
• Advances represent amounts due to the bank
• Amounts due to the bank are appropriately supported by loan documents
• There are no unrecorded advances
• The stated basis of valuation of advances is appropriate and properly applied and
recoverability of advances is recognized in their valuation.
• Advances are disclosed, classified and described in accordance with recognized accounting
policies and practices and relevant statutory and regulatory requirements
• Appropriate provisions towards advances are made as per RBI norms, accounting standards
and generally accepted accounting practices
It would be worth recalling that there exists elaborate and detailed control system &
procedure in banks pertaining to appraisal, sanctioning, documentation, disbursal, review,
monitoring and supervision of advances. Audit approach of advances should encompass
designing appropriate audit procedures to obtain audit evidence in all these areas.
Audit Procedures - In carrying out audit of advances, the auditor is primarily concerned with
obtaining evidence about the following:
Area of Focus Suggested Audit Procedures
Evaluation of • Examine area of credit appraisal and verify whether laid down
Internal Controls procedures regarding credit appraisals including loan
over Advances applications, preparation of proposals, obtaining satisfaction
about credit worthiness of borrowers are being followed;
• Examine advances are sanctioned according to delegated
authority;
• Examine all necessary loan documents have been executed after
sanction but before disbursals are made to borrowers;
• Examine compliance with stipulated terms of sanction and end
use of funds more particularly in case of term loans;
• Examine existence, enforceability and valuation of securities. In
respect of securities requiring registration, examine this area
also;
• Examine the validity of the recorded amounts;
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14.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
• Review operations of the accounts and look for adverse features
like unauthorised over drawings beyond limits;
• Examine whether system laid down in bank for review/renewals
of advances is being followed;
• Review whether drawing power is being calculated properly on
basis of stock/book debt statements received from borrowers as
stipulated in respective sanction letters;
• Ensure compliance with Loan Policy of Bank as well as
prudential norms of RBI including appropriate asset classification
and provisioning.
Substantive Audit • Verify correctness of master data of loan accounts updated in
Procedures CBS. Check parameters like instalments, EMI, rate of interest,
tenure of loans etc.
• Verify that each customer of bank is tagged under single
customer id in respect of all its accounts including those in which
credit facilities are granted.
• Examine all large advances while other advances may be
examined on a sample basis.
• Examine accounts identified to be problem accounts but which
have not yet slipped into NPA category. This can be done by
obtaining list of SMA1 and SMA2 borrowers from the bank and
same can be considered for selection of problematic accounts.
• Examine those accounts which have been adversely commented
upon by concurrent auditors/bank’s internal inspection/RBI
inspection team.
• Examine list of restructured accounts to ensure that restructure
is as per RBI guidelines. Remember restructured account
portfolio requires additional provisioning.
• Examine quick/early mortality accounts. Any advance slippage to
NPA within 12 months of its sanction is called as quick/early
mortality case.
• Verify completeness and accuracy of interest being charged.
• Carry out appropriate analytical procedures.
Recoverability of • Review periodic statements submitted by the borrowers
Advances indicating the extent of compliance with terms and conditions.
• Review latest financial statements of borrowers.
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• Review reports on inspection of security.
• Review auditor’s reports in case of borrowers having credit
facilities from the banking system beyond a cut-off limit fixed by
board of directors of bank
Example 3
FT Cooperative Bank lent housing loan of ` 1 crore to Rahul, for an under construction flat.
The project was still incomplete and the builder absconded. It turned out that the builder had
taken a loan from another bank for the entire property on the basis of an equitable mortgage.
Since equitable mortgage is not registered, FT bank was unable to trace the loan taken by the
builder and therefore the borrower Rahul and FT bank both suffered.
It would be a better idea to first approve the builder after thoroughly examining his
credentials, past performances etc., and then only consider giving loans to buyers of his flats
to minimize such risks. In fact many banks nowadays do this. Somehow FT Coop bank did
not take the precaution and landed in trouble. Further, CIBIL records of the builder also could
have been checked. Loan sanctioning should not become a mere “tick the box” process.
Verification of asset classification, income recognition and Provision for Non-performing
assets: An important aspect of audit of advances relates to their asset classification and provisioning
(for provisioning norms refer Chapter 12 of Intermediate Auditing & Assurance Study Module). This
implies that advances are classified in accordance with prudential norms on asset classification,
income is recognized on actual record of recovery and a proper provision should be made in respect
of advances where the recovery is doubtful.
Audit approach
The Reserve Bank has prescribed objective norms for determining the quantum of provisions
required in respect of advances. The auditors must take / download the latest Master Circular of RBI
to familiarise himself fully with the norms prescribed by RBI in this regard. The circulars issued by
RBI after the date of issue of Master Circular and till the date of audit should also be taken /
downloaded and reviewed by the auditors for its adherence. However, these norms should be
construed as laying down the minimum provisioning requirements and wherever a higher provision
is warranted in the context of the threats to recovery, such higher provision should be made.
In this regard, the provisions of section 15 of the Banking Regulation Act, 1949 may be noted. This
section, which applies to banking companies, nationalised banks, State Bank of India and regional
© The Institute of Chartered Accountants of India
14.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
rural banks, requires the bank concerned to make adequate provision for bad debts to the
satisfaction of its auditor before paying any dividends on its shares.
It may be noted that verification of applicable prudential norms on asset classification, income
recognition and provisioning is an important responsibility of statutory branch auditor as well as
statutory central auditor.
Area of Focus Suggested Audit Procedures
Classification and • Verify whether bank has a system of ongoing identification and
Provision classification of advances through CBS without manual
intervention and its accuracy in crystallising date of NPA.
• Examine whether the classification made by the branch is
appropriate. Particularly, examine the classification of advances
where there are threats to recovery.
• Examine whether the secured and the unsecured portions of
advances have been segregated correctly and provisions have
been calculated properly.
• Review and compare the date of NPA of loan accounts
mentioned in current year statements with that of previous year.
Reasons for any change should be ascertained.
Accounts regularized As per the Reserve Bank guidelines, if an account has been
near Balance sheet regularised before the balance sheet date by payment of overdue
date amount through genuine sources, the account need not be treated as
NPA. Where, subsequent to repayment by the borrower (which makes
the account regular), the branch has provided further funds to the
borrower (including by way of subscription to its debentures or in other
accounts of the borrower), the auditor should carefully assess whether
the repayment was out of genuine sources or not. Where the account
indicates inherent weakness based on the data available, the account
should be deemed as NPA. In other genuine cases, the banks must
furnish satisfactory evidence to the Statutory Auditors about the
manner of regularisation of the account to eliminate doubts on their
performing status.
It is to be ensured that the classification is made as per the position
as on date and hence classification of all standard accounts be
reviewed as on balance sheet date. The date of NPA is significant to
determine the classification and hence specific care be taken in this
regard. NPA should be recognized only based on concept of Past Due/
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Overdue concept, and not based on the Balance Sheet date.
Drawing Power • Ensure that the drawing power is calculated as per the extant
Calculation guidelines (i.e. the Credit Policy of the Bank) formulated by the
Board of Directors of the respective bank and agreed upon by
the concerned statutory auditors reflected from respective
sanction letters
• Special consideration should be given to proper reporting of
sundry creditors and stocks covered under LCs/guarantees for
the purposes of calculating drawing power. It is to be ensured
that declared stocks shall not cover borrower’s liability
outstanding in form of sundry creditors for goods or covered by
LCs/guarantees availed for procurement of material. Similarly,
in case bank has provided credit facility against primary security
of book debts, net value of debtors (i.e. eligible trade debtors
as per terms of sanction less bills discounted with banks) is to
be arrived at. It is to be ensured that drawing power is
calculated net of stipulated margin. Further, in case of
consortium accounts, drawing power calculation and allocation
made by lead bank is binding on member banks.
• The drawing power needs to be calculated carefully in case of
working capital advances to companies engaged in
construction business. The valuation of work in progress should
be ensured in consistent and proper manner. It also needs to
be ensured that mobilization advance being received by the
contractors is reduced while calculating drawing power.
• The stock audit including audit of book debts should be carried
out by the bank for all accounts having funded exposure of
more than stipulated limit. The report submitted by the stock
auditors should be reviewed during the course of the audit and
special focus should be given to the comments made by the
stock auditors on valuation of security and calculation of
drawing power.
Accounts with • Banks should not classify an advance account as NPA merely
temporary due to the existence of some deficiencies which are temporary
deficiencies in nature such as non-availability of drawing power based on
latest available stock statement, balance outstanding
exceeding the limit temporarily and non-renewal of limits on the
due date. However, stock statements relied upon by the banks
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14.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
for determining drawing power should not be older than 3
months. The outstanding in the account based on drawing
power calculated from stock statements older than 3 months
are considered as irregular. Ensure adherence to these
guidelines.
Limits not reviewed • Accounts where regular/ad hoc limits are not reviewed within
180 days from the due date/date of ad hoc sanction, should be
considered as NPA. Auditors should also ensure that the ad
hoc/short reviews are not done on repetitive basis. In such
cases, auditor can consider the classification of account based
on other parameters and functioning of the account.
Asset classification • Ensure that asset classification is borrower wise and not facility
to be borrower wise wise. Therefore, it is to be ensured that all the facilities granted
and not facility wise by a bank to borrower will have to be treated as NPA and not
particular facility which has become irregular. Further, if debits
arising out of devolvement of LC or invoked guarantees are
kept in separate account, the outstanding balance should be
treated as part of borrower’s principal account for purpose of
application of prudential norms on asset classification, income
recognition and provisioning.
Government • If government guaranteed advance becomes NPA, then for the
Guaranteed purpose of income recognition, interest on such advance
Advances should not to be taken to income unless interest is realized.
However, for purpose of asset classification, credit facility
backed by Central Government Guarantee, though overdue,
can be treated as NPA only when the Central Government
repudiates its guarantee, when invoked. This exception is not
applicable for State Government Guaranteed advances, where
advance is to be considered NPA if it remains overdue for more
than 90 days.
• In case the bank has not invoked the Central Government
Guarantee though the amount is overdue for long, the
reasoning for the same should be taken and duly reported in
LFAR.
Agricultural • Ensure that NPA norms have been applied in accordance with
Advances the crop season determined by the State Level Bankers’
Committee in each State. Depending upon the duration of crops
– short term/ long term - raised by an agriculturist, the NPA
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norms would also be made applicable to agricultural term loans
availed of by them. Also ensure that these norms are made
applicable to all direct agricultural advances listed in Master
Circular on lending to priority sector.
• In respect of agricultural loans, other than those specified in the
circular, ensure that identification of NPAs has been done on
the same basis as non-agricultural advances.
Provisioning The auditor should check the latest RBI Circulars in this regard. It is
Towards Standard be understood that provision for standard assets is also required to be
Assets made at variable rates in respect of different sectors for the funded
outstanding in accordance with RBI norms as a matter of prudence.
The provisions need to be checked in detail with the statement of
advances. The bifurcation of standard advances under relevant
category for proper calculation of provision should be checked and
certified at branches level. The definition of respective items specified
should be adhered as defined by RBI.
Restructured Restructuring is an act in which a lender, for economic or legal reasons
Advances relating to borrower’s financial difficulty, grants concessions to the
borrower. It may involve modification of terms of advances including
alteration of amount of instalments/alteration of repayment period/rate
of interest/sanction of additional credit facilities etc. to help in curing
of default.
RBI has given revised guidelines for treatment of restructured
accounts by its circular. The auditor should verify compliance with the
requirements of the circular issued in this regard.
Banks may restructure the accounts classified under standard,
substandard or doubtful categories. Banks cannot restructure
accounts with retrospective effect. Once the bank receives an
application/proposal in respect of an account for restructuring, it
implies that the account is intrinsically weak. Accordingly, during the
time the account remains pending for restructuring, the auditors need
to take a view whether provision needs to be made in respect of such
accounts, pending approval for restructuring.
On restructuring, the account will be downgraded from Standard to
substandard. NPAs will remain in the same category.
Upgradation of Examine all the accounts upgraded from NPA to standard category
Account during the year, to ensure that the upgrading of each account is strictly
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in terms of RBI guidelines. There can be a possibility of incorrect
upgradation of account on the basis of partial recoveries made in the
account and overdue portion might not have wiped out completely.
There can also be a possibility of recoveries being made in the account
after cut-off date and account being upgraded as on date of balance
sheet.
Sale/ Purchase of In case of Sale/Purchase of NPA by Bank, the auditor should
NPAs examine:
• the policy laid down by the Board of Directors in this regard
relating to procedures, valuation and delegation of powers
including non performing financial assets that may be
purchased/sold, norms or such purchase/sale, valuation
procedure and accounting policy.
• only such NPA has been sold which has remained NPA in the
books of the bank for at least 2 years.
• the assets have been sold/ purchased “without recourse’ only
i.e the entire credit risk associated with the non-performing
asset should be transferred to the purchasing bank.
• subsequent to the sale of the NPA, the bank does not assume
any legal, operational or any other type of risk relating to the
sold NPAs.
• the NPA has been sold at cash basis only. Under no
circumstances, NPA can be sold to another bank at a
contingent price .The entire sale consideration has to be
received on upfront basis.
• the bank has not purchased an NPA which it had originally sold.
In case of sale of an NPA, the auditor should also ensure that:
• on the sale of the NPA, the same has been removed from the
books of the account of selling bank on transfer;
• If the sale is at a price below the net book value (NBV) (i.e.,
book value less provisions held), the shortfall should be debited
to the profit and loss account of that year.
• If the sale is for a value higher than the NBV, the excess
provision shall not be reversed but will be utilised to meet the
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shortfall/ loss on account of sale of other non-performing
financial assets.
Similarly, in case of purchase of NPAs, the auditor should verify
that:
• the NPA purchased has been subjected to the provisioning
requirements appropriate to the classification status in the
books of the purchasing bank.
• any recovery in respect of an NPA purchased from other banks
is first adjusted against its acquisition cost and only the
recovered amount in excess of the acquisition cost has been
recognised as profit.
• for the purpose of capital adequacy, banks have assigned
100% risk weights to the NPAs purchased from other banks.
TEST YOUR UNDERSTANDING 1
CA. Harshit is conducting statutory audit of branch of a public sector bank. On examining 20 large
advances of the branch, he finds that in 5 examined cases, loan applications have been filled up
scantily with important details left out. In these cases, it is also noticed that cash credit limits to the
borrowers were enhanced during the year but there are no records pertaining to assessment of
enhanced working capital requirements in respective borrower files. The branch is unable to show
such assessments/workings in system either.
However, all the five accounts are operating satisfactorily. These accounts have been classified as
standard assets by branch. Would above information prompt auditor to suggest change in asset
classification of above accounts? What does depicted situation reflect?
IV. FIXED ASSETS
The Third Schedule to the Banking Regulation Act, 1949 requires fixed assets to be classified into
two categories in the balance sheet, viz., Premises and Other Fixed Assets. Premises wholly or
partly owned by the banking company for the purpose of business including residential premises
used by employees of bank are shown under the head “Premises”. Other fixed assets include
furniture & fixture, motor vehicles, computers, office equipment etc. Though not specifically
mentioned under the Banking Regulation Act, 1949, the assets taken on lease and intangible assets
should be shown separately for proper classification and disclosure and also to comply with the
requirements of the Accounting Standards (ASs).
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Section 9 of the Banking Regulation Act, 1949, prohibits a banking company from holding any
immovable property, howsoever acquired (i.e., whether acquired by way of satisfaction of claims or
otherwise), for a period exceeding seven years from the date of acquisition, except such as is
required for its own use.
Audit Approach : In most of the banks, fixed assets are generally purchased by the head office or
regional/zonal offices. Statutory branch auditor has to ascertain the procedure followed and plan
accordingly. In most of the banks, maintenance of records is centralized at head office level. In some
of the banks, information relating to purchase, sale of fixed assets is accounted for with help of Fixed
asset management software. The audit procedures have to be designed accordingly.
Audit Procedures
In carrying out the audit of fixed assets, the auditor is concerned primarily with obtaining evidence about
their ownership, existence and valuation. For this purpose, the auditor should review the following:
Area of Focus Suggested Audit Procedures
Internal Examine the system of internal controls broadly covering the following:
Controls
• Control over expenditures incurred on fixed assets acquired or self-
constructed.
• Accountability and utilisation controls.
• Information controls for ensuring availability of reliable information
about fixed assets.
• Ascertain whether the accounts in respect of fixed assets are
maintained at the branch or centrally.
• Ascertain the location of documents of title or other documents
evidencing ownership of various items of fixed assets.
• Examine whether acquisitions, disposals, etc. effected at the branch
during the year have been properly communicated to the head office.
Premises • Verify the opening balance of premises with reference to schedule of
fixed assets, ledger or fixed assets register.
• Acquisition of new premises should be verified with reference to
authorisation, title deeds, record of payment, etc.
• Self-constructed fixed assets should be verified with reference to
authorisation and documents such as, contractors’ bills, work order
records and record of payments.
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• Examine whether the balances as per the fixed assets register
reconcile with those as per the ledger and the final statements.
• In the case of leasehold premises, capitalisation and amortisation of
lease premium, if any, should be examined. Any improvements to
leasehold premises should be amortised over their balance useful life.
• In case the title deeds are held at the head office or some other
location, the branch auditor should obtain a written representation to
this effect from the branch management and should bring this fact to
the notice of the central statutory auditor through a suitable mention in
the report. This fact should also be brought in the Long Form Audit
Report (LFAR).
• Where premises are under construction, it should be seen that they are
shown under a separate heading, e.g., ‘premises under construction’.
• Advances/ payments to contractors for such assets should be shown
under a separate item under the head “fixed assets”.
• Where the premises (or any other fixed assets) are re-valued, the
auditor should examine the appropriateness of the basis of revaluation.
The auditor should also examine whether the treatment of resultant
revaluation surplus or deficit is in accordance with relevant Accounting
Standard. The auditor should also check the impairment, if any, by
applying the principles laid down in relevant Accounting Standard.
• Examine that no immovable properties other than those required for
the own use of the bank have been included in fixed assets (own use
would cover use by employees of the bank, e.g., residential premises
provided to employees). The branch auditor should also obtain a
written representation to the above effect from the branch
management.
Other Fixed • The procedures discussed above regarding premises also apply, to the
Assets extent relevant, to verification of other fixed assets. In respect of
moveable fixed assets, the auditor should pay particular attention to the
system of recording the movements as well as other controls over such
fixed assets, e.g., their physical verification at periodic intervals by the
branch management and/or by inspection/internal/concurrent audit
team. The auditor should also examine whether discrepancies have been
properly dealt with in the books of account and adequate provision in
respect of any damaged assets has been made with appropriate
approvals.
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• In case of transfer of fixed assets, like furniture, office equipment, etc.
from one branch to another; the auditor should examine whether
accumulated depreciation in respect of such assets is also transferred.
• In case of intangible assets, verify whether the relevant guidelines given
by RBI by way of Circulars and the requirements of AS 26 have been
followed.
• Examine whether fixed assets have been properly classified. Fixed
assets of similar nature only should be grouped together.
Example 4. Items like safe deposit vaults should not be clubbed together
with the office equipment’s or the theft alarm system of the bank.
• Examine whether any expenditure incurred on a fixed asset after it has
been brought to its working condition for its intended use, has been
dealt with properly.
• The auditor at head office level should examine if the consolidated fixed
assets schedule matches in all respect and all the transfers in/out, are
tallied. A broad check on the depreciation amount vis-a-vis the gross
block of assets be reviewed with special emphasis on the computer
hardware/software.
Sale of Fixed • Verify the copy of sale deed and receipt of the sale value, in respect of
Assets fixed assets sold during the year. Ensure that the profit/ loss on sale of
assets has been properly accounted for.
Leased Assets • Verify accounting and provisioning norms to be followed by banks
undertaking leasing activity in accordance with RBI circulars and
guidelines. The auditor, in respect of leased assets, should also have
regard to the requirements of AS 19, “Leases”.
Impairment of • Verify whether the guidelines given by RBI’s circular on compliance
Assets with Accounting Standards,and the requirements of AS 28 have been
followed.
V. OTHER ASSETS: The auditor may carry out the audit of various items appearing under the
head ‘other assets’ in the following manner:
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Audit Procedures
Area of Focus Suggested Audit Procedures
Inter-Office Examine whether Inter-branch accounts are normally reconciled at the central
Adjustments level. The auditor should report on the year-end status of inter-branch accounts
indicating the dates up to which all or any segments of the accounts have been
reconciled. The auditor should also indicate the number and amount of
outstanding entries in the inter branch accounts, giving the relevant information
separately for debit and credit entries. The auditor should ensure that any
discrepancies found in inter-branch accounts have been properly dealt with in
the books. The auditor can obtain the relevant information primarily from
branch audit reports.
Interest • Examine whether the interest has been accrued on the entire loans and
Accrued advances portfolio of the bank. Special consideration should be given
to the overdue bills purchased/discounted.
• Ensure that only such interest as can be realised in the ordinary course
of business should be shown under this head. This is based on the
principle, recognised in AS 9, that revenue cannot be recognised if
there is a significant uncertainty about its collectability.
Tax Paid in • Ensure that the certificates for such tax deducted at source is collected
Advance/Tax by the branch and the original copy is sent to the Head Office along
Deducted at with the transfer of such Tax Deducted at Source (TDS) amount to
Source Head Office on periodic basis as defined.
• TDS Certificates / credits in the form 26AS, and claim of the same in
Income Tax returns filed should be checked to ensure the justification
of the claim towards such certificates.
• At Head Office level, the availability of all the TDS Certificates / credits
in the form 26 AS, and claim of the same in Income Tax returns filed
should be checked to ensure the justification of the claim towards such
certificates.
Stationery and • Ensure that the item “Stationery and Stamps” includes only exceptional
Stamps items of expenditure on stationery like bulk purchase of security paper
which is to be written off over a period of time. Such items should be
valued at cost. Normal expenditure on stationery is charged to profit &
loss account. Therefore, this item may not appear at branch level as
considerable part of stationery is supplied to branches by head office.
• Evaluate the existence, effectiveness and continuity of internal controls
over these items in the normal course of audit. It may be noted that the
branch auditor is required to specifically comment on the adequacy of
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the relevant internal controls in the LFAR.
• Physically verify the stationery and stamps on hand as at the year-end,
especially stationery of security items. Any shortage should be inquired
into as it could expose the bank to a potential loss from misuse.
• Examine whether the cost of stationery and stamps consumed during
the year has been properly charged to the profit and loss account for
the year in the context of the accounting policy/instructions from the
head office regarding treatment of cost of stationery and stamps.
Non-Banking • Ensure that the heading includes those immovable properties/tangible
Assets assets which the bank has acquired in satisfaction of debts due or its
Acquired in other claims and these are being held with intention of being disposed
Satisfaction of off.
Claims
• Verify such assets with reference to the relevant documentary
evidence, e.g., terms of settlement with the party, order of the Court or
the award of arbitration, etc.
• Check that the ownership of the property is legally vested with the
bank. If there is any dispute or other claim about the property, the
auditor should examine whether the recording of the asset is
appropriate or not. In case the dispute arises subsequently, the auditor
should examine whether a provision for liability or disclosure of a
contingent liability is appropriate, keeping in view the requirements of
AS 29 "Provisions, Contingent Liabilities and Contingent Assets".
• Ensure compliance with Section 9 of Banking Regulation Act, on
holding period of such assets.
• Ensure that as at date of acquisition, the assets should be recorded at
lower of net book value of advance or net realisable value of asset
acquired.
VI. OTHERS
This is the residual heading, which will include items not specifically covered under other sub-heads,
e.g., claims which have not been received, debit items representing additions to assets or reductions
in liabilities which have not been adjusted for technical reasons or want of particulars, etc.,
receivables on account of government business, prepaid expenses, accrued income other than
interest (e.g., dividend declared but not received) may also be included under this head. The audit
procedures relating to some of the major items included under this head are discussed below:
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Audit Approach and Procedures
Area of Focus Suggested Audit Procedures
Non-Interest- • Examine non-interest-bearing staff advances with reference to the
Bearing Staff relevant documentation and the policy in this regard which is framed by
Advances the bank. The availability, enforceability and valuation of security, if
any, should also be examined.
• Ensure that the same relates to employees on the rolls of the bank on
the date of the preparation of financial statements.
Loans and • The auditor should verify that loans have been ordinarily sanctioned by
Advances to the next higher sanctioning authority as compared to the recipient of
Officials and loan.
Relatives
• Loans to senior officers or of higher amount should have been reported
to the Board.
Security • Examine security deposits with various authorities (e.g., on account of
Deposits telephone, electricity, etc.,) and with others (e.g., deposits in respect of
premises taken on rent) with reference to documents containing
relevant terms and conditions, and receipts obtained from the parties
concerned.
• Ensure that the deposit amount has not become due as per the terms
and conditions. If it is so, then the recoverability of the same needs to
be considered in detail and appropriate provision be made against the
amount which is doubtful to recover.
Suspense • Obtain from the management details of old outstanding entries in
Account suspense account along with reasons for delay in adjusting the entries.
Where the outstanding balances comprised in suspense account
require a provision/write-off, the auditor should examine whether the
necessary provision has been made/write-off.
Prepaid • Examine whether the basis of allocation of expenditure to different
Expenses periods is reasonable.
• Examine whether the allocation of discounting and rediscounting
charges paid by the bank to different accounting periods is in
consonance with the accounting policy followed for the bank as a whole.
Miscellaneous • Review the ageing statements pertaining to these items.
Debit
Balances on • Examine the recoverability of old outstanding items.
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14.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Government • Examine whether claims for reimbursement have been lodged by the
Account branch in accordance with the relevant terms and conditions. The net
balances of the amount recoverable at the Head Office level should
also be taken along with the age-wise analysis of the same. In case of
old outstanding balances without any confirmation or proper
justification of the same, should be provided for in the accounts.
• For major variance as compared to the previous year figures, verify
whether reasons for the same have been recorded and reviewed.
8. VERIFICATION OF CAPITAL & LIABILITIES
I. CAPITAL
The auditor may carry out the audit of various items under ‘Share Capital’ in the following manner:
Audit Approach and Procedures
The auditor should verify the opening balance of capital with reference to the audited balance sheet
of the previous year. In case there has been an increase in capital during the year, the auditor should
examine the relevant documents supporting the increase. For example, in case of an increase in the
authorised capital of a banking company, the auditor should examine the special resolution of
shareholders and the Memorandum of Association. An increase in subscribed and paid-up capital
of a banking company, on the other hand, should be verified with reference to prospectus/other offer
document, reports received from Registrars to the issue, bank statement, returns filed with the
Registrar of Companies etc.
Capital Adequacy: The term ‘capital adequacy’ is used to describe the adequacy of capital
resources of a bank in relation to the risks associated with its operations.
Adequacy of capital of banks has been the subject matter of consideration by banking authorities
around the world for several decades. An international agreement on a common risk-based capital
framework and definition of bank capital was framed by the Committee on Banking Regulations and
Supervisory Practices of the G-1O Nations (popularly known as the Basel Committee) and was
formally adopted in 1988. Basel accords and frameworks were borne out of these deliberations.
The framework attempted to relate a bank’s capital needs to its risk profile. Besides serving to
strengthen the soundness and stability of the banking system, it also sought to give banks an
incentive to hold lower-risk assets, incorporate off-balance sheet exposures explicitly into capital
assessments, and achieve greater uniformity in application of capital standards to banks across
different countries.
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8.1. Stress Testing
RBI has required that all commercial banks (excluding RRBs and LABs) shall put in place a Board
approved ‘Stress Testing framework’ to suit their individual requirements which would integrate into
their risk management systems. Stress tests are designed to understand whether a bank has enough
capital to survive plausible adverse economic conditions and to maintain enough buffer to stay afloat
under extreme scenarios.
8.2 BASEL III framework
Basel III norms relate to the Capital Adequacy requirement compliance which the Bank has to
achieve as contained in the BASEL III accord. Basel capital adequacy norms are meant for the
protection of depositors and shareholders by prescriptive rules for measuring capital adequacy,
thereby evolving methods of determining regulatory capital and ensuring efficient use of capital.
Basel III accord strengthens the regulation, supervision and risk management of the banking sector.
It is global regulatory standard on capital adequacy of banks, stress testing as well as market liquidity
risk.
The Basel III accord, aims at:
(a) improving the banking sector's ability to absorb shocks arising from financial and economic
stress, irrespective of reasons thereof;
(b) improving risk management and governance practices; and
(c) strengthening banks' transparency and disclosure standards.
Capital Adequacy Measures in India: In India, the statutes governing various types of banks lay
down the minimum capital requirements for them. Besides, there are also requirements for
maintenance of statutory reserves. Considering the variations in minimum capital requirements
applicable to distinct types of banks and taking into account the approach adopted by Basel
Committee, the Reserve Bank prescribed, in year 1992, a uniform methodology for determining the
capital adequacy of scheduled commercial banks (other than regional rural banks). The Master
Circular on “Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital
Adequacy Framework (NCAF)”, provides the guidelines to be followed by banks for capital
adequacy. Some of the important aspects of the circular are covered below.
The basic approach of capital adequacy framework is that a bank should have sufficient capital to
provide a stable resource to absorb any losses arising from the risks in its business. Capital is
divided into tiers according to the characteristics/qualities of each qualifying instrument. For
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supervisory purposes capital is split into two categories: Tier I and Tier II, representing different
instruments’ quality as capital.
♦ Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s
highest quality capital because it is fully available to cover losses.
♦ Tier II capital consists of certain reserves and certain types of subordinated debt. The loss
absorption capacity of Tier II capital is lower than that of Tier I capital.
Components of Capital: The Master Circular on Capital Adequacy discusses the Capital Funds in
two categories – capital funds for Indian banks and capital funds of foreign banks operating in India.
In case of foreign banks operating in India, RBI’s Master Circular on Capital Adequacy also lays
down certain additional provisions in respect of capital to be followed by such banks.
Capital Risk Adequacy Ratio (CRAR): The CRAR is computed as follows:
_______________Eligible Total Capital Funds______________ x 100
Risk weighted assets and off-balance sheet items
The RBI requires banks to maintain a minimum CRAR of 9 per cent on an ongoing basis. The Master
Circular on Capital Adequacy contains detailed guidelines on calculation of risk weighted assets and
off-balance sheet items for CRAR.
Example 6: For secured housing loans upto ` 75 lakh, the risk weight, subject to some conditions
is 50%.for those above ` 75 lakhs, it is 75%, for loans to commercial real estate , it is 100%.Thus
for a housing loan of ` 60 lakh given by the bank, the risk weighted asset will be taken at 60 x 50%
= ` 30 lakhs for the purpose of the denominator in the above formula.
II. RESERVES AND SURPLUS
The following are required to be disclosed in the balance sheet under the head ‘Reserves and
Surplus’.
Statutory Reserves* Capital Reserves* Share Premium*
Revenue and Other Reserves Balance in Profit and Loss
including investment Account
Fluctuation Reserve*
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*In respect of these items above, opening balance, additions during the year and deductions during
the year are to be shown separately in respect of each item
Audit Approach and Procedures
The auditor should verify the opening balances of various reserves with reference to the audited
balance sheet of the previous year. Additions to or deductions from reserves should also be verified
in the usual manner, e.g., with reference to board resolution. In the case of statutory reserves and
share premium, compliance with legal requirements should also be examined. Thus, the auditor
should specifically examine whether the requirements of the governing legislation regarding transfer
of the prescribed percentage of profits to reserve fund have been complied with. In case the bank
has been granted exemption from such transfer, the auditor should examine the relevant documents
granting such exemption. Similarly, it should be examined whether the appropriations from share
premium account conform to the relevant legal requirements. Compliance with foreign laws in
respect of overseas branches, need to be verified by the auditor.
III. DEPOSITS
Audit Approach
Deposits represent the important source of funds for banks. In carrying out audit of deposits and
liabilities, the auditor is primarily concerned with obtaining reasonable assurance that all known
liabilities are recorded and stated at appropriate amounts.
The following areas should be considered when auditing Deposits:
Current Accounts & Deposits Designated in
Term Deposits
Savings Accounts (CASA) Foreign Currencies
Remember that deposits accepted by banks are primarily of two types i.e those repayable on
demand and those repayable after a fixed term. Current and saving accounts are the most common
form of demand deposits. Term deposits (fixed deposits etc. known under different nomenclature in
different banks) are repayable after a specified period of time ranging from 7 days at present to say
one year or five years. Recurring deposits are also an important variant of term deposits in which a
specified sum is deposited in the account at regular intervals for a pre-determined period. At
maturity, proceeds are repaid to depositors along with interest.
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Deposits designated in foreign currencies e.g. Foreign currency non-resident deposits(FCNR) are
accounts which are opened by Non-resident Indians in form of fixed deposit only.
Besides, there are some accounts like NRE [Non-Resident (External)Rupee account scheme] and
NRO [Non-Resident Ordinary Rupee account scheme]. NRE accounts may be opened by Non-
Resident Indians and persons of Indian origin. NRO accounts may be opened by all non-residents.
These accounts may be maintained in form of savings, current, recurring or fixed deposit and are
denominated in Indian Rupees.
Deposits would be appearing in balance sheet of most of the branches. Hence, these are of concern
to auditors at branch and central/head office level.
Audit Procedures:
The auditor may verify various types of deposits in the following manner:
Area of Focus Suggested Audit Procedures
Current and • Verify on a sample basis current account and saving accounts
saving opened during the year for adherence to KYC norms. Verify that
accounts saving accounts are opened in name of individuals, HUF, some
approved institutions like trusts, educational institutes etc.
Remember that saving accounts are not opened for business or
professional concern. The business transactions are carried in
current accounts which can be opened for all kind of customers
like companies, individuals, partnership firms etc.
• Verify the balances in individual accounts on a sample basis.
• Check the calculations of interest on a test check basis. Remember
that no interest is paid generally on current accounts by banks.
• Examine whether the procedure for obtaining balance confirmation
periodically has been followed consistently. Examine, on a sampling
basis, the confirmations received.
• Ensure that debit balances in current accounts are not netted out on
the liabilities side but are appropriately included under the head
‘advances’.
• Inoperative accounts (both current and saving) are a high-risk area of
frauds in banks. As per RBI guidelines, a savings/ current account should
be treated as inoperative/dormant if there are no transactions in the
account for over a period of two years. Verify on a sample basis some of
inoperative accounts revived/closed during the year. Ensure that
inoperative accounts are revived only with proper authority. In this regard,
cases where there is significant reduction in balances of such accounts as
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compared to previous year, examine authorisation for withdrawals.
Term deposits • Examine whether the deposit receipts and cash certificates are issued
serially and all of them are accounted for in the registers.
• Verify in case of bulk deposits (` 2 crore and above for scheduled
commercial banks presently), correct rate of interest has been offered.
• In case of closure of term deposit, test check whether required
foreclosure penalty has been deducted from applicable rate of interest
payable.
• Verify on sample basis some of recurring deposit accounts opened
during the year.
• Verify correctness of rate of interest on term deposits on sample basis.
Deposits • Verify some of FCNR accounts opened during the year on sample
designated in basis and ensure these conform to RBI directions.
foreign • Verify on sample basis permissible credits and debits in FCNR
currencies accounts as per RBI directions.
• In case of FCNR accounts, examine whether these have been
converted into Indian Rupees at rate notified in this behalf by head
office.
• Examine whether any resultant increase or decrease has been taken
to the profit and loss account.
• Verify that interest on deposits has been paid on the basis of 360 days
in a year.
Others • In case of NRE and NRO accounts, verify on a sample basis credits
and debits as per RBI guidelines. Also check repatriablity. NRE
accounts are repatriable whereas NRO accounts are not repatriable
except for all current income subject to certain conditions.
General • Verify that deposits of a bank are not inflated for purpose of balance
sheet presentation. For example, some customers might be given
overdrafts near date of balance sheet and the resultant overdrawn
amounts may be placed as deposits with banks and further advances
may be given on strength and security of these deposits. It would lead
to inflated deposits as well as advances. The transactions may be
reversed after close of the year.
In such cases which indicate the possibility of window-dressing, the
auditor should consider making a suitable qualification in main audit
report besides other applicable reporting.
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• Examine that interest accrued but not due on deposits is not included
under the relevant deposits but is shown under the head ‘other
liabilities and provisions’.
• Ensure that framework relating to ‘Know Your Customer’ and Anti-
Money Laundering measures is formulated and put in place by the
bank.
IV. BORROWINGS
Audit approach
Borrowings of a bank are required to be shown in balance sheet as follows.
- Reserve Bank of India
Borrowings in - Other Banks Borrowings outside
India - Other Institutions & India
Agencies
The total amount of secured borrowings included under the above heads is to be shown by way of
a note to the relevant schedule. Secured borrowings for this purpose include borrowings/refinance
in India as well as outside India. It may be noted that the inter-office transactions are not borrowings
and therefore, should not be presented as such.
Audit Procedures:
Area of Focus Suggested Audit Procedures
Borrowings • Obtain and verify confirmation certificates and other supporting
documents such as, agreements, correspondence, etc.
• External confirmations received directly by the auditor from
appropriate confirming parties may assist the auditor in obtaining audit
evidence that the auditor requires to respond to significant risks of
material misstatement. The auditor is required to comply with the
requirements of SA 505 “External Confirmations” which contains
guidance on designing and performing external confirmation
procedures to obtain relevant and reliable audit evidence.
• Examine whether a clear distinction has been made between
‘rediscount’ and ‘refinance’ for disclosure of the amount under the
above head since rediscount does not figure under this head.
• Examine whether borrowings of money at call and short notice are
properly authorised. The rate of interest paid/payable on, as well as
duration of such borrowings should also be examined by the auditor.
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• Examine the relevant correspondence or other documents to ensure
that the branch has been authorised by the Head Office to
borrow/retain other borrowings and that the terms on which
borrowings have been made are in accordance with the authorisation.
• Examine whether the amount shown in the branch accounts is
properly classified based on security or otherwise.
V. OTHER LIABILITIES AND PROVISIONS
The Third Schedule to the Banking Regulation Act, 1949, requires disclosure of the following items
under the head ‘Other Liabilities and Provisions’.
Inter-office Interest accrued Others (including
Bills payable
adjustments (net) provisions)
Audit Procedures:
The auditor may verify the various items under the head ‘other liabilities and provisions’ in the
following manner.
Area of Focus Suggested Audit Procedures
Bills Payable Evaluate the existence, effectiveness and continuity of internal controls over
bills payable. Such controls should usually include the following-
• Drafts, mail transfers, traveller’s cheques, etc. should be made out in
standard printed forms.
• Unused forms relating to drafts, traveller’s cheques, etc. should be
kept under the custody of a responsible officer.
• The bank should have a reliable private code known only to the
responsible officers of its branches, coding and decoding of the
telegrams should be done only by such officers.
• The signatures on a demand draft should be checked by an officer
with the specimen signature book.
• All the telegraphic transfers and demand drafts issued by a branch
should be immediately confirmed by advices to the branches
concerned. On payment of these instruments, the paying branch
should send a debit advice to the originating branch.
Examine an appropriate sample of outstanding items comprised in bills
payable accounts with the relevant registers. Reasons for old outstanding
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debits in respect of drafts or other similar instruments paid without advice
should be ascertained.
Correspondence with other branches after the year-end (e.g., responding
advices received from other branches, advices received from other branches
in respect of drafts issued by the branch and paid by the other branches
without advice) should be examined specially in so far as large value items
outstanding on the balance sheet date are concerned.
Inter-office The balance in inter-office adjustments account, if in credit, is to be shown
Adjustments under this head.
Interest Examine interest accrued with reference to terms of the various types of
Accrued deposits and borrowings. It should be specifically examined that such interest
has not been clubbed with the figures of deposits and borrowings shown
under the head ‘Deposits and Borrowings’.
Others It may be noted that the figure of advances and investments in the balance
(Including sheet of a bank excludes provisions in respect thereof made to the
Provisions) satisfaction of auditors. The auditor should examine other provisions and
other items of liabilities in the same manner as in the case of other entities.
VI. CONTINGENT LIABILITIES
Contingent Liabilities
- Claims against the bank not acknowledged as debts
- Liability for partly paid investments
- Liability on account of outstanding forward exchange contracts &
Derivative Contracts
- Guarantees given on behalf of constituents (within India; outside India)
- Acceptances, endorsements and other obligations
- Other items for which the bank is contingently liable
Bills for Collection
Audit Approach
In respect of contingent liabilities, the auditor is primarily concerned with seeking reasonable
assurance that all contingent liabilities are identified and properly valued. The auditor should obtain
representation from management that:-
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(i) all off-balance sheet transactions have been accounted in the books of accounts as and when
such transaction has taken place;
(ii) all off balance sheet transactions have been entered into after following due procedure laid
down;
(iii) all off balance sheet transactions are supported by the underlying documents;
(iv) all year end contingent liabilities have been disclosed;
(v) the disclosed contingent liabilities do not include any crystallised liabilities which are of the
nature of loss/ expense and which, therefore, require creation of a provision/adjustment in
the financial statements;
(vi) the estimated amounts of financial effect of the contingent liabilities are based on the best
estimates in terms of Accounting Standard 29, including consideration of the possibility of
any reimbursement;
(vii) in case of guarantees issued on behalf of the bank’s directors, the bank has taken appropriate
steps to ensure that adequate and effective arrangements have been made so that the
commitments would be met out of the party’s own resources and that the bank will not be
called upon to grant any loan or advances to meet the liability consequent upon the invocation
of the said guarantee(s) and that no violation of section 20 of the Banking Regulation Act,
1949 has arisen on account of such guarantee; and
(viii) such contingent liabilities which have not been disclosed on account of the fact that the
possibility of their outcome is remote include the management’s justification for reaching such
a decision in respect of those contingent liabilities.
Audit procedures
To this end, the auditor should, generally follow the audit procedures given below:
Area of Focus Suggested Audit Procedures
Contingent • Ensure that there exists a system whereby the non-fund based
Liabilities facilities or additional/ad hoc credit facilities to parties are
extended only to their regular constituents, etc.
• Ascertain whether there are adequate internal controls to ensure
that transactions giving rise to contingent liabilities are executed
only by persons authorised to do so and in accordance with the
laid down procedures.
• Verify in case of LCs for import of goods, the payment to the
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overseas suppliers is made based on shipping documents and
after ensuring that the said documents are in strict conformity
with the terms of LCs.
• Ascertain whether the accounting system of the bank provides for
maintenance of adequate records in respect of such obligations
and whether the internal controls ensure that contingent liabilities
are properly identified and recorded.
• Test the completeness of the recorded obligations.
• Review the reasonableness of the year-end amount of contingent
liabilities in the light of previous experience and knowledge of the
current year's activities.
• Review whether comfort letters issued by the bank has been
considered for disclosure of contingent liabilities.
• Examine whether the bank has given any guarantees in respect
of any trade credit (buyer’s credit or seller’s credit) and the period
of guarantees is co-terminus with the period of credit reckoned
from the date of shipment.
• Verify whether bank has extended any non-fund facility or
additional/ad hoc credit facilities to other than its regular
customers. In such cases, auditor should ensure concurrence of
existing bankers of such borrowers and enquire regarding
financial position of those customers.
Claims Against the • Examine the relevant evidence, e.g., correspondence with
Bank Not lawyers/ others, claimants, workers/officers, and
Acknowledged as workmen’s/officers’ unions.
Debts
• Review the minutes of meetings of board of directors/committees
of board of directors, contracts, agreements and arrangements,
list of pending legal cases, and correspondence relating to taxes,
and duties, etc. to identify claims against the bank.
• Ascertain from the management the status of claims outstanding
as at the end of the year.
• A review of subsequent events would also provide evidence
about completeness and valuation of claims.
Liability on • Verify the outstanding forward exchange contracts with the
Account of statement of outstanding forward exchange contracts generated
Outstanding from the bank’s computerised accounting system or manual
Forward Exchange register maintained by the branch. The auditor may physically
Contracts & verify the underlying documents including confirmations from
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derivative merchants to test the existence of such outstanding contracts.
contracts
• The auditor may verify outstanding derivative contracts like
options, interest rate swaps etc with reports generated in this
regard.
Guarantees Given • Ascertain whether there are adequate internal controls over
on Behalf of issuance of guarantees, e.g., whether guarantees are issued
Constituents under proper sanctions, whether adherence to limits sanctioned
for guarantees is ensured, whether margins are taken from
customers before issuance of guarantees as per the prescribed
procedures, etc.
• Ascertain whether there are adequate controls over unused
guarantee forms, e.g., whether these are kept under the custody
of a responsible official, whether a proper record is kept of forms
issued, whether stock of forms is periodically verified and
reconciled with the book records, etc.
• Examine the guarantee register to seek evidence whether the
prescribed procedure of marking off the expired guarantees is
being followed or not.
• Check the relevant guarantee registers with the list of outstanding
guarantees to obtain assurance that all outstanding guarantees
are included in the amount disclosed in this behalf.
• Examine that expired guarantees are not included in this head.
Verify guarantees with the copies of the letters of guarantee issued
by the bank and with the counter-guarantees received from the
customers. The auditor should also verify the securities held as
margin. If a claim has arisen, the auditor should consider whether
a provision is required in terms of the requirements of AS 29,
"Provisions, Contingent Liabilities and Contingent Assets”.
Acceptances, • Evaluate the adequacy of internal controls over issuance of
Endorsements and letters of credit and over custody of unused LC forms in the same
Other Obligations manner as in the case of guarantees.
• Verify the balance of letters of credit from the register maintained
by the bank. The register indicates the amount of the letters of
credits and payments made under them. The auditor may
examine the guarantees of the customers and copies of the
letters of credit issued. The security obtained for issuing letters
of credit should also be verified.
• Examine whether the bank has incurred a potential financial
obligation in respect of letters of comfort and if such obligation
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has been cast, ensure the amount to be disclosed under
contingent liability.
Other Items for • Determine and verify any other items under this head as required.
which the Bank is For example, outstanding underwriting contracts, bills
Contingently rediscounting, disputed tax demands,
Liable
Bills for Collection • Ensure that the bills drawn on other branches of the bank are not
included in bills for collection.
• Verify outward bills for collection with reference to the
corresponding register maintained.
• Examine collections made subsequent to the date of the balance
sheet to obtain further evidence about the existence and
completeness of bills for collection as on the date of Balance
Sheet.
• Examine the procedure for crediting the party on whose behalf a
bill has been collected. Confirm that this procedure is in
consonance with the nature of obligations of the bank in respect
of bills for collection.
• Examine that adequate internal controls exist that debits the
customer’s account with the amount of bank’s commission as
soon as a bill collected is credited to the customer’s account. The
auditor should also examine that no income has been accrued in
the accounts in respect of bills outstanding on the balance sheet
date.
Example 4:
A large scam happened at ABC bank wherein the employees, in collusion with an unscrupulous
businessman, misused the SWIFT network to transmit messages to other banks on fund
requirement. While all this was done using SWIFT passwords, the transactions were never
recorded in the bank’s core system, thereby keeping the bank management in the dark for years.
No securities were being obtained. It caused loss of thousands of crores to the bank. Thus, it is
important to give proper importance to the recording and disclosure of contingent liabilities even
though they do not form part of the main balance sheet or at the most appear on both assets as
well as liabilities side with equal amounts as contra items.
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9. AUDITOR'S REPORT
In the case of a nationalised bank, the auditor is required to make a report to the Central Government
in which the auditor should state the following:
Whether, in the auditor’s opinion, the balance sheet is a full and fair balance sheet
containing all the necessary particulars and is properly drawn up so as to exhibit a true
and fair view of the affairs of the bank.
In case the auditor had called for any explanation or information, whether it has been given and
whether it is satisfactory.
Whether or not the transactions of the bank, which have come to the auditor’s notice,
have been within the powers of that bank.
Whether or not the returns received from the offices and branches of the bank have
been found adequate for the purpose of audit.
Whether the profit and loss account shows a true balance of profit or loss for the period
covered by such account.
Any other matter which the auditor considers should be brought to the notice of the
Central Government.
9.1 Format of Audit Report
The auditors, central as well as branch, should also ensure that the audit report issued by them
complies with the requirements of SA 700, “Forming an Opinion and Reporting on Financial
Statements”, SA 705, “Modifications to the Opinion in the Independent Auditor’s Report”, SA 706,
“Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”,
SA 710, “Comparative Information-Corresponding Figures and Comparative Financial Statements”
and SA 720, The Auditor’s Responsibility Relating to Other Information in Documents Containing
Audited Financial Statements.
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The auditor should ensure that not only the information relating to number of unaudited branches is
given but quantification of advances, deposits, interest income and interest expense for such
unaudited branches has also been disclosed in the audit report. Such disclosure in the audit report
is not only in accordance with the best international trends but also provides useful information to
users of financial statements.
It may be noted that, in addition to the aforesaid, the auditor of a banking company is also required
to state in the report the matters covered by Section 143 of the Companies Act, 2013. However, it
is pertinent to mention that the reporting requirements relating to the Companies (Auditor’s Report)
Order, 2020 is not applicable to a banking company as defined in clause (c) of section 5 of the
Banking Regulation Act, 1949.
As per reporting requirements cast through Rule 11 of the Companies (Audit and Auditors)
Rules, 2014 the auditor’s report shall also include their views and comments on the following
matters, namely:
(1) whether the company has disclosed the impact, if any, of pending litigations on its financial
position in its financial statement;
(2) 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;
(3) whether there has been any delay in transferring amounts, required to be transferred, to the
Investor Education and Protection Fund by the company.
(4) (i) Whether the management has represented that, to the best of it’s knowledge and
belief, other than as disclosed in the notes to the accounts, no funds have been
advanced or loaned or invested (either from borrowed funds or share premium or any
other sources or kind of funds) by the company to or in any other person(s) or
entity(ies), including foreign entities (“Intermediaries”), with the understanding,
whether recorded in writing or otherwise, that the Intermediary shall, whether, directly
or indirectly lend or invest in other persons or entities identified in any manner
whatsoever by or on behalf of the company (“Ultimate Beneficiaries”) or provide any
guarantee, security or the like on behalf of the Ultimate Beneficiaries;
(ii) Whether the management has represented, that, to the best of it’s knowledge and
belief, other than as disclosed in the notes to the accounts, no funds have been
received by the company from any person(s) or entity(ies), including foreign entities
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(“Funding Parties”), with the understanding, whether recorded in writing or otherwise,
that the company shall, whether, directly or indirectly, lend or invest in other persons
or entities identified in any manner whatsoever by or on behalf of the Funding Party
(“Ultimate Beneficiaries”) or provide any guarantee, security or the like on behalf of
the Ultimate Beneficiaries; and
(iii) Based on such audit procedures that the auditor has considered reasonable and
appropriate in the circumstances, nothing has come to their notice that has caused
them to believe that the representations under sub-clause (i) and (ii) contain any
material mis-statement.
(5) Whether the dividend declared or paid during the year by the company is in compliance with
section 123 of the Companies Act, 2013.
(6) Whether the company, has used such accounting software for maintaining its books of
account which has a feature of recording audit trail (edit log) facility and the same has been
operated throughout the year for all transactions recorded in the software and the audit trail
feature has not been tampered with and the audit trail has been preserved by the company
as per the statutory requirements for record retention.]
9.2 Long Form Audit Report
Besides the audit report as per the statutory requirements discussed above, the terms of
appointment of auditors of public sector banks, private sector banks and foreign banks (as well as
their branches), require the auditors to also furnish a long form audit report (LFAR). The long form
audit report is to be given by statutory branch auditors as well as statutory central auditors. The
LFAR for branch auditors is in form of questionnaire where observations/comments have to be
provided on range of matters including cash, balance with banks, investments, advances, deposits
etc. These are submitted by the statutory branch auditors to statutory central auditors.
The consolidation is done at head office level and LFAR for bank is submitted by statutory central
auditors to management. The LFAR, on the bank, after due examination, should be placed before
the ACB of the bank indicating the action taken/proposed to be taken for rectification of the
irregularities, if any, mentioned therein; and a copy of the LFAR and the relative agenda note,
together with the Board's views or directions, is submitted to RBI within 60 days of submission of
LFAR by statutory auditors.
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9.3 Other Reporting Requirements
The RBI issued a Circular relating to implementation of recommendations of Committee on Legal
Aspects of Bank Frauds applicable to all scheduled commercial banks (excluding Regional Rural
Banks). The said circular provides details regarding liability of accounting and auditing profession
including the professional conduct, non-disclosure of client information and need to report fraud.
Auditor should also consider the compliance with provisions of Standards on Auditing.
8. SA 250, “Consideration of Laws and Regulations in an Audit of Financial
Statements”, explains that the duty of confidentiality is over-ridden by statute, law or
by courts. Whereas an auditor conducting an audit in accordance with SAs is
responsible for obtaining reasonable assurance that the financial statements taken as a whole
are free from material misstatement, whether caused by fraud or error according to SA 240.
Further, 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 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.
It must be noted that auditor is not expected to consider each and every transaction but to evaluate
the system as a whole. Therefore, if the auditor while performing normal duties comes across any
instance, he/she should report the matter to the RBI in addition to Chairman/Managing Director/Chief
Executive of the concerned bank.
9.4 Reports and certificates
Besides, as part of statutory audit process, statutory central auditor provides reports and certificates
mainly consisting of following:-
Report on adequacy and operating effectiveness of Internal financial Controls over
Financial Reporting in case of banks
Long form audit report.
Report on compliance with SLR requirements.
Report on whether the treasury operations of the bank have been conducted in
accordance with the instructions issued by the RBI from time to time.
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Certificate on reconciliation of securities by the bank (both on its own investment
account as well as PMS Banks' account).
Certificate on compliance by the bank in key areas of prudential and other guidelines
relating to such transactions issued by the RBI. (investment transactions)
Report on whether the income recognition, asset classification and provisioning have
been made as per the guidelines issued by the RBI from time to time.
Report on whether any serious irregularity was noticed in the working of the bank which
requires immediate attention (in accordance with sec 143(12) of the Companies Act,
2013.)
Certificate in respect of custody of unused Bank Receipt forms and their utilisation.
Authentication of capital adequacy ratio, including disclosure requirements and other
ratios reported in the notes to accounts.
Report on status of the compliance by the bank with regard to the implementation of
recommendations of the Ghosh Committee relating to frauds and malpractices and of
the recommendations of Jilani Committee on internal control and inspection/credit
system.
Report on instances of adverse credit-deposit ratio in the rural areas.
Asset liability management.
Certificate on Corporate Governance in case of banks listed on Stock Exchange. In
some banks this certification may not be got done by the central auditors.
Certification on claim of various interest subsidies and interest subvention.
10. CONCURRENT AUDIT
Concurrent audit, as the name suggests, is an audit or verification of
transactions or activities of an organisation concurrently as the
transaction/activity takes place. It is not a pre-audit. The concept in
this audit is to verify the authenticity of the transaction/activity within
the shortest possible time after the same takes place. It is akin to
internal audit which is a concept recognised under the Companies
Act. In view of the complexities of economic activities it is now well recognised that there must be a
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system of someone, other than the person involved in the operations, verifying the authenticity of
the transaction/activity on a regular basis, so that any deviation from the laid down procedures can
be noticed in the shortest possible time and remedial action can be taken.
The concept of concurrent audit in the public as well as the private sector banks has gained
acceptance in recent years. In some banks, this task has been entrusted to the internal inspection
staff who are not engaged in operational activities. In other banks, this work is allotted to outside
professional firms of chartered accountants. The Reserve Bank of India (RBI) has issued certain
guidelines for the conduct of this audit.
10.1 Scope of Concurrent Audit
The detailed scope of the concurrent audit should be clearly and uniformly determined for the Bank
as a whole by the Bank’s Central Inspection and Audit Department in consultation with the Bank’s
Audit Committee of the Board of Directors (ACB). In determining the scope, importance should be
given to checking high-risk transactions having large financial implications as opposed to
transactions involving lesser amounts. The detailed scope of the concurrent audit may be
determined and approved by the ACB.
Further, the guidelines issued by the RBI cover all the key areas of activities of the branch which is
under concurrent audit. Most banks have prepared an Audit Manual for this purpose. Broadly stated,
the following areas are covered by these guidelines:
Scope of Concurrent Foreign House
Audit in Banks Exchange Keeping
Cash Investments Other Items
Deposits Advances
10.2 Concurrent Audit System in Commercial Banks
It hardly needs to be stressed that the concurrent audit system is to be regarded as part of a bank’s
early-warning system to ensure timely detection of irregularities and lapses which helps in preventing
fraudulent transactions at branches. It is, therefore, necessary for the bank’s management to bestow
serious attention to the implementation of various aspects of the system such as selection of
branches/coverage of business operations, appointment of auditors, appropriate reporting
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procedures, follow-up/rectification processes and utilisation of the feedback from the system for
appropriate and quick management decisions.
The bank should once in a year review the effectiveness of the system and take necessary measures
to correct the lacunae in the implementation of the programme.
10.3 Coverage of Business/Branches
The scope of work to be entrusted to concurrent auditors, coverage of business/branches, etc. is left
to the discretion of the head of internal audit of banks with the due prior approval of the Audit
Committee of the Board of Directors (ACB).
Banks may, however, ensure that risk sensitive areas identified by them as per their specific
business models are covered under concurrent audit. The detailed scope of the concurrent audit
may be determined and approved by the ACB.
The broad areas of coverage under concurrent audit shall be based on the identified risk of the unit
and must include random transaction testing of sufficiently large sample of such transactions
wherever required.
10.4 Types of Activities to be Covered
The areas that are typically covered as part of a concurrent audit and the suggested audit procedures
are as follows:
Area of Focus Suggested Audit Procedures
Cash • Daily cash transactions with particular reference to any abnormal/
high value receipts and payments.
• Proper accounting of inward and outward cash remittances.
• Proper accounting of currency chest transactions, its prompt
reporting to the RBI.
• Expenses incurred by cash payment involving sizeable amount.
Investments • Ensure that in respect of purchase or sale of securities the branch
has acted within its delegated power having regard to its Head
Office instructions.
• Ensure that the securities held in the books of the branch are
physically held by it.
• Ensure that the branch is complying with the RBI/head Office
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guidelines regarding BRs, SGL forms, delivery of scrips,
documentation and accounting.
• Ensure that the sale or purchase transactions are done at rates
beneficial to the bank.
Deposits • Check the transactions about deposits received and repaid.
• Percentage check of interest paid on deposits may be made
including calculation of interest on large deposits.
• Check new accounts opened particularly current accounts.
Operations in new current/SB accounts may be verified in the
initial periods to see whether there are any unusual operations.
Advances • Ensure that loans and advances have been sanctioned properly
in accordance with delegated authority.
• Ensure that securities and documents have been received and
properly charged/ registered.
• Ensure that post disbursement supervision and follow-up is
proper, such as receipt of stock statements, instalments,
recovery/ renewal of sanction limits, etc.
• Verify whether there is any misutilisation of the loans and whether
there are instances indicative of diversion of funds.
• Check whether the letters of credit issued by the branch are within
the delegated power and ensure that they are for genuine trade
transactions.
• Check the bank guarantees issued, whether they have been
properly worded and recorded in the register of the bank. Whether
they have been promptly renewed on the due dates.
• Ensure proper follow-up of overdue bills of exchange.
• Verify whether the classification of advances has been done as
per RBI guidelines.
• Verify whether the claims to DICGC and ECGC is submitted in
time.
• Verify that instances of exceeding delegated powers have been
promptly reported to controlling/Head Office by the branch and
have been confirmed or ratified at the required level.
Foreign • Check foreign bills negotiated under letters of credit.
Exchange
• Check FCNR and other non-resident accounts whether the debits
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and credits are permissible under rules.
• Check whether inward/outward remittance have been properly
accounted for.
• Examine extension and cancellation of forward contracts for
purchase and sale of foreign currency. Ensure that they are duly
authorised and necessary charges have been recovered.
• Ensure that balances in Nostro accounts in different foreign
currencies are within the limit as prescribed by the bank.
• Ensure that the overbought/oversold position maintained in
different currencies is reasonable, considering the foreign
exchange operations.
• Ensure adherence to the guidelines issued by RBI/HO of the
bank about dealing room operations.
• Ensure verification/reconciliation of Nostro and Vostro account
transactions/balances.
House Keeping • Ensure that the maintenance and balancing of accounts, ledgers
and registers including clean cash is proper.
• Early reconciliation of entries outstanding in the inter-branch and
inter-bank accounts, Suspense Account, Sundry Deposits
Account, DDRR Account, Drafts Account, etc.
• Ensure timely adjustment of large value entries.
• Carry out a percentage check of calculations of interest, discount,
commission and exchange.
• Check whether debits in income account have been permitted by
the competent authorities.
• Check the transactions of staff accounts.
• Examine the day book to verify as to how the differences in
clearing have been adjusted.
• Detection & prevention of revenue leakages through close
examination of income and expenditure accounts.
• Verify cheques returned/bills returned register and look into
reasons for return of those instruments.
• Checking of inward and outward remittances (DDs, MTs & TTs).
Other items • In case the branch has been entrusted with government business,
ensure that the transactions are done in accordance with the
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instructions issued by Government, RBI & HQ.
• Ensure that the branch gives proper compliance to the internal
inspection/audit reports.
• Ensure that customers’ complaints are dealt with promptly.
• Verify the statements, returns, statutory returns etc. submitted to
RBI/ HQ.
10.5 Appointment of Concurrent Auditors and Accountability
• The option to consider whether concurrent audit should be done by bank’s own staff or
external auditors is left to the discretion of individual banks.
• In case the bank has engaged its own officials, they should be experienced, well
trained and sufficiently senior. The staff engaged on concurrent audit must be
independent of the branch where concurrent audit is to be conducted.
• ACB of the bank shall decide the maximum tenure of external concurrent auditors
with the bank. Generally, tenure of external concurrent auditors with a bank shall
not be more than five years on continuous basis. However, no concurrent auditor
shall be allowed to continue with a branch/business unit for a period of more than
three years.
• If external firms are appointed and any serious acts of omissions or commissions
are noticed in their working their appointments may be cancelled and the fact may
be reported to RBI & ICAI.
10.6 Remuneration of Concurrent Auditor
Terms of appointment of the external firms of Chartered Accountants for the concurrent audit and
their remuneration may be fixed by ACB of banks keeping in view various factors such as coverage
of areas, skill sets required, number of staff required and time to be devoted to audit.
10.7 Reporting Systems
• There should be proper reporting of the findings of the concurrent auditors. For this
purpose, each bank should prepare a structured format. The major deficiencies/
aberrations noticed during audit should be highlighted in a special note and given
immediately to the bank’s branch/controlling offices. A quarterly review containing key
features brought out during the concurrent audits should be placed before the ACB.
• There should be zone-wise reporting of the findings of the concurrent audit to ACB and
an annual appraisal/report of the audit system should be placed before the ACB.
• Before submission of the report the auditor should discuss the important issues on which
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he/she wishes to report with the branch manager and concerned officers. This will enable
the auditor to take into consideration the opposite view point and clarify any doubts.
• Minor irregularities pointed out by the concurrent auditors are to be rectified in a timely
manner. Serious irregularities should be reported to the controlling offices/ Head Offices
for immediate action.
• Whenever fraudulent transactions are detected, they should immediately be reported to
Inspection & Audit Department (Head Office) as also the Chief Vigilance Officer as well
as Branch Managers concerned (unless the branch manager is involved).
• Follow-up action on the concurrent audit reports should be given high priority by the
controlling office/Inspection and Audit Department and rectification of the features done
without any loss of time.
11. AUDIT COMMITTEE
Banks are required to constitute an Audit Committee of their Board in pursuance of RBI guidelines.
One of the functions of this committee is to provide direction and also oversee the operations of the
total audit function in the bank. The committee also has to review the internal inspection/audit
function in the bank, with special emphasis on the system, its quality and effectiveness in terms of
follow up. The committee has to review the system of appointment and remuneration of concurrent
auditors.
The Audit Committee is, therefore, connected with the functioning of the system of concurrent audit.
The method of appointment of auditors, their remuneration and the quality of their work is to be
reviewed by the Audit Committee. It is in this context that periodical meetings by the members of the
audit committee with the concurrent auditors and statutory auditors help the audit committee to
oversee the operations of the total audit function in the bank.
TEST YOUR UNDERSTANDING 2
You are conducting concurrent audit of branch of a public sector bank. It is a large branch having
advances of about ` 500 crores including export advances of ` 300 crores. Some borrowers also
get LCs issued from branch for importing raw diamonds from diamond hubs of Belgium. You want
to be sure that there is no revenue leakage in branch. For the time being, you are focusing upon
advances. Discuss any five areas pertaining to advances of the branch which you would verify to
ensure no revenue leakage.
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TEST YOUR UNDERSTANDING 3
CA. Seema is appointed as stock auditor of Bhawani Rice Mills Pvt. Ltd. availing credit facilities from
R.K. Puram Branch, Near Tamil Educational Society, New Delhi.
The borrower is enjoying cash credit limit of ` 12 crore from branch against security of paid stocks
and debtors up to 90 days against margin of 25%. She proceeds to visit premises of Bhawani Rice
Mills Pvt. Ltd. located on outskirts of Delhi. She verifies books of accounts and stock records of the
company and also test checks quantity of paddy and rice of 20000 quintals and 8000 bags lying in
premises of the company. Drawing power of ` 12.05 crore is computed in stock audit report and
report stands submitted to bank.
After about a week, regular internal inspector appointed by Inspection department of bank also
happened to visit premises of the borrower and found that rice contained in about 5000 bags included
in stocks having approx. value of ` 1.50 crore was fungus ridden. The company was holding this
stock for last 15 months.
How do you view the above situation? Discuss.
Integrated Case Scenario
CA. Madhusudan is conducting concurrent audit of a branch of a nationalized bank. It is a large
branch having deposits of ` 350 crore and advances of ` 600 crore respectively. The deposits of
branch consist of term deposits apart from CASA deposits. It is an old branch in operation since late
70s. Therefore, there are many dormant deposit savings, current and term deposit accounts at the
branch.
Of late, the top management of the bank has been pushing for aggressive targets in opening of
CASA deposits. He wants to ensure that CASA deposit accounts opened by the branch during his
term comply with KYC norms.
During the course of concurrent audit of a particular month, he finds that temporary over limits are
granted to few borrowers availing cash credit facilities up to 10% of their respective sanctioned limits.
Granting of such over limits falls within the powers of Chief Manager of the said branch. It is also
noticed by him that temporary overdrafts are allowed to few customers in their current accounts.
However, granting of these temporary overdrafts also falls in Chief Manager’s delegated powers.
Temporary over limits and overdrafts as discussed above have been adjusted and paid before the
end of the month.
It is further noticed by him during the same month that branch has sanctioned 5 fresh advances
falling within Chief Manager’s powers and conforming to bank norms aggregating to ` 10 crore. All
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these sanctioned advances pertain to same industry i.e., jute mills manufacturing jute sacks. He
feels that branch’s approach is not proper and sanction of 5 advances to the same industry lacks
diversity and lending decision of branch is not proper.
He further notices that during the month, one borrower of branch falling under definition of “small
enterprise” in MSME sector has shifted its credit facilities from the branch to a bank in private sector.
The branch has levied foreclosure charges on outstanding credit facilities pertaining to borrower by
disregarding “Code of Bank’s Commitment to Micro and Small Enterprises”. The borrower is still
having current account with branch. Reversal of such charges would lead to revenue loss for branch.
He is in a fix as far as reporting is concerned.
Keeping in view above, answer the following questions: -
1. As regards dormant deposit accounts in the branch, which of the following is not part of duty
of concurrent auditor?
(a). Verifying that dormant accounts are revived with appropriate authority
(b). Examining authorisation for withdrawals
(c). Following up with account holders to ensure status of accounts remains active
(d). Verifying that dormant accounts at the branches ageing more than 10 years have been
transferred to Deposit Education and Awareness Fund (DEAF)
2. The concurrent auditor wants to ensure that fresh CASA accounts opened in the branch are
KYC compliant. Which of the following best sums up scope of KYC guidelines prescribed by
RBI?
(a). The basic purpose of such guidelines is to weed out duplicate customers at the same
branch.
(b). Such guidelines contain detailed requirements for banks to enable them to draw a 360-
degree credit profile of the customers by monitoring of transactions. Its primary
purpose is assisting banks in making prudent credit decisions.
(c). Such guidelines have a basic objective of ensuring credit of Direct benefit transfers
(DBT) in accounts of deserving account holders.
(d). Such guidelines contain detailed requirements in respect of customer acceptance
policy, customer identification procedures, monitoring of transactions and risk
management.
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14.70 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3. Which of the following statements is most appropriate as regards reporting of matters relating
to temporary over limits in cash credit accounts and temporary overdrafts in current accounts?
(a). The said instances cannot be reported as these fall in powers of Chief Manager.
(b). The said instances can be reported in monthly concurrent audit report. No discussion
is necessary with Chief Manager in this respect to ensure sanctity of report.
(c). The said instances can be reported in monthly concurrent audit report. However, a
discussion is necessary with Chief Manager in this respect.
(d). The said instances cannot be reported as these fall in powers of Chief Manager and
have been adjusted and paid before the end of the month.
4. Which of the following statements is most appropriate regarding sanction of fresh advances
to borrowers in the same industry in a month from concurrent auditor’s perspective?
(a). Such a lending lacks diversity and needs to be reported without fail.
(b). Such a lending increases credit risk for branch and needs immediate attention of
higher authorities of bank.
(c). Lending has been made within Chief Manager’s powers. It does not fall in concurrent
auditor’s domain to question wisdom of lending decision conforming to bank norms.
(d). Although lending has been made within Chief Manager’s powers, branch should have
reported to higher authorities flagging sanction of fresh advances to same industry.
Only this aspect should be reported in concurrent auditor’s report.
5. As regards matter of levying of foreclosure charges described in case scenario, what is
appropriate course of action for concurrent auditor?
(a). The matter should be reported even though it would lead to revenue loss for branch.
(b). The matter should not be reported as it is part of duties of concurrent auditor to
safeguard branch’s revenue interests.
(c). The matter should be reported only for its disregard of Code without highlighting
revenue impact.
(d). The matter concerns branch management’s decision. It does not fall in purview of
concurrent audit.
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Key Takeaways
Special audit considerations arise in audit of banks due to particular nature of risks associated
with transactions undertaken, scale of banking operations, extensive dependence on IT to
process transactions, effect of statutory and regulatory requirements and continuous roll out
of new products and services.
Every banking company is required to prepare a Balance Sheet and a Profit and Loss Account
in the forms set out in the Third Schedule to the Act or as near thereto as the circumstances
admit. Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form
of Balance Sheet and Form B contains the form of Profit and Loss Account.
It is pertinent to state that preparation of balance sheet of a bank usually involves preparation
of standalone financial statements and consolidated financial statements. Preparation of
Standalone financial statements involve consolidation of branch accounts and incorporation
of various verticals/departments of bank in case of a nationalized bank/public sector bank.
The detailed procedures in this regard may vary from bank to bank. In case of private banks,
the processes of accounting are centralized and there is no concept of mandatory branch
audit in accordance with RBI guidelines.
Most banks, especially those in nationalised banks or public sector, appoint four or more
(depending upon their size and Board decision, as per RBI guidelines) firms of chartered
accountants to act jointly as statutory central auditors (SCAs)
As per the provisions of the relevant enactments, the auditor of a banking company is to be
appointed at the annual general meeting of the shareholders, whereas the auditor of a
nationalised bank is to be appointed by the concerned bank acting through its Board of
Directors. In either case, approval of the Reserve Bank is required before the appointment is
made.
The technological developments have brought new challenges for auditors as audit is
required to be conducted through the system.
It is responsibility of statutory central auditors to obtain understanding of IT environment and
various controls put in place by management and evaluate whether controls are operating
effectively.
Banks are required to implement and maintain a system of internal controls for mitigating
risks, maintain good governance and to meet the regulatory requirements. Areas of focus in
respect of internal control include cash, clearings, bills for collection, bills purchased, loans
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14.72 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
and advances, inter-branch accounts and credit card operations. Audit procedures have to
be designed for verification of items of assets and liabilities taking into account special
considerations relevant to banks.
Advances generally constitute the major part of the assets of the bank. The audit of advances
requires the major attention from the auditors. There exists elaborate and detailed control
system & procedure in banks pertaining to appraisal, sanctioning, documentation, disbursal,
review, monitoring and supervision of advances. Audit approach of advances should
encompass designing appropriate audit procedures to obtain audit evidence in all these
areas.
Concurrent audit is an audit or verification of transactions or activities of an organisation
concurrently as the transaction/activity takes place. The concept in this audit is to verify the
authenticity of the transaction/activity within the shortest possible time after the same takes
place.
Concurrent audit system is to be regarded as part of a bank’s early-warning system to ensure
timely detection of irregularities and lapses which helps in preventing fraudulent transactions
at branches. The important areas to be covered in concurrent audit include cash, investments,
deposits, advances, foreign exchange and house- keeping etc.
Banks are required to constitute an Audit Committee of their Board in pursuance of RBI
guidelines. One of the functions of this committee is to provide direction and also oversee the
operations of the total audit function in the bank. The committee also has to review the internal
inspection/audit function in the bank, with special emphasis on the system, its quality and
effectiveness in terms of follow up. The committee has to review the system of appointment
and remuneration of concurrent auditors.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank
follows financial year as accounting year. Your Audit Manager informed that the bank has
recognised on accrual basis income from dividends on securities and Units of Mutual Funds
held by it as at the end of financial year. The dividends on securities and Units of Mutual
Funds were declared after the end of financial year. Comment.
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2. As statutory central auditors of a Nationalized bank, what special points are to be borne in
mind in the audit of compliance with "Statutory Liquidity Ratio" (SLR) requirements?
3. Explain the scope of concurrent audit of a bank with reference to Reserve Bank of India
guidelines.
4. In course of audit of Good Samaritan Bank as at 31st March, 23 you observed the following:
(a) In a particular account there was no recovery in the past 18 months. The bank has not
applied the NPA norms as well as income recognition norms to this particular account.
When queried the bank management replied that this account was guaranteed by the
central government and hence these norms were not applicable. The bank has not
invoked the guarantee. Please respond. Would your answer be different if the
advance is guaranteed by a State Government?
(b) The bank’s advance portfolio comprised of significant loans against Life Insurance
Policies. Write suitable audit program to verify these advances.
5. Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The bank
is a consortium member of Cash Credit Facilities of ` 50 crores to X Ltd. Bank's own share
is ` 10 crores only. During the last two quarters against a debit of ` 1.75 crores towards
interest the credits in X Ltd's account are to the tune of ` 1.25 crores only. Based on the
certificate of lead bank, the bank has classified the account of X Ltd as performing. The Bank
follows financial year as accounting year. Advise your views on the issue which were brought
to your notice by your Audit Manager.
6. You have been appointed as an auditor of LCO Bank, a nationalized bank. LCO Bank also
deals in providing credit card facilities to its account holder. The bank is aware of the fact that
there should be strict control over storage and issue of credit cards. How will you evaluate
the Internal Control System in the area of Credit Card operations of a Bank?
7. You have been appointed as Concurrent Auditor of a nationalized bank branch. The main
business at the branch is dealing in foreign exchange. Suggest the main areas of coverage
with regard to foreign exchange transactions of the said branch under concurrent audit.
8. While auditing FAIR Bank, you observed that a lump sum amount has been disclosed as
contingent liability collectively. You are, therefore, requested by the management to guide
them about the disclosure requirement of Contingent Liabilities for Banks. Kindly guide.
9. ABC Chartered Accountants have been appointed as concurrent auditors for the branches of
Effective Bank Ltd. for the year 2022-23. You are part of the audit team for Agra branch of
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14.74 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
the bank and have been instructed by your senior to verify the advances of the audit period.
You are required to guide your assistant about the areas to be taken care while doing
verification during the concurrent audit.
10. In the course of audit of Skip Bank Ltd., you found that the Bank had sold certain of its non-
performing assets. Draft the points of audit check that are very relevant to this area of
checking.
11. Banks, because of certain characteristics, are distinguished from other commercial
enterprises and hence it needs special audit consideration. As an auditor of a bank, specify
the various peculiarities which may necessitate special audit consideration to be taken care
by you?
12. ABC Bank had sanctioned credit limits of ` 100 lakh to M/s Volkart Ltd on 1st September
2021. The renewal of limits was due on 1st September 2022. While doing the statutory branch
audit for the year ended 31st March 2023, you find that the renewal has not been done even
though 180 days are over. The bank says that the renewal process has been initiated on time
and most of the document are received. The account is operated regularly and is in order;
balance is maintained within drawing power. It also shows a letter from Volkart stating that
due to a sudden death of their auditor, a new auditor had to be appointed. Procedure for
appointment took some time and the new auditor was doing the audit all over again. The limit
was not renewed till 31/3/2023. However, the audited financials are received on 10 th April
2023 and the renewal letter was issued immediately. Your assistant is insisting that the
account must be classified as NPA since the limit was not renewed as on 31/3/2023. What is
your opinion?
13. You are auditing a small bank branch with staff strength of the manager, cashier and three
other staff S1 ,S2 and S3. Among allocation of work for other areas, S1 who is a peon also
opens all the mail and forwards it to the concerned person. He does not have a signature
book so as to check the signatures on important communications. S2 has possession of all
bank forms (e.g. Cheque books, demand draft/pay order books, travelers’ cheques, foreign
currency cards etc.). He maintains a record meticulously which you have test checked also.
However, no one among staff regularly checks that. You are informed that being a small
branch with shortage of manpower, it is not possible to always check the work and records.
Give your comments.
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Answers to Test your understanding
1. An account becomes NPA when it ceases to generate income for bank. In the given situation,
all the examined five accounts are operating satisfactorily. There is no reason for suggesting
changes in their classification.
The matter of scantily filling up loan applications and lack for record for assessment of
enhanced working capital requirements shows that internal control over advances in branch
is not proper. The above said situation shows deficiencies in “credit appraisal” at branch level.
Such deficiencies need to be highlighted by auditor in LFAR.
2. The areas of advances which need to be verified are as under: -
i. Interest rates fed in the system need to be verified with respect to corresponding
sanction letters. It would help ensure that correct rate of interest is fed into the system
and interest is applied properly at stipulated intervals on advances.
ii. Processing fees in respect of freshly sanctioned advances and renewed limits need to
be levied in accordance with bank guidelines and these need to be verified. Any
revision in processing fees from time to time has to be given effect to in accordance
with circulars/manual of bank.
iii. Sanction of cash credit limits is generally accompanied with stipulation to submit stock
statements. Non-submission of stock statements can involve levying of penal interest.
Verification of this aspect is required.
iv. Verification of overdue interest on export bills purchased and packing credit facilities
for overdue period.
v. Verification of charges/commission in respect of letters of credit issued in accordance
with Bank’s circulars/manual.
3. The above situation reflects that professional work of stock audit was not performed diligently
by stock auditor. It is one of the important responsibilities of stock auditor to verify condition
of stocks. The auditor’s role is not limited to verify physical quantities only.
In given case, she should have got opened rice bags on test check basis. In the process, she
could have come to know about fungus ridden condition of rice. Value of such rice should
have been excluded while arriving at value of stocks for purpose of computation of drawing
power. It shows that she has failed to perform her work diligently and drawing power
calculated in the report submitted to bank is not proper.
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14.76 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Integrated Case Scenario
1. (c)
2. (d)
3. (c)
4. (c)
5. (a)
Answers to Theoretical Questions
1. Banks may book income from dividend on shares of corporate bodies on accrual basis,
provided dividend on the shares has been declared by the corporate body in its annual
general meeting and the owner's right to receive payment is established. This is also in
accordance with AS 9. In this case the dividends have been declared after the financial year
end. Therefore, the recognition of income by the bank on accrual basis is not in order.
In respect of income from government securities and bonds and debentures of corporate
bodies, where interest rates on these instruments are pre-determined, income could be
booked on accrual basis, provided interest is serviced regularly and as such is not in arrears.
It was further, however, clarified that banks may book income on accrual basis on securities
of corporate bodies/public sector undertakings in respect of which the payment of interest
and repayment of principal have been guaranteed by the central government or a State
government.
2. Refer Para no 6.
3. Refer Para no. 10.1
4. (a) Government Guaranteed Advance: If a government guaranteed advance becomes
NPA, then for the purpose of income recognition, interest on such advance should not
to be taken to income unless interest is realized. However, for purpose of asset
classification, credit facility backed by Central Government Guarantee, though
overdue, can be treated as NPA only when the Central Government repudiates its
guarantee, when invoked.
Since the bank has not invoked the guarantee, the question of repudiation does not
arise. Hence the bank is correct to the extent of not applying the NPA norms for
provisioning purpose. But this exemption is not available in respect of income
recognition norms. Hence the income to the extent not recovered should be reversed.
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The situation would be different if the advance is guaranteed by State Government
because this exception is not applicable for State Government Guaranteed advances,
where advance is to be considered NPA if it remains overdue for more than 90 days.
In case the bank has not invoked the Central Government Guarantee though the
amount is overdue for long, the reasoning for the same should be taken and duly
reported in LFAR.
(b) The Audit Programme to Verify Advances against Life Insurance Policies is as
under-
(i) The auditor should inspect the policies and see whether they are assigned to
the bank and whether such assignment has been registered with the insurer.
(ii) The auditor should also examine whether premium has been paid on the
policies and whether they are in force.
(iii) Certificate regarding surrender value obtained from the insurer should be
examined.
(iv) The auditor should particularly see that if such surrender value is subject to
payment of certain premium, the amount of such premium has been deducted
from the surrender value.
5. The bank is a consortium member of cash credit facilities of ` 50 crores to X Ltd. Bank's own
share is ` 10 crores only. During the last two quarters against a debit of
` 1.75 crores towards interest, the credits in X Ltd.’s account are to the tune of
` 1.25 crores only. Sometimes, several banks form a group (the 'consortium') under the
leadership of a 'lead bank' to make advance to a large customer on same conditions and
security with proportionate rights. In such cases, each bank may classify the advance given
by it according to its own experience of recovery and other factors. Since in the last two
quarters, the amount remains outstanding and, thus, interest amount should be reversed.
This is despite the certificate of lead bank to classify that the account as performing.
Accordingly, the amount should be shown as non-performing asset.
6. Refer Para 5.
7. Refer Para 10.4.
8. Refer Para 8 - Part (VI)
9. Refer Para 7 sub heading III
10. Refer Para 7 sub heading III
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14.78 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
11. Refer Para 1
12. As per Guidelines of Reserve Bank of India the account should be classified as NPA if renewal
is not done in 180 days. However, in the present case, operations in the account are excellent.
The bank has shown a letter from that company that due to certain reasons the audited
financial statements are delayed. Further, the limit has been renewed before signing the audit
report.
Thus, even if the sanction was issued after the balance sheet date, it relates to the position
as on the balance sheet date. Therefore, it is an adjusting event under AS 4, Contingencies
and Events Occurring After the Balance Sheet Date. It is also a matter of substance over
form.
The auditor would consider classifying the account as a standard asset.
13. Banks are required to implement and maintain a system of internal controls for mitigating
risks, maintain good governance and to meet the regulatory requirements. Given below are
examples of internal controls that are violated in the given situation:
In the instant case, S1 who is a peon opens all the mail and forwards it to the concerned
person. Further, he does not have a signature book so as to check the signatures on important
communications is not in accordance with implementation and maintenance of general
internal control. As the mail should be opened by a responsible officer. Signatures on all the
letters and advices received from other branches of the bank or its correspondence should
be checked by an officer with the signature book.
All bank forms (e.g. Cheque books, demand draft/pay order books, travelers’ cheques, foreign
currency cards etc.) should be kept in the possession of an officer, and another responsible
officer should verify the issuance and stock of such stationery. In the given case, S2 has
possession of all bank forms (e.g. cheque books, demand draft/pay order books, travelers’
cheques, foreign currency cards etc.). He maintains a record meticulously which were also
verified on test check basis.
Further, contention of bank that being a small branch with shortage of manpower they are not
able to check the work and records on regular basis, is not tenable as such lapses in internal
control pose risk of fraud.
The auditor should report the same in his report accordingly.
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UNIT 2 – SPECIAL FEATURES OF AUDIT OF
NON-BANKING FINANCIAL COMPANIES (NBFCs)
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Understand the definition, regulations and types of Non-Banking Finance
Companies (NBFCs).
Difference between Banks and NBFCs.
Gain the knowledge of the prudential norms- Capital Requirements,
Income Recognition, and Provisioning requirements.
Learn the audit procedures and Audit Checklist for NBFCs.
Apply & analyse the above-mentioned concepts in moderately complex
scenarios.
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14.80 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
UNIT OVERVIEW
Audit of NBFCs
Definition,
Registration Audit Audit Check- Auditor's
Audit Report
and Procedures list Duties
Regulations
CA Sachet is appointed as the statutory auditor of an NBFC. How important are NBFCs in
financial system of a large and diverse country as India? Part of country’s financial services
sector, NBFCs cater to variety of customers in rural and urban areas thus promoting
inclusive growth. Such entities have become an important source of credit for those
segments of society which cannot meet strict requirements of banks for lending purposes.
They are popular in areas of housing finance, financing for commercial vehicles,
microfinance industry, MSME sector and in other areas. And how does an NBFC differ from
a bank? Although NBFCs lend like banks, they cannot accept demand deposits and are not
part of payment and settlement system like banks.
As part of understanding NBFCs, Sachet found such entities to be strictly regulated. They
have to obtain certificate of registration to commence business of non-banking financial
institution. There are RBI directions and norms on acceptance of public deposits, capital
adequacy, risk exposure and other measures to monitor financial solvency and reporting.
NBFCs are also subject to regulatory norms for asset classification, provisioning and
income recognition as per directions of RBI. NBFCs having applicability of Ind AS are also
required to consider principles of relevant Ind AS in the preparation of financial statements.
In fact, financial statements of an NFBC having applicability of Ind-AS are required to be
prepared in accordance with Division III of Schedule III of Companies Act, 2013. Audit
approach to an NBFC has to take into account all such issues.
He was also checking for regulatory updates in NBFC sector as part of understanding it.
He became aware of applicability of “scale based” regulations defining NBFCs on basis of
their size, activity and perceived riskiness into four layers i.e., base layer, middle layer,
upper layer and top layer.
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Whereas upper layer comprises of NBFCs specifically identified by RBI for enhanced
regulatory requirement, top layer would ideally remain empty unless RBI is of the opinion
that there is substantial increase in potential systemic risk from specific NBFCs in upper
layer. Not in the upper layer published by RBI, he was trying to confirm classification of
this very auditee company in accordance with such regulations.
Sensing that there was increased responsibility of an auditor of NBFC in view of various
RBI directions, he tweaked his audit approach accordingly. Not only auditor of NBFC is
required to report to shareholders, he is also responsible for making an additional report
to the Board of Directors of the company on certain specified matters in accordance with
RBI directions.
1. INTRODUCTION
Non-Banking Finance Company sector has evolved considerably in terms of its size, operations,
technological sophistication, and entry into new areas of financial services and products. NBFCs are
now deeply interconnected with the entities in the financial sector, on both sides of their balance
sheets. Being financial entities, they are exposed to risks arising out of counterparty failures, funding
and asset concentration, interest rate movement and risks pertaining to liquidity and solvency, as
any other financial sector player. At the same time there are segments within the sector that do not
pose any significant risks to the system.
Fig. : NBFCs ∗ Fig.: Audit of NBFCs ∗
∗
Source: Techno Legal Journalists
∗
Source: Inventicon
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14.82 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Definition of NBFC: 45 I(f) of Reserve Bank of India (Amendment) Act, 1997 defines a
non-banking financial company as:
(i) A financial institution which is a company;
(ii) A non-banking institution which is a company and which has as its principal business
the receiving of deposits, under any scheme or arrangement or in any other manner, or
lending in any manner;
(iii) Such other non-banking institution or class of such institutions, as the Bank may, with
the previous approval of the Central Government and by notification in the Official
Gazette, specify;”
Fig. : What is NBFC ∗
Further, in order to identify a particular company as Non-Banking Financial Company (NBFC), it will
consider both assets and income pattern as evidenced from the last audited balance sheet of the
company to decide its principal business. The company will be treated as NBFC when a
company's financial assets constitute more than 50 per cent of the total assets (netted off by
∗
Source: Slideshare
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FINANCIAL COMPANIES
intangible assets) and income from financial assets constitute more than 50 per cent of the gross
income. A company which fulfils both these criteria shall qualify as an NBFC and would require to
be registered as NBFC by RBI.
Registration and Regulation of NBFC:
Under Section 45–IA of the Reserve Bank of India Act, 1934, no non-banking financial company is
allowed to commence or carry on the business of a non-banking financial institution without
♦ obtaining a certificate of registration issued by the Reserve Bank of India and
♦ having the net owned fund of twenty-five lakh rupees or such other amount, not exceeding
hundred crore rupees, as the Bank may, by notification in the Official Gazette, specify.
♦ Provided that the Bank may notify different amount of net owned fund for different categories
of non-banking financial companies.
RBI has notified different amounts of net owned fund for different categories of NBFCs including
rupees 2 crore for certain categories of NBFCs
(For certain categories companies currently applying for registration as a NBFC, the minimum net
owned fund requirement is INR 10 Crore (previously it was INR 2 Crore) (Minimum NOF amount
may be higher depending on specific type of NBFC).
RBI has prescribed a timeline to meet NOF amount of INR 10 Crore in a phased manner for certain
categories of existing NBFCs by 31st March 2027. However, for NBFC-P2P, NBFC-AA, and NBFCs
with no public funds and no customer interface, the NOF shall continue to be INR 2 Crore.
A company incorporated under the Companies Act and desirous of commencing business of non-
banking financial institution as defined under Section 45–IA of the RBI Act, 1934 can apply to the
Reserve Bank of India in prescribed form along with necessary documents for registration. The RBI
issues Certificate of Registration after satisfying itself that the conditions as enumerated in Section
45-IA of the RBI Act, 1934 are satisfied.
The Reserve Bank of India has issued directions to non-banking financial companies on acceptance
of public deposits, prudential norms like capital adequacy, income recognition, asset classification,
provision for bad and doubtful debts, risk exposure norms and other measures to monitor the
financial solvency and reporting by NBFCs.
Directions were also issued to auditors to report non-compliance with the RBI Act and the
Regulations to the RBI, Board of Directors and shareholders. RBI has also issued Fair Practices
Code to be adopted by all NBFCs while doing lending business. The guidelines inter alia, covered
general principles on adequate disclosures on the terms and conditions of a loan and also adopting
a non-coercive recovery method.
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14.84 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Types of NBFCs- Compliance and Regulatory Perspective:
In terms of the Section 45-I(f) read with Section 45-I (c) of the RBI Act, 1934, as amended in 1997,
non-banking financial company (NBFC) is a company registered under the Companies
Act,1956/2013, engaged in the business of loans and advances, acquisition of shares/stocks/bonds/
debentures/ securities issued by Government or local authority or other marketable securities of a
like nature, leasing, hire-purchase, insurance business, chit business but does not include any
institution whose principal business is that of agriculture activity, industrial activity, purchase or sale
of any goods (other than securities) or providing any services and sale/purchase/construction of
immovable property.
A non-banking institution which is a company and has principal business of receiving deposits under
any scheme or arrangement in one lump sum or in installments by way of contributions or in any
other manner, is also a non-banking financial company (Residuary non-banking company).
NBFCs mandated to register under RBI
NBFCs registered with RBI are categorized as follows:
(a) in terms deposit acceptance or otherwise into Deposit and Non-Deposit accepting NBFCs;
(b) non deposit taking NBFCs by their size into systemically important and non-systemically
important (NBFC-NDSI and NBFC-ND); and
(c) by the kind of activities, they conduct.
Within the categorization mentioned in (c) above, (i.e. by the kind of activity they conduct) the
different types of NBFCs are as follows:
Asset
Non- Finance
Systematic Infrastructu
Banking Non- NBFC- Company,
ally re Debt
Financial Banking Non- Investment
Investment Infrastructu Important Fund- Non-
Company - Financial Operative Company,
and Credit re Finance Core Banking
Micro Company – Financial Loan
Company Company Investment Financial
Finance Factors Holding Company,
(ICC) (IFC) Company Company
Institution (NBFC- Company Mortgage
(CIC-ND- (IDF-
(NBFC- Factors) (NOFHC) Guarantee
SI) NBFC)
MFI) Companies
etc
Types of NBFCs
All NBFCs are either deposit taking or non-deposit taking. If they are non-deposit taking, ND is
suffixed to their name (NBFC-ND).
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A. Companies exempted from registration under RBI
Companies that do financial business but are regulated by other regulators are given specific
exemption by the Reserve Bank from its regulatory requirements for avoiding duality of regulation.
Following NBFCs have been exempted from the requirement of registration under Section 45-IA of
the RBI Act, 1934 subject to certain conditions.
Housing Finance Institutions (regulated by National Housing Bank);
Merchant Banking Companies (regulated by Securities and Exchange Board of India);
Stock Exchanges (regulated by Securities and Exchange Board of India);
Companies engaged in the business of stock-broking/sub-broking (regulated by Securities
and Exchange Board of India);
Venture Capital Fund Companies (regulated by Securities and Exchange Board of India);
Nidhi Companies (regulated by Ministry of Corporate Affairs, Government of India);
Insurance companies (regulated by Insurance Regulatory and Development Authority); and
Chit Companies (as defined in clause (b) of section 2 of the Chit Funds Act, 1982 (Act 40 of
1982)).
Specified Micro Finance Companies
Securitisation and Reconstruction Companies
Mutual Benefit Companies
Core Investment Companies i.e. a non-banking financial company being a Core Investment
Company referred to in the Core Investment Companies (Reserve Bank) Directions, 2016,
which is not a Systemically Important Core Investment Company, as defined in sub-
paragraph (xxv) of paragraph 3 of the Core Investment Companies (Reserve Bank)
Directions, 2016.
Alternative Investment Fund (AIF) Companies
Core Investment Companies with asset size of less than ₹ 100 crore, and those with asset size of
₹ 100 crore and above but not accessing public funds are exempted from registration with the RBI.
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Pursuant to the announcement of Scale Based Regulation (SBR): A Revised Regulatory
Framework for NBFCs on 22 October 2021 to be effective from 01 October 2022, RBI has
revised different facets of existing NBFC Classification and regulation like Capital
Requirements, Governance Standards, Prudential Regulations, etc. based on four layers that
are defined based on their size, activity, and perceived riskiness.
These four layers are NBFC – Base Layer (NBFC-BL), then NBFC- Middle Layer (NBFC-ML),
NBFC Upper Layer (NBFC-UL) and lastly NBFC – Top Layer (NBFC-TL).
The Top layer is ideally expected to be empty and will be filled by RBI based on required need.
Details of NBFCs populating the various layers is mentioned below:
Base Layer
The Base Layer shall comprise of (a) non-deposit taking NBFCs below the asset size of ₹1000 crore
and (b) NBFCs undertaking the following activities- (i) NBFC-Peer to Peer Lending Platform (NBFC-
P2P), (ii) NBFC-Account Aggregator (NBFC-AA), (iii) Non-Operative Financial Holding Company
(NOFHC) and (iv) NBFCs not availing public funds and not having any customer interface.
Middle Layer
The Middle Layer shall consist of (a) all deposit taking NBFCs (NBFC-Ds), irrespective of asset size,
(b) non-deposit taking NBFCs with asset size of ₹1000 crore and above and (c) NBFCs undertaking
the following activities (i) Standalone Primary Dealers (SPDs), (ii) Infrastructure Debt Fund - Non-
Banking Financial Companies (IDF-NBFCs), (iii) Core Investment Companies (CICs), (iv) Housing
Finance Companies (HFCs) and (v) Infrastructure Finance Companies (NBFC-IFCs).
Upper Layer
The Upper Layer shall comprise of those NBFCs which are specifically identified by the Reserve
Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring
methodology as provided (for detailed circular scan the QR code given in Key Takeaways). The
top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective
of any other factor.
Top Layer
The Top Layer will ideally remain empty. This layer can get populated if the Reserve Bank is of the
opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the
Upper Layer. Such NBFCs shall move to the Top Layer from the Upper Layer.
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Categorisation of NBFCs carrying out specific activity
As the regulatory structure envisages scale based as well as activity-based regulation, the following
prescriptions shall apply in respect of the NBFCs
(a) NBFC-P2P, NBFC-AA, NOFHC and NBFCs without public funds and customer interface will
always remain in the Base Layer of the regulatory structure.
(b) NBFC-D, CIC, IFC and HFC will be included in Middle Layer or the Upper Layer (and not in
the Base layer), as the case may be. SPD and IDF-NBFC will always remain in the Middle
Layer.
(c) The remaining NBFCs, viz., Investment and Credit Companies (NBFC-ICC), Micro Finance
Institution (NBFC-MFI), NBFC-Factors and Mortgage Guarantee Companies (NBFC-MGC)
could lie in any of the layers of the regulatory structure depending on the parameters of the
scale based regulatory framework.
(d) Government owned NBFCs shall be placed in the Base Layer or Middle Layer, as the case
may be. They will not be placed in the Upper Layer till further notice.
References to NBFC-ND, NBFC-ND-SI & NBFC-D - From October 01, 2022:
All references to NBFC-ND shall mean NBFC-BL and all references to NBFC-D and NBFC-NDSI shall
mean NBFC-ML or NBFC-UL, as the case may be. However, existing NBFC-ND-SIs having asset size
between INR 500 Crore and below INR 1000 Crore ( except those necessarily featuring in Middle Layer)
will be known as NBFC- BL (for detailed circular scan the QR code given in Key Takeaways).
2. DIFFERENCE BETWEEN BANKS AND NBFCS
NBFCs lend and make investments and hence, their activities are akin to that of banks, however,
there are a few differences between the two as given below:
i. NBFC cannot accept demand deposits, however some NBFCs can accept Term
Deposits;
ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques
drawn on itself;
iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation (DICGC)
is not available to depositors of NBFCs, unlike in case of banks.
iv. No Minimum Exposure to Priority Sector required by NBFCs.
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3. PRUDENTIAL NORMS
3.1 Capital Requirements
Every applicable NBFC as defined in the Master Direction- Non-Banking Financial Company –
Systemically Important Non-Deposit Taking Company & Deposit Taking Company (Reserve
Bank) Directions, 2016 shall maintain a minimum capital ratio consisting of Tier I and Tier II capital
which shall not be less than 15 % of its aggregate risk weighted assets on-balance sheet and of risk
adjusted value of off-balance sheet items.
The Tier I capital in respect of applicable NBFCs (other than NBFC-MFI and IDF-NBFC), at any point
of time, shall not be less than 10% by March 31, 2017.
Applicable NBFCs primarily engaged in lending against gold jewellery (such loans comprising 50
percent or more of their financial assets) shall maintain a minimum Tier l capital of 12 %.
However, in the case of Non-Systemically Important Non-Deposit Taking Company (Reserve Bank)
Directions, 2016, Net Owned Fund requirements have to be complied.
The RBI vide it’s Guidelines dated 22nd October,2021 has revised the regulatory framework for NBFC
basis the Scale. There are many changes made depending on the categorization of the NBFCs and
those are broadly in the areas of NPA classification, Capital requirements, Prudential Guidelines
specifically for NBFC- ML and NBFC-UL relating to Concentration of credit/ Investment, Sensitive
Sector Exposure, Loans to Related parties and KMP, for NBFC-UL address Large Exposure
framework, Internal exposure limit, Stricture and more broader Governance Guidelines, etc.
Note for Students : [Students may refer detailed Guidelines given in the Appendix.
Explanations: In these Directions, degrees of credit risk expressed as percentage weightages have
been assigned to balance sheet assets. For example, percentage weights assigned to Fixed
Assets is 100, Cash & Bank Balances is 0, etc. Hence, the value of each asset / item requires to
be multiplied by the relevant risk weights to arrive at risk adjusted value of assets. The aggregate
shall be taken into account for reckoning the minimum capital ratio. The risk weighted asset shall
be calculated as the weighted aggregate of funded items as detailed hereunder:
S. No. Weighted risk assets - On-Balance Sheet items Percentage weight
(i) Cash and bank balances including fixed deposits and 0
certificates of deposits with banks
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(ii) Investments:
(a) Approved securities [Except at (c) below] 0
(b) Bonds of public sector banks 20
(c) Fixed deposits/certificates of deposits/bonds of public 100
financial institutions
(d) Shares of all companies and debentures / bonds/
commercial papers of all companies and units of all 100
mutual funds
(e) All assets covering PPP and post commercial
operations date (COD) infrastructure projects in
existence over a year of commercial operation 50
(iii) Current assets:
(a) Stock on hire (net book value) 100
(b) Intercorporate loans/deposits 100
(c) Loans and advances fully secured against deposits held 0
(d) Loans to staff 0
(e) Other secured loans and advances considered good 100
[Except at (vi) below]
(f) Bills purchased/discounted 100
(g) Others (To be specified) 100
(iv) Fixed Assets (net of depreciation):
(a) Assets leased out (net book value) 100
(b) Premises 100
(c) Furniture & Fixture 100
(v) Other assets:
(a) Income tax deducted at source (net of provision) 0
(b) Advance tax paid (net of provision) 0
(c) Interest due on Government securities 0
(d) Others (to be specified) 100
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14.90 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(vi) Domestic Sovereign:
(a) Fund based claims on the Central Government 0
(b) Direct loan / credit / overdraft exposure and investment 0
in State Government securities
(c) Central Government guaranteed claims 0
(d) State Government guaranteed claims, which have not 20
remained in default / which are in default for a period
not more than 90 days 20
(e) State Government guaranteed claims, which have 100
remained in default for a period of more than 90 days
3.2 Income Recognition
The income recognition shall be based on recognised accounting principles. Income including
interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognised only
when it is actually realised. Any such income recognised before the asset became non-performing
and remaining unrealised shall be reversed.
Asset classification: The asset classification norms as given below shall apply to every applicable
NBFC (except NBFC-MFIs):
(1) Every NBFC shall, after taking into account the degree of well-defined credit weaknesses and
extent of dependence on collateral security for realisation, classify its lease/hire purchase
assets, loans and advances and any other forms of credit into the following classes, namely:
(i) Standard assets;
(ii) Sub-standard assets;
(iii) Doubtful assets; and
(iv) Loss assets.
(2) The class of assets referred to above shall not be upgraded merely as a result of
rescheduling, unless it satisfies the conditions required for the upgradation.
(3) (i) Standard asset shall mean the asset in respect of which, no default in repayment of
principal or payment of interest is perceived and which does not disclose any problem
or carry more than normal risk attached to the business;
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(ii) “Sub-Standard Asset” shall mean:
(a) an asset which has been classified as non-performing asset for a period not
exceeding 18 months (in case of NBFCs covered in Non-Banking Financial
Company – Non-Systemically Important Non-Deposit taking Company
(Reserve Bank) Directions, 2016);
The period ‘not exceeding 18 months’ stipulated in this sub-clause shall be ‘not
exceeding 12 months’ for the financial year ended March 31, 2018 and
thereafter for NBFCs covered in Non-Banking Financial Company -
Systemically Important Non-Deposit taking Company and Deposit taking
Company (Reserve Bank) Directions, 2016.
(b) an asset where the terms of the agreement regarding interest and / or principal
have been renegotiated or rescheduled or restructured after commencement of
operations, until the expiry of one year of satisfactory performance under the
renegotiated or rescheduled or restructured terms;
Provided that the classification of infrastructure loan as a sub-standard asset
shall be in accordance with the provisions of paragraph 25 of these Directions.
(iii) Doubtful Asset shall mean:
(a) a term loan, or
(b) a lease asset, or
(c) a hire purchase asset, or
(d) any other asset,
which remains a sub-standard asset for a period ‘exceeding 18 months’ (in case of
NBFCs covered in Non-Banking Financial Company – Non-Systemically Important
Non-Deposit taking Company (Reserve Bank) Directions, 2016).
The period ‘exceeding 18 months’ stipulated in this sub-clause shall be ‘exceeding 12
months’ for the financial year ended March 31, 2018 and thereafter for NBFCs covered
in Non-Banking Financial Company - Systemically Important Non-Deposit taking
Company and Deposit taking Company (Reserve Bank) Directions, 2016.
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14.92 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(iv) Loss Asset shall mean:
(a) an asset which has been identified as loss asset by the applicable NBFC or its
internal or external auditor or by the Bank during the inspection of the applicable
NBFC, to the extent it is not written off by the applicable NBFC; and
(b) an asset which is adversely affected by a potential threat of non-recoverability
due to either erosion in the value of security or non-availability of security or
due to any fraudulent act or omission on the part of the borrower
(v) Non-Performing Asset (referred as “NPA”) shall mean:
(a) an asset, in respect of which, interest has remained overdue for a period of six
months or more;
(b) a term loan inclusive of unpaid interest, when the instalment is overdue for a
period of six months or more or on which interest amount remained overdue for
a period of six months or more;
(c) a demand or call loan, which remained overdue for a period of six months or
more from the date of demand or call or on which interest amount remained
overdue for a period of six months or more;
(d) a bill which remains overdue for a period of six months or more;
(e) the interest in respect of a debt or the income on receivables under the head
‘other current assets’ in the nature of short term loans/advances, which facility
remained overdue for a period of six months or more;
(f) any dues on account of sale of assets or services rendered or reimbursement
of expenses incurred, which remained overdue for a period of six months or
more;
NBFCs covered in Non-Banking Financial Company - Systemically Important
Non-Deposit taking Company and Deposit taking Company (Reserve Bank)
Directions, 2016, period of ‘six months or more’ stipulated in sub-clauses (a) to
(f) shall be ‘three months or more’, for the financial year ended March 31, 2018
and thereafter].
This implies for NBFCs covered in Non-Banking Financial Company – Non-
Systemically Important Non-Deposit taking Company (Reserve Bank)
Directions, 2016, the criteria is 6 months only.
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(g) the lease rental and hire purchase instalment, which has become overdue for
a period of twelve months or more;
[NBFCs covered in Non-Banking Financial Company - Systemically Important
Non-Deposit taking Company and Deposit taking Company (Reserve Bank)
Directions, 2016, the period of ‘twelve months or more’ stipulated in this sub-
clause shall be ‘three months or more’ for the financial year ended March 31,
2018 and thereafter].
It implies that as per Non-Banking Financial Company – Non-Systemically
Important Non-Deposit taking Company (Reserve Bank) Directions, 2016, the
criteria is 12 months only.
(h) in respect of loans, advances and other credit facilities (including bills
purchased and discounted), the balance outstanding under the credit facilities
(including accrued interest) made available to the same borrower/beneficiary
when any of the above credit facilities becomes non-performing asset.
[Provided that in the case of lease and hire purchase transactions, an applicable
NBFC shall classify each such account on the basis of its record of recovery].
3.3 Provisioning Requirements
The provisioning requirements as given below shall apply to every applicable NBFC (except
NBFC-MFIs): Every applicable NBFC shall, after taking into account the time lag between an
account becoming non-performing, its recognition as such, the realisation of the security and the
erosion over time in the value of security charged, make provision against sub-standard assets,
doubtful assets and loss assets as provided hereunder:
The provisioning requirement in respect of loans, advances and other credit facilities including bills
purchased and discounted shall be as under:
(i) Loss Assets: The entire asset shall be written off. If the assets are permitted to remain in
the books for any reason,100% of the outstanding shall be provided for;
(ii) Doubtful Assets:
(a) 100% provision to the extent to which the advance is not covered by the realisable
value of the security to which the applicable NBFC has a valid recourse shall be made.
The realisable value is to be estimated on a realistic basis;
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14.94 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) In addition to item (a) above, depending upon the period for which the asset has
remained doubtful, provision to the extent of 20% to 50% of the secured portion (i.e.
Estimated realisable value of the outstanding) shall be made on the following basis:
Period for which the asset has been Percent of provision
considered as doubtful
Up to one year 20
One to three years 30
More than three years 50
(iii) Sub-standard assets: A general provision of 10 percent of total outstanding shall be
made.
(iv) Standard asset provisioning: Every NBFC (covered under Non-Banking Financial
Company - Systemically Important Non-Deposit taking Company and Deposit taking
Company (Reserve Bank) Directions, 2016) shall make provisions for standard
assets at 0.40 per cent by the end of March 2018 and thereafter, of the outstanding,
which shall not be reckoned for arriving at net NPAs.
Note: As per Non-Banking Financial Company – Non-Systemically Important Non-Deposit
taking Company (Reserve Bank) Directions, 2016, every applicable NBFC shall make
provision for standard assets at 0.25 percent of the outstanding amount.
The provision towards standard assets need not be netted from gross advances but shall
be shown separately as ‘Contingent Provisions against Standard Assets’ in the balance
sheet.
The above regulatory requirements are to be amended in a phased manner under the Scale-
Based Regulation prescribed by RBI for NBFCs.
[Students may refer Master Direction NBFC - Non-Systemically Important Non-deposit Taking
Company (Updated as on February 17, 2020) and Master Direction NBFC - Systemically Important
Non-deposit Taking Company and Deposit Taking Company (Updated as on February 17, 2020)
for detailed guidelines on prudential norms relating to Non-Banking Financial Companies covered
in these Directions.]
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4. AUDIT PROCEDURES
The following are the necessary steps involved -
(1) Ascertaining the Business of the Company - The first step in carrying out the audit of a
NBFC is to scan through the Memorandum and Articles of Association of the company, so as
to acquaint oneself with the type of business that the company is engaged into. Normally, the
Memorandum of Association of any company would be very wide in scope thereby permitting
it to undertake a host of business activities, but companies generally lend to specialise in and
focus on a few select activities. An auditor should, therefore, make a careful study of the
business policy of the company so as to ascertain its principal business activities. For this
purpose, an auditor may also scan through the minutes of the Board/Committee Meetings
and hold discussions with the top level management to ascertain the corporate business
plan/strategy which would give him a clear picture as to the principal objects of the company.
An auditor should then independently corroborate his findings with the actual business done
by the company, as reflected by the company’s financial results.
The task of ascertaining the principal business activity of any NBFC is of paramount
importance since the very classification of a company as a NBFC and its further classification
would all depend upon its principal business activity. Based on the classification of a
company, it will be required to comply with the provisions relating to limits on acceptance of
public deposits as contained in the NBFC Public Deposit Directions.
(2) Evaluation of Internal Control System - The responsibility of maintaining an adequate
accounting system incorporating various internal controls to the extent appropriate to the size
and nature of its business vests with the management. A sound internal control system would
enable an organisation to plug loopholes in its workings, particularly in the detection of frauds
and would also aid in timely decision making. An auditor should gain an understanding of the
accounting system and related internal controls adopted by the NBFC to determine the
nature, timing and extent of his audit procedures. An auditor should also ascertain whether
the internal controls put in place by the NBFC are adequate and are being effectively followed.
In particular, an auditor should review the effectiveness of the system of recovery prevalent
at the NBFC. He should ascertain whether the NBFC has an effective system of periodical
review of advances in place which would facilitate effective monitoring and follow up. The
absence of a periodical review system could result in non-detection of sticky advances at
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their very inception which may ultimately result in the NBFC having an alarmingly high level
of NPAs.
(3) Registration with the RBI - Section 45-IA inserted in the
RBI Act, 1934, w.e.f. 9th January, 1997, has made it
incumbent on the part of all NBFCs to comply with
registration requirements and have minimum net owned
funds (NOF) of ` 10 crore (Although the requirement of
minimum NOF at present stands at ` 200 lakh, . However,
for strengthening the financial sector and technology adoption, and in view of the increasing
complexities of services offered by NBFCs, it shall be mandatory for all NBFCs to raise
minimum NOF to ` 10 crore) for commencing/ carrying on its business. An auditor should
obtain a copy of the certificate of registration granted by the RBI or in case the certificate of
registration has not been granted, a copy of the application form filed with the RBI for
registration. It may particularly be noted that NBFCs incorporated after 9th January, 1997 are
not entitled to commence business without first obtaining a registration certificate from the
RBI. An auditor should, therefore, verify whether the dual conditions relating to registration
with the RBI and maintenance of minimum net owned funds have been duly complied with by
the concerned NBFC.
Every NBFC holding public deposits is required to invest a specified percentage (as the RBI
may specify from time to time). The RBI has also prescribed a format for reporting to ensure
compliance with the requirement of maintenance of liquid assets on a quarterly basis. This
quarterly return (duly signed by an officer of the NBFC) is required to be submitted within
prescribed time limit from the end of the relevant quarter and with reference to investments
held in approved securities during the relevant quarter. The auditor should ascertain whether
investment in prescribed liquid assets have been made and whether quarterly returns as
mentioned above have been regularly filed with the RBI by the concerned NBFC.
(4) NBFC Acceptance of Public Deposit Directions (Non-Banking Financial Companies
Acceptance of Public Deposits (Reserve Bank) Directions, 2016) - The auditors must
ascertain whether the company properly classified as per the requirements of various
regulations. In case, the NBFC has not been classified by the RBI, the classification of a
company will have to be determined after a careful consideration of various factors such as
particulars of earlier registration granted, if any, particulars furnished in the application form
for registration, company’s Memorandum of Association and its financial results. Thereafter,
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it must be ascertained whether the company has complied with the following aspects in
relation to the activity of mobilisation of public deposits:
(i) The ceiling on quantum of public deposits has been linked to its credit rating as given
by an approved credit rating agency. Obtain a copy of the credit rating assigned to
NBFC and check whether the public deposits accepted/held by it are in accordance
with the level of credit rating assigned to it.
In the event of a upgrading/downgrading of credit rating, the auditor should bear in
mind that the NBFC will have to increase/reduce its public deposits in accordance with
the revised credit rating assigned to it within a specified time frame and should ensure
that the NBFC has informed about the same to the RBI in writing.
In the event of downgrading of credit rating below the minimum specified investment
grade, a non-banking financial company, being an investment and credit company or
a factor, shall regularise the excess deposit as provided hereunder:
(a) with immediate effect, stop accepting fresh public deposits and renewing
existing deposits;
(b) all existing deposits shall run off to maturity; and
(c) report the position within 15 working days, to the concerned Regional Office of
the RBI where the NBFC is registered.
Provided no matured public deposit shall be renewed without the express and
voluntary consent of the depositor.
(ii) Test check the interest calculations in respect of public deposits mobilised by a NBFC
to ascertain that the NBFC has not paid interest in excess as per specification.
Likewise, test check the brokerage/ commission/ incentive calculations with the bills
and vouchers for reimbursement of out of pocket expenses submitted by the parties
to ascertain that the NBFC has not paid brokerage/ commission/ incentive/
reimbursement of expenses in excess as per specification.
(iii) Ascertain whether the NBFC has accepted or renewed any public deposit only after a
written application form the depositor in the form to be supplied by the company, and
shall contain all particulars specified in the Non-Banking Financial Companies and
Miscellaneous Non-Banking Companies (Advertisement) Rules, 1977. Further ensure
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whether it contain the specific category of depositor, i.e., whether depositor is a
shareholder or a director or a promoter or a member of public.
(iv) Verify the deposit register maintained by a NBFC and test check the particulars that
have been entered therein in respect of each depositor with supporting receipts issued
to the depositors. Also check whether the NBFC is regularly paying its deposits on due
dates and in the case of a delay/default, the reasons for the delay/default and the
actual date of payment.
(v) Check whether the investments made in approved liquid assets by a NBFC holding
public deposits have been lodged in safe custody with a designated scheduled
commercial bank as required by the NBFC Acceptance of Public Deposits Directions
and also whether. certificate was obtained from the RBI to that effect.
(vii) Check whether the NBFC has filed its prescribed returns in a timely manner.
(viii) In the case of NBFCs not accepting/holding public deposits, check whether a board
resolution has been passed by the NBFC to the effect that it has neither accepted any
public deposits nor would it accept any public deposits during the year.
(ix) In the case of Group Holding Investment Companies, check whether the NBFC has
passed a board resolution to the effect that the company has invested or would
invest/hold its investments in share and securities of group companies specifying the
names of the companies. In addition to the above, group holding investment
companies are required to give a further undertaking that it would not trade in such
shares/securities and that it has neither accepted nor would it accept any public
deposits during the year.
(5) NBFC Prudential Norms -
(i) Check compliance with prudential norms encompassing income recognition, income
from investments, accounting standards, accounting for investments, asset
classification, provisioning for bad and doubtful debts, capital adequacy norms,
prohibition on granting of loans by a NBFC against its own shares, prohibition on loans
and investments for failure to repay public deposits and norms for concentration of
credit/investments.
(ii) An auditor should ensure that the Board of Directors of every NBFC granting/intending
to grant demand/call loans shall frame and implement a policy for the company.
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(iii) An auditor should assess on the basis of examinations conducted by him whether the
NBFC has complied with the prudential norms. In particular, he should verify that
advances and other credit facilities have been properly classified as
standard/substandard/doubtful/loss and that proper provision has been made in
accordance with the Directions.
(iv) In respect of Non-Performing Assets, an auditor should check whether the unrealised
income in respect of such assets has not been taken to the Profit & Loss Account on
an accrual basis. Income from NPAs should be accounted for on realisation basis only.
(v) Check whether all accounts which have been classified as NPAs in the previous year
also continue to be shown as such in the current year also. If the same is not treated
as an NPA in the current year, the auditor should specifically examine such accounts
to ascertain whether the account has become regular and the same can be treated as
performing as per the Directions.
TEST YOUR UNDERSTANDING 1
“Fin crazy” is a P2P online platform owned by Future Technologies Pvt Limited which is registered
with RBI as NBFC. Peer to Peer Platform (P2P) means an intermediary providing the services of
loan facilitation via online medium or otherwise to the participants.
Participants have to enter into an arrangement with NBFC-P2P to lend on its platform or avail loan
facilitation services provided by it. It provides only as a medium connecting lenders and borrowers.
It also carries out the credit assessment and risk profiling of the participants on the platform. It
also provides services relating to loan documentation and loan recovery. The company falls
outside purview of upper layer.
Where does such NBFC fit into in accordance with scale-based regulations? Suggest few audit
procedures for above NBFC-P2P.
5. CLASSIFICATION OF FRAUDS BY NBFC
In order to have uniformity in reporting, frauds have been classified as under based mainly on the
provisions of the Indian Penal Code:
(a) Misappropriation and criminal breach of trust.
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14.100 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) Fraudulent encashment through forged instruments, manipulation of books of account or
through fictitious accounts and conversion of property.
(c) Unauthorised credit facilities extended for reward or for illegal gratification.
(d) Negligence and cash shortages.
(e) Cheating and forgery.
(f) Irregularities in foreign exchange transactions.
(g) Any other type of fraud not coming under the specific heads as above.
Cases of ‘negligence and cash shortages’ and ‘irregularities in foreign exchange transactions’
referred to in items (d) and (f) above are to be reported as fraud if the intention to cheat/ defraud is
suspected/ proved. However, the following cases where fraudulent intention is not suspected/
proved, at the time of detection, will be treated as fraud and reported accordingly:
(a) cases of cash shortages more than ` 10,000/- and
(b) cases of cash shortages more than ` 5000/- if detected by management/ auditor/ inspecting
officer and not reported on the occurrence by the persons handling cash.
NBFCs, covered in Master Direction - Monitoring of Frauds in NBFCs (Reserve Bank) Directions,
2016, having overseas branches/offices should report all frauds perpetrated at such
branches/offices also to the Reserve Bank as per the prescribed format and procedures.
6. AUDIT CHECK-LIST
Some important points that may be covered in the audit of NBFCs, in addition to the audit points
that may be covered for companies in general, are given below:
(eg. NBFC - Investment and Credit Company (NBFC-ICC)
i. Physically verify all the shares and securities held by a NBFC. Where any security is lodged
with an institution or a bank, a certificate from the bank/institution to that effect must be
verified.
ii. Verify whether the NBFC has not advanced any loans against the security of its own shares.
iii. Verify that dividend income wherever declared by a company, has been duly received by
an NBFC and interest wherever due [except in case of NPAs] has been duly accounted for.
NBFC Prudential Norms require dividend income on shares of companies and units of
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mutual funds to be recognised on cash basis. However, the NBFC has an option to account
for dividend income on accrual basis, if the same has been declared by the body corporate
in its Annual General Meeting and its right to receive the payment has been established.
Income from bonds/debentures of corporate bodies is to be accounted on accrual basis
only if the interest rate on these instruments is predetermined and interest is serviced
regularly and not in arrears.
iv. Test check bills/contract notes received from brokers with reference to the prices vis-à-vis
the stock market quotations on the respective dates.
v. Verify the Board Minutes for purchase and sale of investments. Ascertain from the Board
resolution or obtain a management certificate to the effect that the investments so acquired
are current investments or Long-Term Investments.
vi. Check whether the investments have been valued in accordance with the NBFC Prudential
Norms and adequate provision for fall in the market value of securities, wherever
applicable, have been made there against, as required by the Directions.
vii. Obtain a list of subsidiary/group companies from the management and verify the
investments made in subsidiary/group companies during the year. Ascertain the basis for
arriving at the price paid for the acquisition of such shares and whether the Valuation is as
per Prudential norms.
viii. Check whether investments in unquoted debentures/bonds have not been treated as
investments but as term loans or other credit facilities for the purposes of income
recognition and asset classification.
ix. An auditor will have to ascertain whether the requirements of AS 13 “Accounting for
Investments” or other accounting standard, as applicable, (to the extent they are not
inconsistent with the Directions) have been duly complied with by the NBFC.
x. In respect of shares/securities held through a depository, obtain a confirmation from the
depository regarding the shares/securities held by it on behalf of the NBFC.
xi. Verify that securities of the same type or class are received back by the lender/paid by the
borrower at the end of the specified period together with all corporate benefits thereof (i.e.
dividends, rights, bonus, interest or any other rights or benefit accruing thereon).
xii. Verify charges received or paid in respect of securities lend/borrowed.
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xiii. Obtain a confirmation from the approved intermediary regarding securities deposited
with/borrowed from it as at the year end.
xiv. An auditor should examine whether each loan or advance has been properly sanctioned.
He should verify the conditions attached to the sanction of each loan or advance i.e. limit
on borrowings, nature of security, interest, terms of repayment, etc.
xv. An auditor should verify the security obtained and the agreements entered into, if any, with
the concerned parties in respect of the advances given. He must ascertain the nature and
value of security and the net worth of the borrower/guarantor to determine the extent to
which an advance could be considered realisable.
xvi. Obtain balance confirmations from the concerned parties.
xvii. As regards bill discounting, verify that proper records/documents have been maintained for
every bill discounted/rediscounted by the NBFC. Test check some transactions with
reference to the documents maintained and ascertain whether the discounting charges,
wherever, due, have been duly accounted for by the NBFC.
xviii. Check whether the NBFC has not lent/invested in excess of the specified limits to any single
borrower or group of borrowers as per NBFC Prudential Norms.
xix. An auditor should verify whether the NBFC has an adequate system of proper appraisal
and follow up of loans and advances. In addition, he may analyse the trend of its recovery
performance to ascertain that the NBFC does not have an unduly high level of NPAs.
xx. Check the classification of loans and advances (including bills purchased and discounted)
made by a NBFC into Standard Assets, Sub-Standard Assets, Doubtful Assets and Loss
Assets and the adequacy of provision for bad and doubtful debts as required by NBFC
Prudential Norms.
(Note: The above checklist is not exhaustive. It is only illustrative. There could be various other
audit procedures which may be performed for audit of an NBFC. Based on the nature and size of
the NBFC, the auditor will have to perform specific audit techniques in that regard)
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7. AUDITOR’S DUTY
The following are the important duties of an auditor -
7.1 Compliance with NBFC Auditor’s Report - RBI Directions
The RBI Directions have considerably increased the responsibility of auditors of NBFCs. A very
onerous task of reporting to the Board of Directors on certain specified matters and to the RBI on an
exception basis has been imposed upon him. This reporting requirement is in addition to the
normal reporting requirements to the shareholders under section 143 of the Companies Act, 2013.
Auditors will, thus, have to be very careful whilst carrying out audits of NBFCs to ensure that all
matters which they are required to take into consideration for the purposes of reporting to the RBI
have been taken due care of.
Section 45MA of the Reserve Bank of India Act, 1934 was introduced with effect from 13.12.1974.
Under this provision the auditor of a non-banking financial company or a non-banking
miscellaneous company which has accepted public deposits, has to inquire whether or not the
company has furnished to the Reserve Bank of India statements, information of particulars relating
to the deposits as are required to the furnished under Chapter IIIB of the Reserve Bank of India
Act, 1934. The provision further states that if on inquiry the auditor is not satisfied about the
compliance by the company, it is his duty to make to the Reserve Bank of India giving the
aggregate amount of deposits held by the company. The auditor is also required to incorporate
the report or intended to be made to the Reserve Bank of India in his report to the company under
Section 143 of the Companies Act, 2013.
Report to Board of Directors under RBI Directions as per Master Direction No. DNBS.
PPD.03/66.15.001/2016-17 dated September 29, 2016
(1) The Reserve Bank of India (RBI) has issued Non-Banking Financial Companies Auditor’s
Report (Reserve Bank) Directions, 2016 (the Directions) to auditor of every non-banking
financial companies.
(2) The Directions shall apply to every auditor of a non-banking financial company as defined
in section 45 I(f) of the Reserve Bank of India Act, 1934.
Auditors to submit additional Report to the Board of Directors: In addition to the Report
made by the auditor under Section 143 of the Companies Act, 2013 or section 227 of the
Companies Act, 1956 (Act 1 of 1956) on the accounts of a non-banking financial company
examined for every financial year ending on any day on or after the commencement of
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these Directions, the auditor shall also make a separate report to the Board of Directors of
the Company on the matters specified in paragraphs 3 and 4 below.
(3) Material to be included in the Auditor’s report to the Board of Directors: The auditor’s
report on the accounts of a non-banking financial company shall include a statement on the
following matters, namely –
(A) In the case of all non-banking financial companies:
I. Conducting Non-Banking Financial Activity without a valid Certificate of
Registration (CoR) granted by the RBI is an offence under chapter V of the RBI
Act, 1934. Therefore, if the company is engaged in the business of non-banking
financial institution as defined in section 45-I (a) of the RBI Act and meeting the
Principal Business Criteria (Financial asset/income pattern) as laid down vide
the RBI’s press release dated April 08, 1999, and directions issued by DNBR,
auditor shall examine whether the company has obtained a Certificate of
Registration (CoR) from the RBI.
II. In case of a company holding CoR issued by the RBI, whether that company is
entitled to continue to hold such CoR in terms of its Principal Business Criteria
(Financial asset/income pattern) as on March 31 of the applicable year.
III. Whether the non-banking financial company is meeting the required net owned
fund requirement as laid down in Master Direction - Non-Banking Financial
Company – Non-Systemically Important Non-Deposit taking Company (Reserve
Bank) Directions, 2016 and Master Direction - Non-Banking Financial Company
- Systemically Important Non-Deposit taking Company and Deposit taking
Company (Reserve Bank) Directions, 2016.
Note: Every non-banking financial company shall submit a Certificate from its
Statutory Auditor that it is engaged in the business of non-banking financial institution
requiring it to hold a Certificate of Registration under Section 45-IA of the RBI Act
and is eligible to hold it. A certificate from the Statutory Auditor in this regard with
reference to the position of the company as at end of the financial year ended March
31 may be submitted to the Regional Office of the Department of Non-Banking
Supervision under whose jurisdiction the non-banking financial company is
registered, within one month from the date of finalization of the balance sheet and in
any case not later than December 30th of that year.
The format of Statutory Auditor’s Certificate (SAC) to be submitted by NBFCs has
been issued vide DNBS. PPD.02/66.15.001/2016-17 Master Direction- Non-Banking
Financial Company Returns (Reserve Bank) Directions, 2016.
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(B) In the case of a non-banking financial companies accepting/holding public
deposits
Apart from the matters enumerated in (A) above, the auditor shall include a statement
on the following matters, namely-
(i) Whether the public deposits accepted by the company together with other
borrowings indicated below viz.
(a) from public by issue of unsecured non-convertible debentures/bonds;
(b) from its shareholders (if it is a public limited company); and
(c) from entities which are not excluded from the definition of ‘public deposit’
in the Non-Banking Financial Companies Acceptance of Public Deposits
(Reserve Bank) Directions, 2016, are within the limits admissible to the
company as per the provisions of the Non-Banking Financial Companies
Acceptance of Public Deposits (Reserve Bank) Directions, 2016;
(ii) Whether the public deposits held by the company in excess of the quantum of
such deposits permissible to it under the provisions of Non-Banking Financial
Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016 are
regularised in the manner provided in the said Directions;
(iii) Whether the non-banking financial company is accepting "public deposit”
without minimum investment grade credit rating from an approved credit rating
agency as per the provisions of Non-Banking Financial Companies Acceptance
of Public Deposits (Reserve Bank) Directions, 2016;
(iv) Whether the capital adequacy ratio as disclosed in the return submitted to the
Bank in terms of the Non-Banking Financial Company - Systemically Important
Non-Deposit taking Company and Deposit taking Company (Reserve Bank)
Directions, 2016 has been correctly determined and whether such ratio is in
compliance with the minimum CRAR prescribed therein;
(v) In respect of non-banking financial companies referred to in clause (iii) above,
(a) whether the credit rating, for each of the fixed deposits schemes that
has been assigned by one of the Credit Rating Agencies listed in Non-
Banking Financial Companies Acceptance of Public Deposits (Reserve
Bank) Directions, 2016 is in force; and
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14.106 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) whether the aggregate amount of deposits outstanding as at any point
during the year has exceeded the limit specified by the such Credit
Rating Agency;
(vi) Whether the company has violated any restriction on acceptance of public
deposit as provided in Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 2016;
(vii) Whether the company has defaulted in paying to its depositors the interest
and/or principal amount of the deposits after such interest and/or principal
became due;
(viii) Whether the company has complied with the prudential norms on income
recognition, accounting standards, asset classification, provisioning for bad and
doubtful debts, and concentration of credit/investments as specified in the
Directions issued by the Bank in terms of the Master Direction - Non-Banking
Financial Company - Systemically Important Non-Deposit taking Company and
Deposit taking Company (Reserve Bank) Directions, 2016;
(ix) Whether the company has complied with the liquid assets requirement as
prescribed by the Bank in exercise of powers under section 45-IB of the RBI
Act and whether the details of the designated bank in which the approved
securities are held is communicated to the office concerned of the RBI in terms
of NBS 3; Non-Banking Financial Company Returns (Reserve Bank) Directions,
2016;
(x) Whether the company has furnished to the RBI within the stipulated period the
return on deposits as specified in the NBS 1 to – Non- Banking Financial
Company Returns (Reserve Bank) Directions, 2016;
(xi) Whether the company has furnished to the RBI within the stipulated period the
quarterly return on prudential norms as specified in the Non-Banking Financial
Company Returns (Reserve Bank) Directions, 2016;
(xii) Whether, in the case of opening of new branches or offices to collect deposits
or in the case of closure of existing branches/offices or in the case of
appointment of agent, the company has complied with the requirements
contained in the Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 2016.
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(C) In the case of a non-banking financial company not accepting public deposits
Apart from the aspects enumerated in (A) above, the auditor shall include a
statement on the following matters, namely: -
(i) Whether the Board of Directors has passed a resolution for non- acceptance
of any public deposits;
(ii) Whether the company has accepted any public deposits during the relevant
period/year;
(iii) Whether the company has complied with the prudential norms relating to
income recognition, accounting standards, asset classification and
provisioning for bad and doubtful debts as applicable to it in terms of Non-
Banking Financial Company – Non-Systemically Important Non-Deposit
taking Company (Reserve Bank) Directions, 2016 and Non-Banking
Financial Company - Systemically Important Non-Deposit taking Company
and Deposit taking Company (Reserve Bank) Directions, 2016;
(iv) In respect of Systemically Important Non-deposit taking NBFCs as defined
in Non-Banking Financial Company - Systemically Important Non-Deposit
taking Company and Deposit taking Company (Reserve Bank) Directions,
2016:
(a) Whether the capital adequacy ratio as disclosed in the return
submitted to the RBI in form NBS - 7, has been correctly arrived at
and whether such ratio is in compliance with the minimum CRAR
prescribed by the RBI;
(b) Whether the company has furnished to the RBI the annual statement
of capital funds, risk assets/exposures and risk asset ratio (NBS-7)
within the stipulated period.
(v) whether the non-banking financial company has been correctly classified as
NBFC Micro Finance Institutions (MFI) as defined in the Non-Banking
Financial Company – Non-Systemically Important Non-Deposit taking
Company (Reserve Bank) Directions, 2016 and Non-Banking Financial
Company - Systemically Important Non-Deposit taking Company and
Deposit taking Company (Reserve Bank) Directions, 2016.
(D) In the case of a company engaged in the business of non-banking financial
institution not required to hold CoR subject to certain conditions
Apart from the matters enumerated in (A)(I) above where a company has obtained a
specific advice from the RBI that it is not required to hold CoR from the RBI, the auditor
shall include a statement that the company is complying with the conditions stipulated
as advised by the RBI.
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14.108 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(4) Reasons to be stated for unfavourable or qualified statements: Where, in the auditor’s
report, the statement regarding any of the items referred to in paragraph 3 above is
unfavourable or qualified, the auditor’s report shall also state the reasons for such
unfavourable or qualified statement, as the case may be. Where the auditor is unable to
express any opinion on any of the items referred to in paragraph 3 above, his report shall
indicate such fact together with reasons therefor.
(5) Obligation of auditor to submit an exception report to the RBI
(I) Where, in the case of a non-banking financial company, the statement regarding
any of the items referred to in paragraph 3 above, is unfavorable or qualified, or in
the opinion of the auditor the company has not complied with:
(a) the provisions of Chapter III B of RBI Act (Act 2 of 1934); or
(b) Non-Banking Financial Companies Acceptance of Public Deposits (Reserve
Bank) Directions, 2016; or
(c) Non-Banking Financial Company – Non-Systemically Important Non-Deposit
taking Company (Reserve Bank) Directions, 2016 and Non-Banking
Financial Company - Systemically Important Non-Deposit taking Company
and Deposit taking Company (Reserve Bank) Directions, 2016.
It shall be the obligation of the auditor to make a report containing the details of
such unfavourable or qualified statements and/or about the non-compliance, as the
case may be, in respect of the company to the concerned Regional Office of the
Department of Non-Banking Supervision of the RBI under whose jurisdiction the
registered office of the company is located as per first Schedule to the Non-Banking
Financial Companies Acceptance of Public Deposits (Reserve Bank)
Directions, 2016.
(II) The duty of the Auditor under sub-paragraph (I) shall be to report only the
contraventions of the provisions of RBI Act, 1934, and Directions, Guidelines,
instructions referred to in sub-paragraph (1) and such report shall not contain any
statement with respect to compliance of any of those provisions.
7.2 Compliance with CARO 2020
As per CARO 2020, the auditor is required to report that –
I. Whether during the year the company has made investments in, provided any guarantee or
security or granted any loans or advances in the nature of loans, secured or unsecured, to
companies, firms, Limited Liability Partnerships or any other parties, If so,
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(a) whether the investments made, guarantees provided, security given and the terms and
conditions of the grant of all loans and advances in the nature of loans and guarantees
provided are not prejudicial to the company’s interest;
(b) in respect of loans and advances in the nature of loans, 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;
(d) whether the company has granted any loans or advances in the nature of loans either
repayable on demand or without specifying any terms or period of repayment, if so,
specify the aggregate amount, percentage thereof to the total loans granted,
aggregate amount of loans granted to Promoters, related parties as defined in clause
(76) of section 2 of the Companies Act, 2013; [Paragraph 3(iii)]
(II) (a) 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.
(b) Whether the company has conducted any Non-Banking Financial or Housing Finance
activities without a valid Certificate of Registration (CoR) from the Reserve Bank of
India as per the Reserve Bank of India Act, 1934;
(c) Whether the company is a Core Investment Company (CIC) as defined in the
regulations made by the Reserve Bank of India, if so, whether it continues to fulfil the
criteria of a CIC, and in case the company is an exempted or unregistered CIC,
whether it continues to fulfil such criteria;
(d) Whether the Group has more than one CIC as part of the Group, if yes, indicate the
number of CICs which are part of the Group; [Paragraph 3(xvi)]
(Note: Students are required to refer Guidance Note on CARO, 2020 for more details).
TEST YOUR UNDERSTANDING 2
Sugam Housing Finance Limited is in the business of housing finance activities having asset size of
` 800 crores. Its principal business is of providing finances for housing mainly to individuals. It is not
identified by RBI in upper layer. Under scale-based regulations introduced by RBI, what should be
appropriate classification for such a company?
Is there any specific reporting requirement under CARO, 2020 for statutory auditor of a company
engaged in housing finance activities?
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88. INDIAN ACCOUNTING STANDARDS (IND AS)
8.1 Applicability of Indian Accounting Standards (Ind AS) on NBFCs
As per Rule 4 (1)(iv) of the Companies (Indian Accounting Standards) Rules, 2015 and as amended
by Companies (Indian Accounting Standards) (Amendment) Rules, 2016, NBFCs are required to
comply with Indian Accounting Standards (Ind AS) as under-
(i) Accounting periods beginning 1 April 2018: Listed and unlisted NBFCs having a net worth
of ` 500 crore or more and holding, subsidiary, joint venture or associate companies of such
NBFCs;
(ii) Accounting periods beginning 1 April 2019: All other listed NBFCs, unlisted NBFCs having
a net worth of ` 250 crore or more but less than ` 500 crore and holding, subsidiary, joint
venture or associate companies of such NBFCs.
The net worth shall be calculated in accordance with the standalone financial statements of the
NBFCs as on 31st March 2016 or the first audited financial statements for accounting period which
ends after that date.
8.2 Format for preparation of financial statements by NBFCs under
Ind- AS
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 preparation of financial
statements by NBFCs complying with Ind AS has been prescribed.
Every NBFC required to comply with Ind AS shall prepare its financial statements as per below
format:
Illustrative format of Balance Sheet under Division III of Schedule III-
Particulars Note Figures as at the Figures as at the
No. end of current end of previous
reporting period reporting period
(`) (`)
ASSETS
(1) Financial Assets
(a) Cash and cash equivalents
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Particulars Note Figures as at the Figures as at the
No. end of current end of previous
reporting period reporting period
(`) (`)
(b) Bank balance other than (a)
above
(c) Derivative financial instruments
(d) Receivables
(1) Trade Receivables
(2) Other Receivables
(e) Loans
(f) Investments
(g) Other Financial assets
(2) Non-Financial Assets
(a) Inventories
(b) Current tax assets (net)
(c) Deferred tax assets (net)
(d) Investment property
(e) Biological assets other than
bearer plants
(f) Property, Plant and Equipment
(g) Capital work-in-progress
(h) Intangible assets under
development
(i) Goodwill
(j) Other intangible assets
(k) Other non-financial assets (to be
specified)
Total Assets
LIABILITES AND EQUITY
LIABILITIES
(1) Financial Liabilities
(a) Derivative financial instruments
(b) Payables
(I) Trade Payables
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Particulars Note Figures as at the Figures as at the
No. end of current end of previous
reporting period reporting period
(`) (`)
(i) total outstanding dues
of micro enterprises
and small enterprises
(ii) total outstanding dues
of creditors other than
micro enterprises and
small enterprises
(II) Other Payables
(i) total outstanding dues
of micro enterprises
and small enterprises
(ii) total outstanding dues
of creditors other than
micro enterprises and
small enterprises
(c) Debt Securities
(d) Borrowings (other than debt
securities)
(e) Deposits
(f) Subordinated liabilities
(g) Other financial liabilities (to be
specified)
(2) Non-financial Liabilities
(a) Current tax liabilities (net)
(b) Provisions
(c) Deferred Tax Liabilities (net)
(d) Other non-financial liabilities (to
be specified)
(3) Non-financial Capital
(a) Equity share capital
(b) Other equity
Total Liabilities and Equity
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Illustrative format of Statement of Profit and Loss prescribed under Division III of
Schedule III
Particulars Notes Figures for the Figures for the
No. current reporting previous reporting
period period
(`) (`)
Revenue from operations
(a) Interest Income
(b) Dividend income
(c) Rental income
(d) Fee and commission income
(e) Net gain on fair vale changes
(f) Net gain on derecognition of
financial instruments under
amortised category
(g) Sale of products (including Excise
duty)
(h) Sale of services
(i) Others (to be specified)
Total revenue from operations (I)
Other income (to be specified) (II)
Total Income (III= I + II)
Expenses
(a) Finance costs
(b) Fees and commission expense
(c) Net loss on fair vale changes
(d) Net loss on derecognition of
financial instruments under
amortised category
(e) Impairment on financial instruments
(f) Cost of material consumed
(g) Purchases of stock-in-trade
(h) Changes in Inventories of finished
goods, stock-in-trade and work-in-
progress
(i) Employee Benefits Expenses
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14.114 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Particulars Notes Figures for the Figures for the
No. current reporting previous reporting
period period
(`) (`)
(j) Depreciation, amortization and
impairment
(k) Other expenses (to be specified
Total Expenses (IV)
Profit / (loss) before exceptional items
and tax (V= III - IV)
Exceptional items (VI)
Profit / (loss) before tax (VII= V - VI)
Tax Expense (VIII):
(1) Current tax
(2) Deferred tax
Profit / (loss) for the period from
continuing operations (IX= VII - VIII)
Profit / (loss) for the period from
discontinued operations (X)
Tax Expense of discontinued operations
(XI)
Profit / (loss) for the period from
discontinued operations after tax (XII=
X - XI)
Profit / (loss) for the period (XIII= IX +
XII)
Other Comprehensive Income (XIV)
(A) (i) Items that will not be reclassified
to profit or loss (specify items
and amounts)
(ii) income tax relating to items
that will not be reclassified to
profit or loss
SUB-TOTAL (A)
(B) (i) Items that will be reclassified
to profit or loss (specify items
and amounts)
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Particulars Notes Figures for the Figures for the
No. current reporting previous reporting
period period
(`) (`)
(ii)income tax relating to items
that will be reclassified to
profit or loss
SUB-TOTAL (B)
Other Comprehensive Income (A+B)
Total Comprehensive Income for the
period (XV = XIII + XIV) (Comprising
Profit (Loss) and other
Comprehensive Income for the period)
Earnings per equity share (for
continuing operations) (XVI)
Basic (`)
Diluted (`)
Earnings per equity share (for
discontinued operations) (XVII)
Basic (`)
Diluted (`)
Earnings per equity share (for
continuing and discontinued
operations) (XVIII)
Basic (`)
Diluted (`)
Note : Student may also refer illustrative format of Statement of Changes in Equity prescribed
under Division III of Schedule III for more understanding.
8.3 Difference between Division II (Ind- AS- Other than NBFCs) and
Division III (Ind- AS- NBFCs) of Schedule III
The presentation requirements under Division III for NBFCs are similar to Division II (Non NBFC) to
a large extent except for the following:
(a) NBFCs have been allowed to present the items of the balance sheet in order of their liquidity
which is not allowed to companies required to follow Division II.
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14.116 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) An NBFC is required to separately disclose by way of a note any item of ‘other income’ or
‘other expenditure’ which exceeds 1 per cent of the total income. Division II, on the other
hand, requires disclosure for any item of income or expenditure which exceeds 1 per cent of
the revenue from operations or `10 lakhs, whichever is higher.
(c) NBFCs are required to separately disclose under ‘receivables’, the debts due from any
Limited Liability Partnership (LLP) in which its director is a partner or member.
(d) NBFCs are also required to disclose items comprising ‘revenue from operations’ and ‘other
comprehensive income’ on the face of the Statement of profit and loss instead of showing
those only as part of the notes.
(e) Separate disclosure of trade receivable which have significant increase in credit risk & credit
impaired
(f) The conditions or restrictions for distribution attached to statutory reserves have to be
separately disclose in the notes as stipulated by the relevant statute.
TEST YOUR UNDERSTANDING 3
You are auditor of a deposit taking NBFC (NBFC-D). The NBFC is identified by RBI in its upper
layer and its financial statements are required to prepared in accordance with requirements of Ind
AS. The following is extract of statement of profit and loss for year ending 31 St March, 2023 in
accordance with Division III of Schedule III of Companies Act, 2013. Previous year figures are
ignored.
Particulars Note No. Figures for year ended 31 st
March, 2023 (in ` Crores)
Revenue from Operations
(i) Interest income 15 9500
(ii) Dividend income -
(iii) Rental Income 150
(iv) Fees and commission income 16 100
(v) Net gain on fair value changes 17 150
(vi) Net gain on derecognition of financial
instruments under amortised category
(I) Total revenue from operations 9900
(II) Other Income 18 100
(III) Total Income 10000
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On going through details of head “other expenditure” in expenses side of statement of
profit and loss, it is noticed that there is an expenditure relating to manpower outsourcing
cost amounting to ` 99.50 crores included under “other expenditure”.
Does it meet the requirements of Division III of Schedule III of Companies Act, 2013?
Integrated Case Scenario
CA. Parampara is statutory auditor of “Lohit Finance Limited”, a micro finance institution, working
pre-dominantly in states popularly described as “seven sisters of North East”, West Bengal, Odisha
and Andhra Pradesh. It is a non-deposit taking NBFC catering to credit requirements of rural and
semi-urban households and provides small ticket loans. She has performed audit procedures for
year 2022-23 and following further information is given as under:-
(A) The Board of Directors of the company has passed a resolution in its meeting held on 1.5.22
for non-acceptance of public deposits during year ended 31st March, 2023.
(B) The company has obtained certificate of registration dated 15 th March, 2012 from RBI in
pursuance of section 45-IA of RBI Act, 1934 and it is entitled to hold such certificate of registration
in terms of its financial assets/income pattern for year ended 31st March, 2023.
(C) The company has identified instances of cash embezzlement by the employees during the
year. Such instances relate to employees fleeing after collection of instalments from customers at
some centres. The total amount involved is `15 lacs and ` 5 lacs have been recovered subsequently.
The matter has also been reported in note 35 of financial statements.
(D) It falls in middle layer of scale-based regulations and regulations for a systemically important
non-deposit taking NBFC are applicable to it. Its capital adequacy ratio is stated in note 36 of
financial statements.
(E) Audit procedures performed by her included testing design and operating effectiveness of
controls relating to allowances for loan losses using Expected credit loss model (ECL) in accordance
with Ind AS 109. Tests of details performed by her included verifying assumptions affecting ECL
calculations.
Keeping in view above information, answer the following questions: -
1 The Board of Directors has passed a resolution for non- acceptance of public deposits during
year 2022-23. Which of the following statements is most appropriate in this regard as regards
reporting obligations of auditor are concerned?
(a) Passing of board resolution for non-acceptance of public deposits, being an internal
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14.118 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
governance matter, is not required to be reported by auditor.
(b) Matter of passing of board resolution for non-acceptance of public deposits is a
specific reporting requirement for auditor under CARO, 2020.
(c) Matter of passing of board resolution for non-acceptance of public deposits is a
specific reporting requirement in auditor’s additional report to the Board of Directors
of the company.
(d) Matter of passing of board resolution for non-acceptance of public deposits is a
specific reporting requirement in auditor’s additional report to the Board of Directors
of the company as well as under CARO, 2020.
2. Which of the following statements is most appropriate in respect of reporting requirements
relating to certificate of registration of the company obtained from RBI as described in para
[B] of the case?
(a) It is the duty of auditor to report whether company has obtained certificate of
registration as required under section 45-IA of RBI Act, 1934 in auditor’s additional
report to the Board of Directors of the company.
(b) It is the duty of auditor to report whether company has obtained certificate of
registration as required under section 45-IA of RBI Act, 1934 in auditor’s additional
report to the Board of Directors of the company as well as under CARO,2020.
(c) It is the duty of auditor to report whether company has obtained certificate of
registration as required under section 45-IA of RBI Act, 1934 under CARO,2020.
(d) It is the duty of auditor to report whether company has obtained certificate of
registration as required under section 45-IA of RBI Act, 1934 in auditor’s additional
report to the Board of Directors of the company as well as under CARO,2020. Further,
it is also required to be reported in auditor’s additional report to Board of Directors
whether company is entitled to hold such certificate in terms of its financial
assets/income pattern.
3. Regarding instances of cash embezzlement identified by the company during the year, which
of the following statements best fits into reporting requirements of an auditor?
(a) Such instances are required to be reported under CARO, 2020 under relevant clause.
(b) Cash embezzled amount is less than `1 crore. No reporting under CARO, 2020 is
required of such instances.
(c) Such instances are required to be reported under CARO, 2020 as well as in auditor’s
additional report to Board of Directors of company.
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FINANCIAL COMPANIES
(d) Such instances are to be specifically reported in auditor’s report under Section 143(3)
of Companies Act,2013.
4. As regards description of capital adequacy ratio as described in para [D] of case, which of
the following statements meets regulatory reporting requirements?
(a) Auditor has to ascertain and verify whether such ratio has been disclosed in financial
statements in notes to accounts.
(b) Auditor has to ascertain and verify whether such ratio as disclosed in NBS-7 has been
correctly arrived at.
(c) Auditor has to ascertain and verify whether such ratio as disclosed in NBS-7 has been
correctly arrived at and whether such ratio is in compliance with minimum CRAR
prescribed by RBI.
(d) Auditor has to ascertain and verify whether such ratio has been disclosed in financial
statements in notes to accounts and has been correctly arrived at and is in compliance
with minimum CRAR prescribed by RBI.
5. The auditor has performed audit procedures relating to allowances for loan losses using ECL
in accordance with Ind AS 109. As these allowances involve significant judgment and
estimates, she wants to state how it was addressed by her. How she can do that?
(a) By stating it in Auditor’s additional report to Board of Directors.
(b) By stating it in matters as required under Section 143(3) of Companies Act.
(c) By incorporating Emphasis of Matter Paragraph in Independent auditor’s report.
(d) By identifying it as Key audit matter in Independent auditor’s report.
Key Takeaways
A company incorporated under the Companies Act and desirous of commencing business of
non-banking financial institution as defined under Section 45–IA of the RBI Act, 1934 can
apply to the Reserve Bank of India in prescribed form along with necessary documents for
registration. The RBI issues Certificate of Registration after satisfying itself that the conditions
as enumerated in Section 45-IA of the RBI Act, 1934 are satisfied.
A non-banking company is defined under RBI Act as:-
(i) A financial institution which is a company;
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14.120 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(ii) A non-banking institution which is a company and which has as its principal business
the receiving of deposits, under any scheme or arrangement or in any other manner,
or lending in any manner;
(iii) Such other non-banking institution or class of such institutions, as the Bank may, with
the previous approval of the Central Government and by notification in the Official
Gazette, specify.
Further, in order to identify a particular company as Non-Banking Financial Company (NBFC),
it will consider both assets and income pattern as evidenced from the last audited balance
sheet of the company to decide its principal business. The company will be treated as NBFC
when a company's financial assets constitute more than 50 per cent of the total assets (netted
off by intangible assets) and income from financial assets constitute more than 50 per cent
of the gross income. A company which fulfils both these criteria shall qualify as an NBFC and
would require to be registered as NBFC by RBI.
RBI has issued directions to non-banking financial companies on acceptance of public
deposits, prudential norms like capital adequacy, income recognition, asset classification,
provision for bad and doubtful debts, risk exposure norms and other measures to monitor the
financial solvency and reporting by NBFCs.
RBI has introduced scale based regulations for NBFCs based on four layers that are defined
based on their size, activity, and perceived riskiness. The four layers are- Base layer, middle
layer, upper layer and top layer.
NBFCs lend like banks. However, such entities cannot accept demand deposits although
some can accept term deposits. These also do not form part of payment and settlement
system. DICGC cover is not available to depositors of NBFCs. No minimum exposure to
priority sector is required by NBFCs.
Every applicable NBFC shall, after taking into account the time lag between an account
becoming non-performing, its recognition as such, the realisation of the security and the
erosion over time in the value of security charged, make provision against sub-standard
assets, doubtful assets and loss assets in accordance with prescribed norms.
Audit procedures for NBFCs have to be tailored in accordance of nature of business of NBFC
and regulatory directions.
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Besides issuing a report in accordance with requirements of section 143(3) of Companies Act
and covering matters specified under CARO, 2020, statutory auditor of NBFC is also required
to submit an additional report to Board of Directors of the company.
The Reserve Bank of India (RBI) has issued Non-Banking Financial Companies Auditor’s
Report (Reserve Bank) Directions, 2016 (the Directions) to auditor of every non-banking
financial companies in this regard. Under these directions, auditor of an NBFC has to submit
an additional report to the Board of Directors of the company covering matters specified in
these directions.
Circular on Scale Based Regulation (SBR): A Revised Regulatory
Framework for NBFCS: SCAN ME !
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Define NBFC. Also give a brief description about types of NBFCs covering any five NBFCs.
2. Shubham & Associates are going to start the audit of NBFCs. They have not performed much
work for the NBFCs in the past years. You are required to explain the requirements related
to registration and regulation of NBFCs which an auditor needs to keep in his mind while
planning the audit of NBFC which would help this firm.
3. Satyam Pvt Ltd is a company engaged in trading activities, it also has made investments in
shares of other Companies and advanced loans to group companies amounting to more than
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14.122 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
50% of its total assets. However, trading income constitutes majority of its total income.
Whether the Company is an NBFC?
4. Shivam & Co LLP are the auditors of NBFC (Investment and Credit Company). Some of the
team members of the audit team who audited this NBFC have left the firm and the new team
members are in discussion with the previous team members who are still continuing with the
firm regarding the verification procedures to be performed. In this context, please explain
what verification procedures should be performed in relation to audit of NBFC - Investment
and Credit Company (NBFC-ICC).
5 You are appointed as the auditor of a NBFC registered with the RBI and which is accepting
and holding public deposits. You are considering your reporting requirement in addition to
your report made under Section 143 of the Companies Act, 2013 on the accounts of this
NBFC as per the prescribed Directions.
Please explain what points are required to be known in respect of separate report to be given
by you to the Board of Directors of this NBFC.
6. Kamna & Co LLP, a firm of Chartered Accountants, was appointed as auditor of an NBFC.
The audit work has been completed. The audit team which was involved in the fieldwork came
across various observations during the course of audit of this NBFC and have also limited
understanding about the exceptions which are required to be reported in the audit report.
They would like to understand in detail regarding the obligations on the part of an auditor in
respect of exceptions in his report so that they can conclude their work. Please explain.
7. The Statutory Auditor of the NBFC company is required to give a report to the Board of
Directors. What shall be the content of the Auditor’s Report to the Board.
8. Krishna Pvt Ltd is primarily into the business of selling computer parts. However, the company
is fulfilling the Principal Business Criteria as at the balance sheet date i.e. Financial Assets
are more than 50 % of total assets and Financial Income is more than 50% of Gross Income.
What shall be the obligation of the Statutory Auditor in such a scenario?
9. Mr. G. has been appointed as an auditor of LMP Ltd., a NBFC company registered with RBI.
Mr. G is concerned about whether the format of financial statements prepared by LMP Ltd. is
as per notification issued by the Ministry of Corporate Affairs (MCA) dated October 11, 2018.
The notification prescribed the· format in Division III under Schedule III of the Companies Act,
2013 applicable to NBFCs complying with Ind-AS. Mr. G wants to know the differences in the
presentation requirements between Division II and Division III of Schedule III of the
Companies Act, 2013. Help Mr. G.
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FINANCIAL COMPANIES
10. Abhimanyu Finance Ltd. is a Non-Banking Finance Company and was in the business of
accepting public deposits and giving loans since 2015. The company was having net owned
funds of ` 1,50,00,000/-(one crore fifty lakhs) and was not having registration certificate from
RBI and applied for it on 30th March 2023. The company appointed Mr. Kabra as its statutory
auditors for the year 2022-23. Advise the auditor with reference to auditor procedures to be
taken and reporting requirements on the same in view of CARO 2020?
Answers to Test your Understanding.
1. NBFC-P2P falls in base layer in accordance with scale-based regulations of RBI. Few audit
procedures for NBFC-P2P are as under: -
Gaining an understanding of business conducted by NBFC-P2P. It should be verified
that company undertakes only permissible activities applicable to such type of NBFCs
like providing online marketplace to participants for lending and borrowing. It should
not be engaged in business of lending funds on its own.
Verifying certificate of registration obtained from RBI for carrying business of P2P
platform.
Verifying Board approved policy setting out eligibility criteria for participants i.e lenders
and borrowers.
Verifying board approved policy for pricing of services provided by P2P platform
Verification of adherence to lending and borrowing guidelines prescribed by RBI
Verifying appropriate arrangements have been entered into among participants and
NBFC-P2P.
Compliance with reporting requirements of RBI
Verifying board approved policy for grievance redressal and complaints
2. The said company is not identified in upper layer by RBI. Under scale based regulations
introduced by RBI, NBFCs undertaking housing finance activities constitute “middle layer”.
The asset size is not relevant in such a case. All housing finance companies not identified in
upper layer would constitute middle layer due to nature of such activities undertaken by them.
There is specific reporting requirement under CARO, 2020 under clause 3 (xvi)(b) which
requires auditor to report whether the company has conducted any non-Banking financial or
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housing finance activities without a valid Certificate of Registration (CoR) from the Reserve
Bank of India as per the Reserve Bank of India Act, 1934.
3. An NBFC is preparing financial statements in accordance with requirements of Division III of
Schedule III of Companies Act, 2013 has to separately disclose by way of note any item of
“other expenditure” exceeding 1% of total income.
The said expenditure of `99.50 crore does not exceed 1% of total income. Hence, it meets
requirements of Division III of Schedule III of Companies Act, 2013.
Answers to Integrated Case Scenario
1. (c)
2. (d)
3. (a)
4. (c)
5. (d)
Answers to Theoretical Questions
1. Refer Para 1 – Definition and Types of NBFCs.
2. An auditor should know following points regarding registration and regulation of
NBFCs: Under Section 45–IA of the RBI Act, 1934, no NBFC shall commence or carry on the
business of a non-banking financial institution without
obtaining a certificate of registration issued by the RBI; and
having a net owned fund (NOF) of ` 25 lakhs (₹ Two crore since April 1999) not
exceeding two hundred lakhs rupees, as the RBI may, by notification in the Official
Gazette, specify.
(The RBI (Amendment) Act (1997) provided an entry point norm of ` 25 lakh as the minimum
NOF which was revised upwards to ` 2 crore for new NBFCs seeking grant of certificate of
registration (CoR) on or after 21 April 1999).
A company incorporated under the Companies Act and desirous of commencing business of
non-banking financial institution as defined under Section 45–IA of the RBI Act, 1934 can
apply to the RBI in prescribed form along with necessary documents for registration. The RBI
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issues CoR after satisfying itself that the conditions as enumerated in Section 45-IA of the
RBI Act, 1934 are satisfied.
However, to obviate dual regulation, certain categories of NBFCs which are regulated by
other regulators are exempted from the requirement of registration with RBI viz. Venture
Capital Fund/Merchant Banking companies/Stock Broking Companies registered with SEBI,
Insurance Company holding a valid CoR issued by IRDA, Nidhi Companies as notified under
Section 406 of the Companies Act, 2013, Chit Companies as defined in clause (b) of Section
2 of the Chit Funds Act, 1982 or Housing Finance Companies regulated by National Housing
Bank.
The RBI has issued directions to NBFCs on acceptance of public deposits, prudential norms
like capital adequacy, income recognition, asset classification, provision for bad and doubtful
debts, risk exposure norms and other measures to monitor the financial solvency and
reporting by NBFCs.
Directions were also issued to auditors to report non-compliance with the RBI Act and
regulations to the Reserve Bank, Board of Directors and shareholders.
3. In order to identify a particular company as Non-Banking Financial Company (NBFC), it will
consider both assets and income pattern as evidenced from the last audited balance sheet
of the company to decide its principal business. The company will be treated as NBFC when
a company's financial assets constitute more than 50 per cent of the total assets (netted off
by intangible assets) and income from financial assets constitute more than 50 per cent of
the gross income. A company which fulfils both these criteria shall qualify as an NBFC and
would require to be registered as NBFC by Reserve Bank of India.
In the given case, though Satyam Pvt Ltd is fulfilling the criteria on the asset side, but however
is not fulfilling the criteria on the income side, the company cannot be classified as a deemed
NBFC.
4. Refer Para 6
5. Refer Para 7.1(3), (4)
6. Refer Para 7.1(5)
7. Ref Para 7.1
The statutory auditor of Karma Pvt Ltd, being a Non-Deposit Taking Non-Systemically
Important NBFC is required to submit separate report to the Board of Directors on the matters
as specified as below:
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14.126 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
I. Conducting Non-Banking Financial Activity without a valid Certificate of Registration
(CoR) granted by the RBI is an offence under chapter V of the RBI Act, 1934.
Therefore, if the company is engaged in the business of non-banking financial
institution as defined in section 45-I (a) of the RBI Act and meeting the Principal
Business Criteria (Financial asset/income pattern) as laid down vide the RBI’s press
release dated April 08, 1999, and directions issued by DNBR, auditor shall examine
whether the company has obtained a Certificate of Registration (CoR) from the RBI.
II. In case of a company holding CoR issued by the RBI, whether that company is entitled
to continue to hold such CoR in terms of its Principal Business Criteria (Financial
asset/income pattern) as on March 31 of the applicable year.
III. Whether the non-banking financial company is meeting the required net owned fund
requirement as laid down in Master Direction - Non-Banking Financial Company –
Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions,
2016 and Master Direction - Non-Banking Financial Company - Systemically Important
Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions,
2016.
Apart from the aspects enumerated above, the auditor shall include a statement on the
following matters, namely: -
(i) Whether the Board of Directors has passed a resolution for non- acceptance of any
public deposits;
(ii) Whether the company has accepted any public deposits during the relevant
period/year;
(iii) Whether the company has complied with the prudential norms relating to income
recognition, accounting standards, asset classification and provisioning for bad and
doubtful debts as applicable to it in terms of Non-Banking Financial Company – Non-
Systemically Important Non-Deposit taking Company (Reserve Bank) Directions,
2016;
Where, in the auditor’s report, the statement regarding any of the items referred to matters
specified above is unfavourable or qualified, the auditor’s report shall also state the reasons
for such unfavourable or qualified statement, as the case may be. Where the auditor is unable
to express any opinion on any of the items referred above, his report shall indicate such fact
together with reasons thereof.
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8. Ref Para 7.1
In the given case, Krishna Pvt Ltd is fulfilling the Principal Business Criteria i.e. Financial
Assets are more than 50 % of total assets and Financial Income is more than 50 % of Gross
Income. The company which fulfils both these criteria shall qualify as an NBFC and hence is
required to obtain Certificate of Registration (CoR) with Reserve Bank of India. In such a
scenario, the statutory auditor has an obligation to submit exception report to the RBI on the
following matters :
(I) Where, in the case of a non-banking financial company, the statement regarding any
of the items referred to in paragraph 3 of the Non-Banking Financial Companies
Auditor’s Report (Reserve Bank) Directions, 2016, is unfavourable or qualified, or in
the opinion of the auditor the company has not complied with:
(a) the provisions of Chapter III B of RBI Act (Act 2 of 1934); or
(b) Non-Banking Financial Companies Acceptance of Public Deposits (Reserve
Bank) Directions, 2016; or
(c) Non-Banking Financial Company – Non-Systemically Important Non-Deposit
taking Company (Reserve Bank) Directions, 2016 and Non-Banking Financial
Company - Systemically Important Non-Deposit taking Company and Deposit
taking Company (Reserve Bank) Directions, 2016.
It shall be the obligation of the auditor to make a report containing the details of such
unfavourable or qualified statements and/or about the non-compliance, as the case
may be, in respect of the company to the concerned Regional Office of the Department
of Non-Banking Supervision of the RBI under whose jurisdiction the registered office
of the company is located as per first Schedule to the Non-Banking Financial
Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016.
(II) The duty of the Auditor under sub-paragraph (I) shall be to report only the
contraventions of the provisions of RBI Act, 1934, and Directions, Guidelines,
instructions referred to in sub-paragraph (1) and such report shall not contain any
statement with respect to compliance of any of those provisions.
9. Refer Para 8.3
10. As per Clause (xvi) of Paragraph 3 of CARO 2020, the auditor is required to report that
“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.”
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14.128 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The auditor is required to examine whether the company is engaged in the business which
attract the requirements of the registration. The registration is required where the financing
activity is a principal business of the company. The RBI restrict companies from carrying on
the business of a non-banking financial institution without obtaining the certificate of
registration.
Audit Procedures and Reporting:
(i) The auditor should examine the transactions of the company with relation to the
activities covered under the RBI Act and directions related to the Non-Banking
Financial Companies.
(ii) The financial statements should be examined to ascertain whether company’s financial
assets constitute more than 50 per cent of the total assets and income from financial
assets constitute more than 50 per cent of the gross income.
(iii) Whether the company has net owned funds as required for the registration as NBFC.
(iv) Whether the company has obtained the registration as NBFC, if not, the reasons
should be sought from the management and documented.
(v) The auditor should report incorporating the following:-
(1) Whether the registration is required under section 45-IA of the RBI Act, 1934.
(2) If so, whether it has obtained the registration.
(3) If the registration not obtained, reasons thereof.
In the instant case Abhimanyu Finance Ltd. is a Non Banking Finance Company and was in
the business of accepting public deposits and giving loans since 2015. The company was
having net owned funds of ` 1,50,00,000/-(one crore fifty lakhs) which is less in comparison
to the prescribed limit i.e. 2 crore rupees and was also not having registration certificate from
RBI (though applied for it on 30 th March 2021). The auditor is required to report on the same
as per Clause (xvi) of Paragraph 3 of CARO 2020.
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iii
CONTENTS
MODULE – 1
Chapter 1: Quality Control
Chapter 2: General Auditing Principles and Auditors Responsibilities
Chapter 3: Audit Planning, Strategy and Execution
Chapter 4: Materiality, Risk Assessment and Internal Control
Chapter 5: Audit Evidence
Chapter 6: Completion and Review
Chapter 7: Reporting
MODULE – 2
Chapter 8: Specialised Areas
Chapter 9: Related Services
Chapter 10: Review of Financial Information
Chapter 11: Prospective Financial Information and Other Assurance Services
Chapter 12: Digital Auditing & Assurance
Chapter 13: Group Audits
Chapter 14: Special Features of Audit of Banks & Non-Banking Financial Companies
MODULE – 3
Chapter 15: Overview of Audit of Public Sector Undertakings
Chapter 16: Internal Audit
Chapter 17: Due Diligence, Investigation & Forensic Accounting
Chapter 18 : Sustainable Development Goals (SDG) & Environment, Social and Governance
(ESG) Assurance
Chapter 19: Professional Ethics & Liabilities of Auditors
© The Institute of Chartered Accountants of India
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DETAILED CONTENTS MODULE - 3
CHAPTER 15: OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKINGS
LEARNING OUTCOMES ........................................................................................................ 15.1
CHAPTER OVERVIEW ........................................................................................................... 15.2
Contents:
1. Introduction .................................................................................................................. 15.4
2. Framework for Government Audit ................................................................................. 15.5
3. Objective and Scope of Public Enterprises Audit ........................................................... 15.9
3.1 Elements of PSU Audits ................................................................................... 15.10
3.2 Principles of PSU Audits .................................................................................. 15.12
4. Financial Audit ........................................................................................................... 15.13
5. Compliance Audit ....................................................................................................... 15.13
6. Performance Audit ...................................................................................................... 15.16
6.1 Objectives of Performance Audit ...................................................................... 15.19
6.2 Planning for Performance Audit ........................................................................ 15.21
7. Comprehensive Audit ................................................................................................. 15.26
8. Propriety Audit ........................................................................................................... 15.28
8.1 Definition and Principles ................................................................................... 15.28
9. Audit Report of the Comptroller and Auditor General ................................................... 15.31
KEY TAKEAWAYS ............................................................................................................... 15.34
TEST YOUR KNOWLEDGE .................................................................................................. 15.35
© The Institute of Chartered Accountants of India
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CHAPTER 16: INTERNAL AUDIT
LEARNING OUTCOMES ........................................................................................................ 16.1
CHAPTER OVERVIEW ........................................................................................................... 16.2
Contents:
1. Internal Audit ................................................................................................................ 16.3
2. Management Functions and Scope of Internal Auditing ................................................. 16.8
3. Integrity, Objectivity and Independence of Internal Auditor........................................... 16.12
4. Qualities of Internal Auditor ........................................................................................ 16.14
5. Performing Internal Audit Engagement ........................................................................ 16.15
6. Internal Audit Report .................................................................................................. 16.17
6.1 Follow up ......................................................................................................... 16.20
7. Relationship between Internal and External Auditors ................................................... 16.21
7.1 Determining whether, in which areas, and to what extent the
work of the Internal Audit function can be used ................................................. 16.22
7.2 Determining the Nature and Extent of work of the
Internal Audit function that can be used ............................................................ 16.23
7.3 Determining whether in which areas, and to what extent Internal
Auditors can be used to provide direct assistance ............................................ 16.23
7.4 If the External Auditor uses Internal Auditors to provide direct assistance on
the audit, the External Auditor shall include in the Audit Documentation ............ 16.24
8. Internal Audit as a Management Function .................................................................. 16.25
9. Audit Trail .................................................................................................................. 16.26
KEY TAKEAWAYS ............................................................................................................... 16.27
APPENDIX ........................................................................................................................... 16.29
TEST YOUR KNOWLEDGE .................................................................................................. 16.30
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CHAPTER 17-DUE DILIGENCE, INVESTIGATION & FORENSIC AUDIT
LEARNING OUTCOMES ........................................................................................................ 17.1
CHAPTER OVERVIEW ........................................................................................................... 17.2
Contents:
1. Due Diligence Review................................................................................................... 17.3
2. Importance of Due Diligence ......................................................................................... 17.4
3. Classification of Due Diligence ...................................................................................... 17.5
4. Work Approach to Due Diligence ................................................................................ 17.13
5. How to Conduct Due Diligence ................................................................................... 17.14
6. Contents of a Due Diligence Report ............................................................................ 17.15
7. Investigation ............................................................................................................... 17.16
7.1 Audit versus Investigation ................................................................................ 17.16
8. Steps in Investigation.................................................................................................. 17.18
9. Special Issues in Investigations .................................................................................. 17.22
10. Special Aspects in Connection with Business Investigations ........................................ 17.24
11. Types of Investigation ................................................................................................. 17.32
11.1 Investigation on behalf of an incoming partner .................................................. 17.33
11.2 Investigation for valuation of shares in private companies ................................. 17.35
11.3 Investigation on behalf of a bank/Financial Institution proposing to advance
loan to a Company ........................................................................................... 17.37
11.4 Investigation of Frauds ..................................................................................... 17.40
11.5 Investigation on behalf of an Individual or Firm proposing to buy
a Business ...................................................................................................... 17.56
11.6 Investigation in connection with review of Profit/Financial Forecasts.................. 17.57
12. Forensic Accounting ................................................................................................... 17.57
13. Forensic Accountant Professional ............................................................................... 17.63
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14. Process of Forensic Accounting ................................................................................. 17.64
15. Forensic Accounting and Investigation Report ............................................................. 17.66
16. Overview of Forensic Accounting and Investigation Standards (FAIS)…………. .......... 17.69
KEY TAKEAWAYS ............................................................................................................... 17.72
TEST YOUR KNOWLEDGE .................................................................................................. 17.73
CHAPTER 18: SUSTAINABLE DEVELOPMENT GOALS (SDG) &
ENVIRONMENT, SOCIAL AND GOVERNANCE (ESG) ASSURANCE
LEARNING OUTCOMES ........................................................................................................ 18.1
CHAPTER OVERVIEW ........................................................................................................... 18.2
Contents:
1. Introduction ................................................................................................................. 18.3
2. Sustainable Developments Goals ................................................................................. 18.6
3. Global Trends in Sustainable Reporting ....................................................................... 18.7
4. Integrated Reporting ..................................................................................................... 18.9
5. Global Scenario in Various Countries .......................................................................... 18.11
5.1 United States ................................................................................................... 18.11
5.2 United Kingdom ............................................................................................... 18.12
6. Evolution of ESG in India ............................................................................................ 18.14
7. Initiatives By ICAI ....................................................................................................... 18.16
7.1 Business Responsibility and Sustainability Report (BRSR) ............................... 18.17
8. Role of Auditor - Consideration of Climate Related Risks in
an Audit of Financial Statements ................................................................................. 18.27
9. Conclusion ................................................................................................................. 18.29
KEY TAKEAWAYS ............................................................................................................... 18.32
TEST YOUR KNOWLEDGE .................................................................................................. 18.33
© The Institute of Chartered Accountants of India
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CHAPTER 19: PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS
LEARNING OUTCOMES ........................................................................................................ 19.1
CHAPTER OVERVIEW ........................................................................................................... 19.2
Contents:
1. Introduction .................................................................................................................. 19.3
2. Overview of the Code of Ethics ..................................................................................... 19.4
2.1 Fundamental Principles ................................................................................... 19.6
2.2 Threats, Evaluation of Threats and Safeguards ............................................... 19.11
2.3 Non-Compliance with Laws and Regulations (NOCLAR) ................................. 19.16
3. Membership of the Institute ......................................................................................... 19.21
3.1 Disabilities for the Purpose of Membership ....................................................... 19.21
3.2 Types of Members of the Institute ..................................................................... 19.22
3.3 Removal of Name from the Register ................................................................. 19.23
3.4 Restoration of Membership............................................................................... 19.23
3.5 Penalty for Falsely Claiming to be a Member etc. ............................................. 19.24
4. Chartered Accountants in Practice .............................................................................. 19.24
4.1 Significance of the Certificate of Practice .......................................................... 19.25
4.2 Cancellation and Restoration of Certificate of Practice ..................................... 19.26
4.3 Members - deemed to be in Practice ................................................................ 19.27
4.4 Companies not to Engage in Accountancy ........................................................ 19.32
4.5 Member in Practice Prohibited from using a designation other than
Chartered Accountant ..................................................................................... 19.33
4.6 Maintenance of Branch Offices ......................................................................... 19.34
4.7 KYC Norms for CA in Practice .......................................................................... 19.37
5. Chartered Accountants in Service ............................................................................... 19.39
6. Disciplinary Procedure ................................................................................................ 19.39
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7. Types of Misconduct- Professional or Other Misconduct .............................................. 19.41
7.1 Professional Misconduct .................................................................................. 19.41
7.2 Other Misconduct ............................................................................................. 19.41
8. Schedules to the Act................................................................................................... 19.42
8.1 The First Schedule ........................................................................................... 19.43
8.2 The Second Schedule: ..................................................................................... 19.91
9. Council Guidelines ................................................................................................... 19.111
9.1 Council Guidelines for Advertisement, 2008 .................................................... 19.129
10. Recommended Self-Regulatory Measures................................................................. 19.137
10.1 Branch Audits ................................................................................................ 19.137
10.2 Joint Audit...................................................................................................... 19.138
10.3 Ratio Between Qualified and Unqualified Staff ................................................ 19.138
10.4 Disclosure of Interest by Auditors in other Firms ............................................. 19.138
10.5 Recommended Minimum Scale of Fees .......................................................... 19.138
KEY TAKEAWAYS ............................................................................................................. 19.143
ANNEXURE – 1 .................................................................................................................. 19.144
ANNEXURE – 2 .................................................................................................................. 19.150
TEST YOUR KNOWLEDGE ................................................................................................ 19.159
© The Institute of Chartered Accountants of India
CHAPTER a 15
7
OVERVIEW OF AUDIT OF PUBLIC
SECTOR UNDERTAKINGS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
❑ Understand the framework for government audit.
❑ Understand objective and scope of public enterprises audit.
❑ Explain the elements of PSU Audits and Principles of PSU Audits.
❑ Understand & explain the concept of Compliance Audit, Performance
Audit, Comprehensive Audit & Propriety Audit in relation to C&AG of India.
❑ Comprehend about Audit report of the C&AG of India.
❑ Apply & analyse the above-mentioned concepts in moderately complex
scenarios.
© The Institute of Chartered Accountants of India
15.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Framework for Government
Audit
Elements of PSU Audits
Objective and Scope of Audit
of Public Enterprises
Principles of PSU Audits
Audit of Government
Companies
Audit of Public Sector Undertakings (PSUs)
Financial Audit
Compliance Audit
Performance Audit
Comprehensive Audit
Propriety Audit
Audit Report
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.3 a
CA Smita had joined Indian Audit and Accounts Service after qualifying as a Chartered
Accountant and cracking competitive exam thereafter. Her initial appointment was in Mumbai
office. As part of audit team for conducting test audit of a PSU in insurance sector, she was
verifying whether company was in compliance with regulatory norms for issuing insurance
policies. It was in nature of compliance audit.
As part of audit, she found that company had issued policies to certain companies dealing in sale
of mobile handsets. Such companies offered free insurance to the customers for their mobiles to
cover fire, theft and similar risks. It was, however, subject to buying of their software application
by customers in stipulated time. It was found by her that no actuarial valuation was done before
issuing such policies and required approvals from competent authorities were not in place. As a
result, she found losses on account of claim settlement due to non-compliant underwriting.
She was part of team conducting performance audit of a government owned steel company. The
said company had undertaken modernization and expansion of its steel plants and the
performance audit of company was carried out. Her team highlighted many deficiencies in areas
ranging from project planning, tender finalisation and project execution. In each area, specific
deficiencies were pointed out. Like, the team found that all material projects were delayed and
not completed in time. It was also pointed that there was growth in domestic steel industry in the
period covered by audit but company failed to take advantage of market conditions due to delays.
After few years, she was posted in a northern state after promotion. Her responsibility included
compiling a report on financial performance of government companies and statutory corporations
owned by state government. Such a report also included impact of significant comments as a
result of supplementary audit of the financial statements of government companies carried out
by C&AG.
One such comment related to supplementary audit already carried out by C&AG pertaining to
improper determining of depreciation in financial statements of a state-owned power generating
company. Its impact was highlighted in the report pointing out that said improper determination
has led to overstatement of profits by ` 20 crore.
Such is encompassing reach of C&AG in relation to PSUs!
© The Institute of Chartered Accountants of India
15.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
1. INTRODUCTION
Public sector undertakings in India are fundamentally owned or controlled by central government, or
any state government or governments, or partly by the central
government and one or more state governments. The public
enterprises have been assigned a key role in the socio-
economic development of the country. These enterprises are
industries supplying basic inputs to industry and agriculture,
such as coal, oil, steel, minerals and metals, cement,
chemicals and fertilizers and heavy equipment. Public utilities
like the railways, postal and telecom services, electricity
generation and supply, road transport, etc. constitute another Fig.: Audit of PSUs
class of public enterprises. Though in the past, the public
sector in India has achieved a dominant role in the national economy, the private sector is also now
actively allowed in various sectors like electricity generation, telecom services, etc.
For example,
Departmentally managed
Indian Railways, Postal
undertakings which form
Services, Security Printing
part and parcel of
Press, Canteen Stores
government activities
Department, etc.
Categories for Government companies and
deemed government
organisation of companies set up under the
PSUs Companies Act, 2013
Corporations set up under For example,
the specific Acts of the Life Insurance Corporation,
legislature Unit Trust of India, etc.
Source :- newsonair.com Source :- wikipedia.com
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.5 a
2. FRAMEWORK FOR GOVERNMENT AUDIT
In India, the Government audit is performed by an independent constitutional authority, i.e.
Comptroller and Auditor General of India (C&AG), through the Indian Audit and Accounts
Department. The Constitution of India gives a special status to the C&AG and contains provisions
to safeguard his independence.
Article 148 to 151 of the Constitution prescribes the role of C&AG as follows:
• Appointment of C&AG by the President.
Article • Special procedure for removal of C&AG, only on the ground of proven
148 misbehaviors or incapacity.
• Salary and other conditions of service to be determined by the Parliament.
• Perform such duties and exercise such powers in relation to the accounts of
the Union and States and of any other authority or body as may be pre-
Article scribed by or under any law made by the Parliament.
149 • The C&AG’s (Duties, Powers and Conditions of Service) Act, 1971 defines
these functions and powers in detail.
Article • On the advice of the C&AG, President to prescribe such form in which
150 accounts of the Union and States shall be kept.
Article • Audit reports of the C&AG relating to the accounts of the Central/ State
Government should be submitted to the President/Governor of the State who
151 shall cause them to be laid before Parliament/State Legislative Assemblies.
The Comptroller and Auditor General’s (Duties, Power and Conditions of Services) Act, 1971,
prescribes that the C&AG shall hold office for a term of six years or upto the age of 65 years,
whichever is earlier. He can resign at any time through a resignation letter addressed to the
President. The Act also assigns the duties regarding the audit to be followed by C&AG.
The number of organisations subject to the audit of the Comptroller and Auditor General of
India is very large. This includes:
All the Union and State Public commercial enterprises
Government departments and controlled by the Union and
offices including the Indian State governments, i.e.
Railways and Posts and government companies and
Telecommunications. corporations.
Non-commercial autonomous
Authorities and bodies
bodies and authorities owned
substantially financed* from
or controlled by the Union or
Union or State revenues.
the States.
© The Institute of Chartered Accountants of India
15.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
As a result of these numerous audits carried out every year, the Comptroller and Auditor General of
India has been issuing a large number of audit reports.
Audit of Government Companies (Commercial Audit) – There is a special arrangement for the
audit of companies where the equity participation by Government is 51 percent or more. The auditors
of these companies are firms of Chartered Accountants, appointed by the Comptroller & Auditor
General, who gives the auditor directions on the manner in which the audit should be conducted by
them. He is also empowered to comment upon the audit reports of the auditors. In addition, he has
a right to conduct a supplementary audit of such companies and cause test audit if considered
necessary, by an order.
Audit Board Setup in Commercial Audit – A unique feature of the audit conducted by the Indian
Audit and Accounts Department is the constitution of Audit Boards for conducting comprehensive
audit appraisals of the working of Public Sector Enterprises engaged in diverse sectors of the
economy.
These Audit Boards associate with them experts in disciplines relevant to the appraisals. They
discuss their findings and conclusions with the managements of the enterprises and their controlling
ministries and departments of government to ascertain their view points before finalisation.
The results of such comprehensive appraisals are incorporated by the Comptroller and Auditor
General in his reports.
These Audit Boards have no separate legal entity and work under the supervision and control of the
Comptroller and Auditor General.
Action on Audit Reports – The scrutiny of the Annual Accounts and the Audit Reports thereon by
the Parliament as a whole would be an arduous task, considering their diverse and specialised
nature, besides imposing excessive demands on the limited time available to the Parliament for
discussion of issues of national importance.
Therefore, the Parliament and the State Legislatures have, for this purpose, constituted specialized
Committees like the Public Accounts Committee (PAC), Estimates Committee and the Committee
on Public Undertakings (COPU), to which these audit Reports and Annual Accounts automatically
stand referred.
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.7 a
Public Accounts Committee (PAC) – It is the duty of the Public Accounts Committee to satisfy
itself:
(i) that the moneys were disbursed legally on the service or purpose to which they were applied;
(ii) that the expenditure incurred was authorised;
(iii) that re-appropriation has been made in accordance with the provisions made (i.e. distribution
of funds).
It is also the duty of the PAC to examine the statement of accounts of autonomous and semi -
autonomous bodies, the audit of which is conducted by the Comptroller & Auditor Ge neral either
under the directions of the President or by a Statute of Parliament.
Estimates Committee – The Committee examines the estimates with a view to:
(i) report what economies, improvements in organization, efficiency or administrative reform,
consistent with the policy underlying the estimates may be effected;
(ii) suggest alternative policies;
(iii) examine whether the money is well laid out within the limit; and
(iv) suggest the form in which the estimates shall be presented to Parliament.
The Committee does not comment upon a policy approved by Parliament, but where there is
evidence that a particular policy is not leading to the desired results, or is leading to waste, it is the
duty of the Committee to bring it to the notice of the House.
Committee on Public Undertakings (COPU) – The Committee on Public Undertakings exercises
the same financial control on the public sector undertakings as the PAC exercises over the
functioning of the Government departments. The functions of the Committee are -
(i) to examine the reports and accounts of public undertakings.
(ii) to examine the reports of the C&AG on public undertakings.
(iii) to examine the autonomy and efficiency of public undertakings and to see whether they are
being managed in accordance with sound business principles and prudent commercial
practices.
(iv) to exercise such other functions vested in the PAC and the Estimates Committee as are not
covered above and as may be allotted by the Speaker from time to time.
© The Institute of Chartered Accountants of India
15.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The examination of public enterprises by the Committee takes the form of comprehensive appraisal
or evaluation of performance of the undertaking. It involves a thorough examination, including
evaluation of the policies, programmes and financial working of the undertak ing.
The objective of the Financial Committees, in doing so, is to focus not only on the individual
irregularity, but also on the defects in the system which led to such irregularity, and the need for
correction of such systems and procedures.
C&AG's Role – The Comptroller & Auditor General of India plays a key role in the functioning of the
financial committees of Parliament and the State Legislatures. He has come to be recognised as a
'friend, philosopher and guide' of the Committees.
(i) His Reports generally form the basis of the Committees' working, although they are not
precluded from examining issues not brought out in his Reports;
(ii) He scrutinises the notes which the Ministries submit to the Committees and helps the
Committees to check the correctness of submissions to the Committees and facts and figures
in their draft reports;
(iv) The Financial Committees present their Report to the Parliament/ State Legislature with their
observations and recommendations.
The various Ministries / Department of the Government are required to inform the Committees
of the action taken by them on the recommendations of the Committees (which are generally
accepted) and the Committees present Action Taken Reports to Parliament / Legislature ;
(v) In respect of those Audit Reports, which could not be discussed in detail by the Committees,
written answers are obtained from the Department / Ministry concerned and are som etimes
incorporated in the Reports presented to the Parliament / State Legislature.
This ensures that the Audit Reports are not taken lightly by the Government, even if the entire
report is not deliberated upon by the Committee.
TEST YOUR UNDERSTANDING 1
PGC & Associates are statutory auditors of BNPC Limited, a PSU in power sector. It is engaged in
building large sized thermal power stations to accelerate development of power sector in the country.
One of the financial committees of Parliament has decided to examine its physical and financial
performance. It has also examined audit findings of C&AG in respect of which action is yet to be
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.9 a
taken by the said PSU. The committee also proposes to include in its report performance of the
company in various operational matters.
Which financial committee of Parliament deals with such matters? Outline its main functions.
3. OBJECTIVE AND SCOPE OF PUBLIC ENTERPRISES
AUDIT
The C&AG’s (Duties, Power and Conditions of Services) Act, 1971 specifies the entities that
come under audit purview of C&AG at the Union and State level. However, the scope and extent
of audit is determined by the C&AG itself.
Audit Conducted by C&AG
Financial Compliance Performance
(1) Audit of PSUs not constrained to Financial and Compliance Audit: Audit of public
enterprises in India is not restricted to financial and compliance audit; it extends also to
performance (efficiency, economy and effectiveness with which these operate and fulfill their
objectives and goals).
(2) Propriety Audit: Another aspect of audit relates to questions of propriety. This audit is
directed towards an examination of management decisions in sales, purchases, contracts,
etc. to see whether these have been taken in the best interests of the undertaking and
conform to accepted principles of financial propriety.
(3) Comprehensive Audit: Under comprehensive audit, the C&AG do not really cover again the
field which has already been covered. He conducts an appraisal or an efficiency -cum-
performance audit. He sees whether the undertakings have fulfilled the objectives for which
they have been established, whether value-for-money spent has been obtained, whether the
targets have been achieved, etc. He locates the areas of weakness including review of the
decisions taken by the management and a comprehensive appraisal of the performance of
the undertaking.
© The Institute of Chartered Accountants of India
15.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(4) Organisation’s Decision to be taken by Competent Authority: In examining the decisions
of a management, the auditor examines that these were taken by the competent authority
after examination of all aspects (economic, technological, public interest) on the basis of all
the relevant information available at that time and taking into consideration the different
alternatives available to management and that the decisions were consistent with the aims
and objectives of the enterprise.
(5) Helping Government: Audit is an instrument of accountability. But an equally important
purpose of audit of public enterprises in India is to help the Government and the enterprise
managements improve their efficiency and effectiveness. This is achieved by bringing out
financial and operational deficiencies, inadequacies or ineffectiveness of systems, shortfalls
in performance, etc. and by analysing the causes of shortfall from acceptable standards of
performance.
(6) Highlighting Issues of Efficient and Economic Operations: Financial performance is
linked with physical performance and issues of efficient and economic operations and
management of resources are highlighted. There is an increasing emphasis on audit being
an instrument of improvement.
(7) Fiscal and Managerial Accountability: In the broader context, Government audit
encompasses two main elements, viz., (a) Fiscal Accountability: It includes audit of
provisions of funds, sanctions, compliances and propriety; and (b) Managerial
Accountability: It includes audit of efficiency, economy and effectiveness (This is often
referred to as efficiency-cum-performance audit).
Efficiency- cum-performance audit, wherever used, is an objective examination of the
financial and operational performance of an organisation, programme, authority or function
and is oriented towards identifying opportunities for greater efficiency , economy, and
effectiveness.
3.1 Elements of PSU Audits
Public sector auditing augments the confidence of the intended users by providing relevant
information and independent and objective assessments concerning deviations from accepted
standards or principles of good governance.
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.11 a
Audit of all public-sector undertakings have the following basic elements:
Basic Elements of PSU
Audits
Subject matter,
Three Types of
criteria and
parties engagement
subject matter information
Direct
Responsibl Intended Attestation
Auditor Reporting
e party users Engagements
Engagement
(a) The Three parties - Auditor, Responsible Party and Intended Users.
Auditor: The role of auditor is fulfilled by Supreme Audit Institution (SAI), India and by its
personnel delegated with the duty of conducting audits. The Comptroller and Auditor General
of India (C&AG) and the Indian Audit and Accounts Department (IAAD) functioning under him,
constitute the Supreme Audit Institution of India. Senior functionaries of the SAI representing
the C&AG in the state are called Accountants General.
Responsible Party: The relevant responsibilities are determined by constitutional or
legislative arrangement. Generally, auditable entities and those charged wi th governance of
the auditable entities would be the responsible parties. The responsible parties may be
responsible for the subject matter information, for managing the subject matter or for
addressing recommendations.
Intended Users: Intended users are the individuals, organizations or classes thereof for
whom the auditor prepares the audit report.
(b) Subject matter, criteria and subject matter information.
• This refers to the information, condition or activity that is
Subject matter
measured or evaluated against certain criteria.
Criteria • These are the benchmarks used to evaluate the subject matter.
Subject matter • This refers to the outcome of evaluating or measuring the subject
information matter against the criteria.
© The Institute of Chartered Accountants of India
15.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) Types of engagement - Attestation Engagements and Direct Reporting Engagement.
Attestation Engagements:
In attestation engagements, the responsible party measures the subject matter
against the criteria and presents the subject matter information, on which the
auditor then gathers sufficient and appropriate audit evidence to provide a
reasonable basis for expressing a conclusion.
Direct Reporting Engagement:
In direct reporting engagements, it is the auditor who measures or evaluates the
subject matter against the criteria.
Financial audits are always attestation engagements, as they are based on financial information
presented by the responsible party.
Performance audits and compliance audits are generally direct reporting engagements.
3.2 Principles of PSU Audits
The principles of PSU Audits constitute the general standards that apply to SAI India’s personnel as
auditors and are fundamental to the conduct of all types of PSU Audits.
The principles are categorized into two distinct groups as below:
I. General Principles
II. Principles related to the Audit Process
General Principles
Audit
Professional
Ethics & Team
Judgement, Quality Documen- Commun-
Indepen- Manage- Audit Risk Materiality
due care and Control tation ication
dence ment &
skepticism
Skill
© The Institute of Chartered Accountants of India
OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.13 a
Principles related to the Audit Process
Planning the Audit Conducting the Audit Reporting & Follow-up
• Establish the terms of the audit. • Perfom the planned audit • Prepare a report based on
• obtain understanding of the procedures to obtain audit the conclusions reached.
entity. evidence. • Follow-up on reported
• Conduct Risk assessment of • Evaluate audit evidence and draw matters as relevant.
problem analysis. conclusions.
• Identify risks of fraud.
• Develop an audit plan.
4. FINANCIAL AUDIT
Financial audit is primarily conducted to:
express an audit opinion on the financial statements; and
enhance the degree of confidence of intended users in the financial statements .
The C&AG shall express an opinion as to whether the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.
In the case of financial statements prepared in accordance with a fair presentation financial reporting
framework, whether the financial statements are presented fairly, in all material respects, or give a
true and fair view, in accordance with that framework.
5. COMPLIANCE AUDIT
Compliance audit is the independent assessment of whether a given subject matter is in
compliance with the applicable criteria.
This audit is carried out by assessing whether activities, financial transactions and information
comply in all material respects, with the regulatory and other rules which govern the audited entity.
Source :- info.cgcompliance.com
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15.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Compliance auditing is concerned with:
(a) Regularity- adherence of the subject matter to the formal criteria emanating from relevant
laws, regulations and agreements applicable to the entity.
(b) Propriety- observance of the general principles governing sound financial management and
the ethical conduct of public officials.
While regularity is emphasized in compliance auditing, propriety is equally pertinent in the public -
sector context, in which there are certain expectations concerning financial management and the
conduct of officials.
Perspective of Compliance Auditing: Compliance Auditing is part of a combined audit that may
also include other aspects. Compliance auditing is generally conducted either-
(i) in relation with the audit of financial statements, or
(ii) separately as individual compliance audits, or
(iii) in combination with performance auditing.
Compliance Audit is generally conducted either:
(i) with audit of financial (ii) separately as individual (iii) in combination with
statements, or compliance audits, or performance auditing.
When compliance auditing is part of a performance audit, compliance is seen as one of the aspects
of economy, efficiency and effectiveness. Noncompliance may be the cause of, an explanation for,
or a consequence of the state of the activities that are the subject matter of the performance audit.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.15 a
COMPLIANCE AUDIT PROCESS (Source:- Compliance & Auditing Guidelines – C&AG of India )
Consider principles with ethical
significance
General principles Consider principles directly relating to
compliance
and Annual audit process
Compliance Audit Determine Auditable entities, audit
units and
Plan implementing units
Develop annual plan for compliance
Documentation, Communication, Quality Control
audits
Determine compliance audit objective
and scope
Develop audit strategy and plan
Identify subject matter and criteria
Planning Understand the entity and its
Compliance environment
Understand internal control
Audits Establish materiality for planning
purpose
Assess risk
Plan audit procedures
Gather evidence through various
Performing the means
Continually update planning and risk
Audit and Gathering assessment
Evidence Consider non-compliance that may
indicate suspected unlawful acts
Evaluate whether sufficient and
Evaluating
appropriate evidence is obtained
Consider materiality for reporting
Evidence and purposes
form conclusions
Forming Ongoing documentation,
Conclusions communication and quality
control
Prepare the report
Include responses from entity as
Reporting appropriate
follow-up previous reports as
necessary
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15.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
6. PERFORMANCE AUDIT
A performance audit is an objective and systematic examination of evidence for the purpose of
providing an independent assessment of the performance of a government organization,
program, activity, or function in order to provide information to improve public accountability and
facilitate decision-making by parties with responsibility to oversee or initiate corrective action.
Performance audit in PSUs is conducted by the C&AG (Supreme Audit Institutions) through various
subordinate offices of Indian Audit and Accounts Department (IAAD).
In conducting performance audit, the subordinate offices are guided by manual and auditing
standards prescribed by C&AG.
This audit promotes accountability by assisting those charged with governance and oversight
responsibilities to improve performance through an examination of whether:
(a) decisions by the legislature or the executive are efficiently and effectively prepared and
implemented; and
(b) tax payers or citizens have received value for money.
According to the guidelines issued by the C&AG, Performance Audits usually address the issues of:
Economy
Effectiveness Efficiency
(i) Economy- It is minimising the cost of resources used for an activity, having regard to
appropriate quantity, quality and at the best price.
Judging economy implies forming an opinion on the resources (e.g. human, financial and
material) deployed. This requires assessing whether the given resources have been used
economically and acquired in due time, in appropriate quantity and quality at the best price.
When conducting audits of economy, the auditor may provide answers to
such questions as: ( ECA Performance Audit Manual , 2017 )
• Have the best prices been obtained for consultancy services?
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.17 a
• Is there potential for reducing the cost of sickness absences?
• Are there procedures in place to ensure that transport costs of food aid are the lowest
available?
• Has there been a waste of resources in achieving an output?
(ii) Efficiency- It is the input-output ratio. In the case of public spending, efficiency is achieved
when the output is maximised at the minimum of inputs, or input is minimised for any given
quantity and quality of output. When the audit objective of efficiency considers outputs, focus
is usually on processes by which an organisation transforms inputs into outputs.
Auditing efficiency embraces aspects such as whether:
(a) sound procurement practices are followed;
(b) resources are properly protected and maintained;
(c) human, financial and other resources are efficiently used;
(d) optimum amount of resources (staff, equipment, and facilities) are used in producing or
delivering the appropriate quantity and quality of goods or services in a timely manner;
(e) public sector programmes, entities and activities are efficiently managed, regulated,
organised and executed;
(f) efficient operating procedures are used; and
(g) the objectives of public sector programmes are met cost-effectively.
In audits of efficiency, you might ask questions such as: How does the cost
per job created by a training programme for the unemployed compare with similar
costs per job elsewhere?
• Could project X have been implemented differently that would have resulted in
improved timeliness and quality?
• Are adequate procedures and criteria for prioritising and selecting transport
infrastructure projects to ensure maximum impact in place?
• Are schools maximising the use of their information technology equipment?
• When the audit objective of efficiency considers outputs, you will usually focus on
processes by which an organisation transforms inputs into outputs.
(Source : ECA Performance Audit Manual , 2017 )
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15.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(iii) Effectiveness- It is the extent to which objectives are achieved and the relationship between
the intended impact and the actual impact of an activity.
In auditing effectiveness, performance audit may, for instance:
(a) assess whether the objectives of and the means provided (legal, financial, etc.) for a
new or ongoing public sector programme are proper, consistent, suitable or relevant
to the policy;
(b) determine the extent to which a program achieves a desired level of program results;
(c) assess and establish with evidence whether the observed direct or indirect social and
economic impacts of a policy are due to implementation of the policy or to other
causes;
(d) identify factors inhibiting satisfactory performance or goal-fulfilment;
(e) assess whether the programme complements, duplicates, overlaps or counteracts
other related programmes;
(f) assess the effectiveness of the program and/or of individual program components;
(g) determine whether management has considered alternatives for carrying out the
program that might yield desired results more effectively or at a lower cost;
(h) assess the adequacy of the management control system for measuring, monitoring
and reporting a programme's effectiveness;
(i) assess compliance with laws and regulations applicable to the program; and
(j) identify ways of making programmes work more effectively.
It focuses on questions such as:
• Have infrastructure projects contributed to increased traffic flow while improving
safety and reducing journey times?
• Have suitable measures to monitor and mitigate the environmental impact in sector X been
set up and properly implemented?
• Are departments or entities achieving their objectives for all sectors of the community?
(Source : ECA Performance Audit Manual,2017 )
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.19 a
Performance Audit Cycle
Strategic goals and
objectives of SAI
Strategic Planning
Strategic plan document and
Planning the individual annual operational plan
performance audits
Individual performance audit plan
Preliminary study
Discussion papers, audit
observations, working papers
Implementation of performance
audits for individual subjects
Field audit report to the field entity
and their response
Report approval Draft performance
process audit report to the Draft performance audit report
Entity-in-Chief
Performance audit report
Follow-up process and impact
assessment
6.1 Objectives of Performance Audit
The objectives of performance auditing are evaluation of economy, efficiency, and effectiveness of
policy, programmes, organization and management. It also promotes accountability by assisting
those charged with governance and oversight responsibilities to improve performance; and
transparency by affording taxpayers, those targeted by government policies and other stakeholders
an insight into the management and outcomes of different government activities.
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15.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Performance auditing focuses on areas in which it can add value which have the greatest po tential
for development. It provides constructive incentives for the responsible parties to take appropriate
action.
Regulations on Audit and Accounts issued by C&AG lay down that the responsibility for the
development of measurable objectives and performance indicators as also the systems of
measurement rests with the Government departments or Heads of entities. They are also required
to define intermediate and final outputs and outcomes in measurable and monitorable terms,
standardise the unit cost of delivery and benchmark quality of outputs and outcomes.
1. Performance Audit of enforcement mechanism for administering the provision
of Minimum Wages Act (a social welfare legislation)
The auditors, who undertake performance audit of a program or unit, must possess
knowledge of the industries or labor contracts where these provisions are applicable and also
identify the population thereof before carrying out audit program. He shall evaluate the standard
of living before implementation and after implementation of the Act.
Further, the auditor shall have to evaluate the evidence available as to nature of returns
prescribed and obtained for taking appropriate action.
The Performance Auditor shall also have to evaluate the economy, efficiency and effectivenes s
in the welfare systems to be audited. He can then study the shortcomings in the coordination
between different agencies like labor department, EPF and ESI organization and the control
systems and point out a set of relevant problems.
The auditor shall also have to point out lacuna, if any in the existing legal frame work or
enforcement mechanism to strengthen the objective of legislation. Another possible area of critical
audit may be to study actual level of compensation required in each area keeping in mind the
local living conditions and where the minimum wages prescribed in the statute is demonstrably
different from this level he may report the same to the Government for taking appropriate action.
In this manner, the performance audit can not only examine the reasons for such vagaries but
also ensures that the legislation serves the intended purpose. By reporting the same to the
legislature, the corrective is made possible.
[Note: Interested students may refer to Background Material on Performance Audit of Public
Sector Enterprises in India published by the CPE Committee of ICAI for further reference].
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6.2 Planning for Performance Audit
Understanding the entity/programme
Defining the objectives and the scope of audit
Determining audit criteria
Deciding audit approach
Planning for Developing audit questions
Performance Audit
Assessing audit team skills and whether outside
expertise required
Preparing Audit Design Matrix
Establishing time table and resources
Intimation of Audit programme to audit entities
The following steps are suggested to the auditors for planning while conducting the performance
audit:
(A) Understanding the Entity/Programme - It is the starting point for planning individual
performance audit.
Sources for Understanding
the Entity
Academic Special
Documents Legislative Policy Media
or special Past audits focus
of the entity documents documents coverage
research groups
The auditor may use the following sources for understanding the entity:
(i) Documents of the entity: Documents on administration and functions of the entity,
policy files, annual reports, budget documents, accounts, minutes of meetings,
information on the website, internal audit reports, electronic databases and MIS
reports, RTI material etc.
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15.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(ii) Legislative documents: Legislation, parliamentary questions and debates, reports of
the Public Accounts Committee, the Committee on Public Undertakings, the Estimates
Committee and letters from Members of Parliament.
(iii) Policy documents: Documents of Planning Commission, Ministry of Finance etc.
(iv) Academic or special research: Independent evaluations on the entity, academic
research and similar work done by other governments and other SAIs.
(v) Past audits: Past financial and performance audits of the entity provide a major
source of information and understanding.
(vi) Media coverage: Print and electronic media - their systematic documentation on
regular basis in a transparent manner.
(vii) Special focus groups: Audit Advisory Committee concerns, annual and special
reports of World Bank, Reserve Bank of India, reports by special interest groups,
NGOs, etc.
(B) Defining the Objectives and the Scope of Audit - The audit objectives should be defined
in a crisp & clear manner as they will impact the nature of the audit, govern its conduct and
affect audit conclusions. Setting audit objectives ensures good quality performance audits. It
facilitates clarity, demonstrates consistent quality of audit and serves as a measure of quality
assurance of the audit.
Defining the scope constricts the audit to significant issues that relate to the audit objectives.
It mainly focuses on the extent, timing and nature of the audit.
(C) Determining Audit Criteria - Audit criteria are the standards used to determine whether a
program meets or exceeds expectations. It provides a context for understanding the results
of the audit. Audit criteria are reasonable and attainable standards of performance against
which economy, efficiency and effectiveness of programmes and activities can be assessed.
The audit criteria may be sought to be obtained from the following sources:
(i) procedure manuals of the entity.
(ii) policies, standards, directives and guidelines.
(iii) criteria used by the same entity or other entities in similar activities or programmes.
(iv) independent expert opinion and know how.
(v) new or established scientific knowledge and other reliable information.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.23 a
(vi) general management and subject matter literature and research papers.
(D) Deciding Audit Approach - There is no uniform audit approach prescribed that can be
applicable to all types of subjects of performance audits. Selection of approach also
determine methods and means used for conducting the audit.
Some of the methods which could be used in conducting performance audits include:
Analysis of Use of
Case studies
procedures existing data
Analysis of Quantitative
Surveys
results analysis
(i) Analysis of procedures: It involves review of the systems in place for planning,
conducting, checking and monitoring the activity. This would consist of examination of
documents such as financial reports, budgets, programme guidelines, procedure
manuals, etc.
(ii) Case studies: A case study is a descriptive analysis of an entity, scheme or a
programme. It involves analysis of a particular issue within the context of the whole
area under review.
(iii) Use of existing data: The audit staff should investigate the data held by entity
management and by other relevant sources. Audit conclusions based on testing of
available data for correctness and completeness enhances the assurance level.
(iv) Surveys: Survey is a method of collecting information from members of a population
to assess the interrelation of events and conditions. Surveys on predetermined
parameters can supplement the audit findings and conclusions adding value to the
performance audits.
(v) Analysis of results: It requires the auditor to carry out actual output-input analysis to
determine the efficiency of the programme.
(vi) Quantitative analysis: It involves examination of available data relating to financials
like earnings, revenue, or data relating to programme implementation like details of
beneficiaries etc. However, it may not be possible for the auditor to work with complete
data due to its high volume. In such cases, sampling techniques are required to be used.
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15.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(E) Developing Audit Questions - Subsequent to designing of audit objectives and
determination of audit criteria, the audit team is required to prepare a list of questions to which
they would seek answers. The questions should be framed in comprehensive manner
involving detailed hierarchy of questions.
(F) Assessing Audit Team Skills and whether Outside Expertise required - It is essential that
the performance auditors possess special aptitude and knowledge. The Auditing Standards
of C&AG of India provide that the audit institution should develop and train the auditors to
enable them to perform their tasks effectively & efficiently and should prepare manuals &
other written guidance notes & instructions concerning conduct of audits.
Given the diverse range of subjects of performance auditing, the audit team needs to develop
sound understanding of the programme or entity proposed to be audited.
The audit team needs to decide at the planning stage on which aspect expertise is required.
Though, the Accountant General may use the work of an expert, he retains full responsibility
for the expression of opinion in the auditor’s report.
(G) Preparing Audit Design Matrix (ADM) - Having determined the audit objective, audit criteria,
audit approach, data collection etc., audit team should prepare an Audit Design Matrix. It is
a structured and highly focused approach to designing a performance audit study.
The ADM highlights the data collection and analysis method as well as the type and sources
of evidence required to support audit opinion/findings.
A specimen of ADM is given as under:
Audit Objective Audit Questions Audit Criteria Evidence Data Collection and
Analysis Method
(1) (2) (3) (4) (5)
An ADM is prepared on the basis of information and knowledge obtained during the planning
stage. A well-designed ADM leads to effective audits thus providing highest assurances to
the auditing entities. It is desirable to prepare ADM for each of the audit objectives.
(H) Establishing Time Table and Resources - It is significant to determine the timetable and
desirable resources. Selection of appropriate audit team is the most vital component in
planning an audit. Considerations for selection of an appropriate audit team should be
recorded along with the proposed timelines for various activities to be undertaken as a part
of audit process. The progress should also be monitored against these timelines. The
Accountant General would be liable for ensuring that the performance audit is completed on
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.25 a
time. The variations between the required and actual time spent should be compared and
approved from the competent authority.
The team should build time for translation, approval and possible delays in their own schedule
in order to meet the targets.
(I) Intimation of Audit Programme to Audit Entities - Audited entities must be intimated about
the intention of taking up planned performance audit with the scope and extent of audit
including the constitution of audit team and the tentative time schedule, well before the
commencement of Audit. Acknowledgement of this may be requested and placed on record.
It may be required to refine an audit's objectives as the audit progresses for gathering the
requisite information to fulfill the audit. The reasons for such changes in the objectives should
also be recorded and approved from the competent authority.
The audit programme should be flexible and reviewed from time to time as it is not possible
to anticipate all the contingencies at the early stage.
The Accountant General should share all significant refinements in the approach and
additional tests and findings, concurrently with other audit teams when different persons
conduct the audit at different locations. The system of sharing of the significant field audit
experience should be documented and reviewed.
Illustration
The objectives of audit in connection with a State Electricity Distribution Company
were to ascertain whether the:
(i) total cost of providing electricity is being recovered by timely submissions to
the State Electricity Regulatory Commission;
(ii) tariff orders, sales circulars and sales instructions were issued timely, without
any ambiguity. They were implemented in time;
(iii) metering, billing and collection was managed efficiently and effectively;
(iv) monitoring and internal controls were efficient.
What kind of audit is this? Prepare two sample observations which could be part of
the audit report.
This is a performance audit. Sample observations could be:
(i) Non replacement of defective/ burnt meters: Large number of meters, much in
excess of the permitted limit of 1% of the total meters were defective and their
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15.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
replacement was not completed within the stipulated time of 1 month. This
resulted in billing on average basis for a continuous period of several months.
This could result in losses as well as administrative hassles and disputes with
consumers.
(ii) Under charging of meter rent: As per Schedule of Charges, the Company is
required to charge meter rent of `30 per month for a single phase meter and
`40 per month for three phase meter. It was observed that the Company had
short charged meter rent of `60 lakh from 3 lakh consumers in 5 lakh bills
during the period.
7. COMPREHENSIVE AUDIT
The Comptroller and Auditor General assists the legislature in reviewing the performance of public
undertakings. He conducts an efficiency-cum-performance audit other than the field which has
already been covered either by the internal audit of the individual concerns or by t he professional
auditors. He locates the area of weakness and extravagance for managements’ information.
The areas covered in comprehensive audit naturally vary from enterprise to enterprise depending
on the nature of the enterprise, its objectives and operations. The auditors combine aspects of
Financial , Compliance and Performance audits. All the audit information is used in such a way that
a holistic assessment is possible. However, in general, the covered areas are those of investment
decisions, project formulation, organisational effectiveness, capacity utilisation, management of
equipment, plant and machinery, production performance, use of materials, prod uctivity of labour,
idle capacity, costs and prices, materials management, sales and credit control, budgetary and
internal control systems, etc.
Some of the issues examined in comprehensive audit are:
(a) How does the overall capital cost of the project compare with the approved planned costs?
Were there any substantial increases and, if so, what are these and whether there is evidence
of extravagance or unnecessary expenditure?
(b) Have the planned production or operational outputs been achieved? Has there been under -
utilisation of installed capacity or shortfall in performance and, if so, what has caused it?
(c) Has the planned rate of return been achieved?
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.27 a
(d) Are the systems of project formulation and execution sound? Are there inadequacies? What
has been the effect on the gestation period and capital cost?
(e) Are cost control measures adequate and are there inefficiencies, wastages in raw materials
consumption, etc.?
(f) Are the purchase policies adequate? Or have they led to piling up of inventory resulting in
redundancy in stores and spares?
(g) Does the enterprise have research and development programmes? What has been the
performance in adopting new processes, technologies, improving profits and in reducing
costs through technological progress?
(h) If the enterprise has an adequate system of repairs and maintenance?
(i) Are procedures effective and economical?
(j) Is there any poor or insufficient or inefficient project planning?
The Bureau of Public Enterprises has issued guidelines to be followed by the public sector
enterprises in respect of general management, financial management, materials management,
production management, construction management, etc. and these guidelines provide anoth er basis
for appraising enterprise performance and its systems. Another source of criteria is industrial
engineering and other technical studies by internal and external experts and the standards given in
these. Then there are standards of financial propriety.
The starting point of a comprehensive appraisal of a public enterprise, which covers aspects of
economy, efficiency and effectiveness, is the preparation of an audit programme based on the study
of decisions relating to the setting up of the enterprise, its objectives, the areas of operation,
organisation, financial and operational details available in the annual reports and accounts, capital
and operational budgets, deliberations of the board of directors, material in the earlier audit
inspection reports on the enterprise and other relevant available papers. These audit programmes
(or guidelines) identify the areas/aspects which require further detailed audit analysis and criteria,
the data required for such analysis and the sources of such data, the extent of the audit analysis
including the test checks to be applied and the instructions to the audit parties assigned to the work.
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15.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
TEST YOUR UNDERSTANDING 2
PS & Associates are statutory auditors of a Central government owned company for a particular
year. The statutory auditors were required to examine the following areas mandatorily, provide their
specific replies and also their impact on financial statements for that particular year in their audit
report.
1. Whether the company has system in place to process all the accounting transactions through IT
system? If yes, the implications of processing of accounting transactions outside IT system on the
integrity of the accounts along with the financial implications, if any, may be stated.
2. Whether there is any restructuring of an existing loan or cases of waiver / write off of debts / loans/
interest etc. made by a lender to the company due to the company’s inability to repay the loan? If
yes, the financial impact may be stated. Whether such cases are properly accounted for?
3. Whether funds (grants/subsidy etc.) received / receivable for specific schemes from Central
government or its agencies were properly accounted for / utilized as per its term and conditions?
List the cases of deviation.
Can you gauge likely nature of such responsibility thrust upon auditors of above PSU?
8. PROPRIETY AUDIT
Auditing, as a composite concept, looks into accounting and arithmetical accuracy, adherence to
applicable rules and regulations, propriety and the ‘’truth and fairness’’ of the end result. According
to the varied requirements, the emphasis on each of the aforesaid factors differs between various
types of audit. Propriety aspects in an audit already exists in the audits carried on by the C&AG.
8.1 Definition and Principles
Propriety audit stands for verification of transactions on the tests of public intere st, commonly
accepted customs and standards of conduct.
E.L. Kohler has defined the term propriety as “that which meets the tests of public interest,
commonly accepted customs, and standards of conduct, and particularly as applied to
professional performance, requirements of law, Government regulations and prof essional
codes”.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.29 a
On an analysis, the tests boil down to tests on economy, efficiency and faithfulness. Instead of too
much dependence on documents, vouchers and evidence, it shifts the emphasis to the substance
of transactions and looks into the appropriateness thereof on a consideration of financial prudence,
public interest and prevention of wasteful expenditure.
Thus, propriety audit is concerned with scrutiny of executive actions and decisions bearing on
financial and profit and loss situation of the company, with special regard to public interest and
commonly accepted customs and standards of conduct. It is also seen whether every officer has
exercised the same vigilance in respect of expenditure incurred from public money, as a person of
ordinary prudence would exercise in respect of expenditure of his own money under similar
circumstances.
In ‘propriety audit’, the auditors try to bring out cases of improper, avoidable, or infructuous
expenditure even though the expenditure has been incurred in conformity with the existing
rules and regulations. A transaction may satisfy all the requirements of regularity audit
insofar as the various formalities regarding rules and regulations are concerned, but may still
be highly wasteful.
A building may be constructed for installing a telephone exchange but may not be used
for the same purpose resulting in infructuous expenditure or a school building may be
constructed but used after five years of its completion is a case of avoidable expenditure .
Audit should, therefore, try to secure a reasonably high standard of public financial morality by
looking into the wisdom, faithfulness and economy of transactions. These considerations have led
to the evolution of audit against propriety which is now being combined by the audit authorities with
their routine function of regularity audit. It is hard to frame any precise rules for regulating the course
of audit against propriety. Such an objective of audit depends for its acceptance on its appeal to the
common sense and straight logic of the auditors and of those whose financial transactions are
subjected to propriety audit. However, some general principles have been laid down in the Audit
Code, which have for long been recognised as standards of financial propriety.
Propriety requires the transactions, and more particularly expenditure, to conform to certain
general principles. These principles are:
(i) that the expenditure is not prima facie more than the occasion demands and that every official
exercises the same degree of vigilance in respect of expenditure as a person of ordinary
prudence would exercise in respect of his own money;
(ii) that the authority exercises its power of sanctioning expenditure to pass an order which will
not directly or indirectly accrue to its own advantage;
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15.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(iii) that funds are not utilised for the benefit of a particular person or group of persons and
(iv) that, apart from the agreed remuneration or reward, no other avenue is kept open to indirectly
benefit the management personnel, employees and others.
It may be stated that it is the responsibility of the executive departments to enforce economy in
public expenditure. The function of audit is to bring to the notice of the proper authorities of
wastefulness in public administration and cases of improper, avoidable and infructuous expenditure.
The functions of Auditor in the context of Propriety Audit may be specified as under as to :
see that all expenditure incurred are properly planned.
see that the size and channels of expenditure are rightful and expected to give maximum
results.
appraise whether those expenditure are likely to give optimum result.
see that any substitute plan of action can bring about an improvement on current operation
and as well as return from capital expenditure.
examine the actions and decisions of the management to see that they are conductive to
public interests and that they meet the standards of conduct.
Propriety Audit-Problems - Problems in propriety audit, however, arise mainly because of its
distinct nature. The expression “propriety” is a moral term and can be understood by reference to
the concept of morality accepted by the society at a given time. In any auditing, the essential test
lies in formulation of auditing propositions. In the audit of financial accounts by reference to financial
and legal requirements, propositions are built up about happening of events, existence, accuracy,
title, ownership, compliance with law and internal regulations etc., which are all verifiable. In
propriety audit the formulation of verifiable auditing propositions poses the problem.
Propriety audit has an inherent element of subjectivity because it is very difficult to establish
standards of public interest, commonly accepted customs, standards for conduct which are not firm
basis for audit evaluation. To take care of this situation, the C&AG has developed the norms of
propriety for expenditure of public funds in our country. By laying down the standards of propriety
for Government expenditure the C&AG has really tried to tackle in a practical way the complex
problem of subjectivity inherent in a situation calling for propriety consideration.
The norms so developed provide the basis of verifying expenditure incurred by various Government
departments. It may be appreciated that the norms of propriety applicable to governmental
transactions may not ipso facto apply to transactions of private sector which have distinct and more
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.31 a
limited, objectives suited to them. Each private sector entity may have its unique objectives related,
to its management philosophy and the transactions should be geared to achieve those. For
example, a management which is operating for maximization of profits without infringing, any legal
regulations may follow certain policies while another management believing in a wider measure of
social justice may follow different policies. Despite these clear angularities, certain commonness
can also be discerned in the policies and approaches of different managements. They include
efficient operations, higher productivity and higher profit, reduction of wasteful expenditure etc.
Above all, each entity has its impact on the society and building up propriety audit prop ositions
becomes of paramount importance.
It is felt that if the management of each entity, irrespective of any legal requirements, formulates
norms of propriety for the entity, taking full note of wider social repercussions inherent in its
operations; a formidable hurdle in the way of wider introduction of propriety audit can be removed.
The element of subjectivity in propriety evaluation will get reduced.
Propriety as a moral element should be a matter of evaluation based on objectives and prevailing
circumstances. For example, a travel by air as such should not be considered wasteful unless it is
proved that a travel by rail would have been feasible in the circumstances and would have brought
the same results brought by the air travel.
The element of subjectivity has sometimes resulted in proper discharge of duty very delicate and
which demands discretion, but wisdom of taking commercial decisions under dynamic environment
(the economic, social and political) must be evaluated with reference to the circumstances in which
these were taken (and not on hindsight) and therefore, the auditor in his field must reconstruct such
circumstances. The judgment of the auditor must be objective as otherwise it would dampen the
initiative of management and others in taking commercial decisions and propriety audit would prove
itself to be counter-productive.
9. AUDIT REPORT OF THE COMPTROLLER AND
AUDITOR GENERAL
To facilitate a proper consideration, the reports of the C&AG on the audit of PSUs are
presented to the Parliament in several parts consisting of the following :
(a) Introduction containing a general review of the working results of Government companies,
deemed Government companies and corporations;
(b) Results of comprehensive appraisals of selected undertakings conducted by the Audit Board ;
© The Institute of Chartered Accountants of India
15.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) Resume of the company auditors’ reports submitted by them under the directions issued by
the C&AG and that of comments on the accounts of the Government companies; and
(d) Significant results of audit of the undertakings not taken up for appraisal by the Audit Board.
For certain specified states, the C&AG submits a separate audit report (commercial) to the
legislature, while for other States/Union Territories with legislature, there is a commercial chapter in
the main audit report. The State audit reports, contains both the results of audit appraisal of
performance of selected companies/corporations as well as important individual instances of
financial irregularities, wasteful expenditure, system deficiencies noticed by the statutory auditors,
and a general review of the working results of Government companies and corporations.
Integrated Case Scenario
SRM & Associates are refreshening up their knowledge on functions of various Parliamentary
financial committees and on the varied functions and duties of Comptroller & Auditor General of
India in relation to audit of government institutions and government companies. They fee l that unless
they have understood scope of duties of C&AG, they would not be in a position to do justice to audits
and professional work in this area.
In the process, they have gone through various materials both offline and online. The summarized
information derived from some of such materials including website of C&AG are stated below:
[A] The C&AG report for a particular year contained results of the compliance audit of Department
of Revenue-Direct Taxes of the Union Government dealing with “Assessments relating to Agricultural
Income”. It included certain observations relating to allowing of claim for exemption of agricultural
income without supporting documents, use of this area by non-agriculturists as a conduit to avoid
taxes etc., in scrutiny assessments performed by the Department.
[B] The C&AG in one of its reports in respect of a state government owned industrial development
corporation pointed out non-adherence of One-time settlement (OTS) guidelines of state government
by the corporation resulting in acceptance of a below par OTS proposal thus foregoing recovery of
loan amounting to ` 6.87 crores. The said corporation was providing loans to industrial units.
[C] Annual report of a listed public sector company which is a “mini-ratna” PSU was also gone
through. The said company is engaged in providing diversified services to Indian Railways.
[D] A state government owned PSU was involved in setting up of a thermal power plant in the
state. The C&AG, in its audit report, pointed out delay in completion of work due to failure to decide
on the type of water treatment in the cooling plant on a timely basis. Besides, other reasons leading
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.33 a
to delay like frequent changes in lay-out and re-testing of soil by the company were pointed out.
Answer the following questions based upon above information:
1. Based on description provided at para [A] of case, which Parliamentary financial
committee is likely to examine above report of C&AG and make its recommendations?
(a) Estimates Committee.
(b) Public Accounts Committee.
(c) Committee on Public Undertakings.
(d) Committee on Commerce.
2. Considering the description stated in para [B] of case, the above audit finding is likely
to fall in which areas?
(a) Compliance audit.
(b) Performance audit.
(c) Propriety audit.
(d) Comprehensive audit.
3. As regards listed PSU described in para [C] of case, which of the following statements
is most appropriate?
(a) The statutory audit of above PSU is to be conducted by a firm of auditors appointed by
shareholders in AGM. C&AG cannot give directions to such firm of auditors. However, its office is
empowered to conduct a supplementary audit.
(b) The statutory audit of above PSU is to be conducted by C&AG.
(c) The statutory audit of above PSU is to be conducted by a firm of auditors appointed by C&AG.
Further, C&AG can give directions to the firm of auditors.
(d) The statutory audit of above PSU is to be conducted by a firm of auditors appointed by
shareholders in AGM. However, C&AG can give directions to the firm of auditors.
4. Considering nature of audit finding described at para [D] of case concerning delay in
completion of work of thermal power plant, the said audit finding is likely to fall in domain of:
(a) Propriety audit.
(b) Performance audit.
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15.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(c) Financial audit.
(d) Compliance audit.
5. PSU engagements are generally attestation engagements or direct reporting
engagements. Which of the following statements is correct in this regard?
(a) Performance audits and compliance audits are generally attestation engagements.
(b) Performance audits and compliance audits are generally direct reporting engagements.
(c) Performance audit is a direct reporting engagement whereas compliance audit is an
attestation engagement.
(d) Performance audit is an attestation engagement whereas compliance audit is a direct
reporting engagement.
Key Takeaways
Public sector undertakings in India are fundamentally owned or controlled by Central
Government, or any State Government or Governments, or partly by the Central Government
and one or more State Governments. Such undertakings play a key role in the socio-economic
development of the country.
The accounts of selected government Companies along with the report of the statutory
auditors are reviewed by C&AG by carrying out a supplementary audit.
The scope and extent of audit carried out by C&AG in relation to PSUs may relate to
compliance audit, financial audit and performance audit.
Compliance audit is the independent assessment of whether a given subject matter is in
compliance with the applicable criteria.
Performance audit is an objective and systematic examination of evidence for providing an
independent assessment of the performance of a government organization, program, activity
or function in order to provide information to improve public accountability and facilitate
decision making by parties with responsibilities to oversee or initiate corrective action.
Performance audits usually address the issues of economy, efficiency and effecti veness.
Comprehensive audit combines aspects of financial, compliance and performance audits. All
the audit information is used in such a way that a holistic assessment is possible.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.35 a
In ‘propriety audit’, the auditors try to bring out cases of improper, av oidable, or infructuous
expenditure even though the expenditure has been incurred in conformity with the existing
rules and regulations. A transaction may satisfy all the requirements of regularity audit insofar
as the various formalities regarding rules and regulations are concerned, however, it may still
be highly wasteful.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. The reports of the Comptroller and Auditor General of India on the audit of PSUs are
presented to the Parliament and to various state legislatures to facilitate a proper
consideration. Enumerate the contents of Audit Report presented by C & AG .
2. ABG & Co., a Chartered Accountant firm has been appointed by C & AG for performance
audit of a Sugar Industry. What factors should be considered by ABG & Co., while planning
a performance audit of Sugar Industry?
3. Sunlight Limited is a public sector undertaking engaged in production of electricity from solar
power. It had commissioned a new project near Goa with a new technology for a cost of
` 5,750 crore. The project had seen delay in commencement and cost overrun. State the
matters that a Comprehensive Audit by C&AG may cover in reporting on the performance
and efficiency of this project.
4. “A performance audit is an objective and systematic examination of evidence for the purpose
of providing an independent assessment of the performance of a government organization,
program, activity, or function in order to provide information to improve public accountability
and facilitate decision-making by parties with responsibility to oversee or initiate corrective
action.” Briefly discuss the issues addressed by Performance Audits conducted in accordance
with the guidelines issued by C&AG.
5. BT Ltd , a company wholly owned by central government was disinvested during the previous
year, resulting in 40% of the shares being held by public. The shares were also listed on the
BSE. Since the shares were listed, all the listing requirements were applicable, including
publication of quarterly results, submission of information to the BSE etc.
Sam, the FM of the company is of the opinion that now the company is subject to stringent
control by BSE and the markets, therefore the auditing requirements of a limited company in
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15.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
private sector under the Companies Act 2013 would be applicable to the company and the
C&AG will not have any role to play. Comment.
6. You have been appointed as auditor of a AKY Ltd. After having determined the audit
objectives, now you have been requested to draft audit criteria. What are the sources that
you will use while doing the task?
7. Comptroller & Auditor General appointed Verma & Associates, a chartered accountant firm,
to conduct Performance audit of MAP Ltd., a public sector undertaking of Government of
India. The firm conducted the audit with a view to check all the expenses of the unit are in
conformity with the public interest and publicly accepted customs. The audit report submitted
by audit firm was rejected by C&AG. Give your opinion on the action of C&AG.
8. The objectives of audit in connection with a State Electricity Distribution Company were to
ascertain whether the:
(i) total cost of providing electricity is being recovered by timely submissions to the State
Electricity Regulatory Commission;
(ii) tariff orders, sales circulars and sales instructions were issued timely, without any
ambiguity. They were implemented in time;
(iii) metering, billing and collection was managed efficiently and effectively;
(iv) monitoring and internal controls were efficient.
What kind of audit is referred in the above scenario? Also briefly discuss the steps suggested
to the auditors for planning such an audit.
Answers to Test Your Understanding
1. The said matters are dealt by Committee on Public Undertakings (COPU). The functions of
the Committee are -
(i) to examine the reports and accounts of public undertakings.
(ii) to examine the reports of the C&AG on public undertakings.
(iii) to examine the autonomy and efficiency of public undertakings and to see whether
they are being managed in accordance with sound business principles and prudent
commercial practices.
(iv) to exercise such other functions vested in the PAC and the Estimates Committee as
are not covered above and as may be allotted by the Speaker from time to time.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.37 a
The examination of public enterprises by the Committee takes the form of comprehensive
appraisal or evaluation of performance of the undertaking. It involves a thorough examination,
including evaluation of the policies, programmes and financial working of the undertaking.
2. The above areas for which statutory auditors of PSU were required to examine, report and
indicate impact of these matters in financial statements are likely to relate to directions issued
by C&AG to statutory auditors under section 143(5) of Companies Act, 2013.
In terms of section 143(5), in case of a government company, the C&AG has the power to
direct the auditor the manners in which accounts of company are required to be audited and
auditor shall submit audit report which among other things, include the directions, if any,
issued by the C&AG the action taken thereon and its impact on the accounts and financial
statements of the company.
Answers to Integrated Case Scenario
1 (b)
2 (a)
3 (c)
4 (b)
5 (b)
Hints /Answers to Theoretical Questions
1. Refer Para 9.
2. Factors to be considered while planning the Performance Audit: Refer Para 6.2.
3. Refer Para 7
4. Refer Para 6.
5. Section 2(45) of the Companies Act, 2013, defines a “Government Company” as 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 an d partly by one
or more State Governments, and includes a company which is a subsidiary company of such a
Government company. The auditors of these government companies are firms of Chartered
Accountants, appointed by the Comptroller & Auditor General, wh o gives the auditor
directions on the manner in which the audit should be conducted by them. The listing
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15.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
of company’s shares on a stock exchange is irrelevant for this purpose and hence Sam’s
opinion is not correct.
6. Refer Para 6.2.
7. In the given scenario, C&AG appointed Verma & Associates, a chartered accountant firm, to
conduct Performance Audit of MAP Ltd., a PSU of Government of India. The firm conducted
audit with a view to check all the expenses of the unit are in conformity to the public int erest
and publicly accepted customs which is not Performance Audit.
A performance audit is an objective and systematic examination of evidence for the purpose
of providing an independent assessment of the performance of a government organization,
program, activity, or function in order to provide information to improve public accountability
and facilitate decision-making by parties with responsibility to oversee or initiate corrective
action.
Performance audit in PSUs is conducted by the C&AG (Supreme Audit Institutions) through
various subordinate offices of Indian Audit and Accounts Department (IAAD). In conducting
performance audit, the subordinate offices are guided by manual and auditing standards
prescribed by C&AG.
Therefore, the objectives of performance auditing are evaluation of economy, efficiency, and
effectiveness of policy, programmes, organization and management. It also promotes
accountability by assisting those charged with governance and oversight responsibilities to
improve performance; and transparency by affording taxpayers, those targeted by
government policies and other stakeholders an insight into the management and outcomes
of different government activities.
Performance auditing focuses on areas in which it can add value which have th e greatest
potential for development. It provides constructive incentives for the responsible parties to
take appropriate action.
Regulations on Audit and Accounts issued by C&AG lay down that the responsibility for the
development of measurable objectives and performance indicators as also the systems of
measurement rests with the Government departments or Heads of entities. They are also
required to define intermediate and final outputs and outcomes in measurable and
monitorable terms, standardise the unit cost of delivery and benchmark quality of outputs and
outcomes.
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OVERVIEW OF AUDIT OF PUBLIC SECTOR UNDERTAKING 15.39 a
Thus, rejection of audit report (submitted by audit firm) by C&AG is in order as audit with a
view to mere check all the expenses of the unit are in conformity to the public interest and
publicly accepted customs done by audit firm is not performance audit in all aspects.
8. In the given scenario, in view of the objectives discussed, performance audit is being referred.
Refer Para 6.2.
© The Institute of Chartered Accountants of India
CHAPTER a 16
7
INTERNAL AUDIT
LEARNING OUTCOMES
After studying this chapter, you will be able to:
❑ Know the meaning and scope of Internal Audit.
❑ Gain the knowledge of the internal audit as per provisions of the
Companies Act, 2013.
❑ Gain understanding of basic steps and activities involved in internal
audit.
❑ Gain understanding of drafting of internal audit report.
❑ Analyse the relationship between Internal and External Auditors.
❑ Understand the Audit Trail.
❑ Acquire the knowledge of basics of the Internal Auditing Standards issued
by the ICAI.
© The Institute of Chartered Accountants of India
16.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Integrity, Relationship
Steps involved
Meaning and Objectivity and Qualities of Drafting of between
in performing
Scope of Independence Internal Internal Audit Internal and
Internal Audit
Internal Audit of Internal Auditor Report External
Engagement
Auditor Auditors
Internal Audit
Try and Scale Limited, a listed company, has advertised for the post of “Chief Internal
Auditor” in the company in few prominent pink newspapers. CA. P. is offered the position
after duly vetting his credentials. The offer letter of the company states that Chief Internal
Auditor is required to report to the CFO of the company. On going through contents of letter,
he finds it weird. What is unusual about it and why?
Since internal audit is an independent function, the Internal Auditor has to be free from any
undue influences which force him to deviate from the truth. Also, the internal auditor has to
resist any undue pressure or interference in establishing the scope of the assignments or the
manner in which these are conducted and reported- in case these deviate from set objectives.
The independence of internal auditor within the company plays a large part in establishing
his independence.
He immediately brought out this anomaly to the company pointing out that same is not proper.
By making him report to the CFO of the company, his independence as internal auditor would
lie in tatters. It was also pointed by him that to ensure independence of internal audit function,
it should be positioned outside the functions which are subject to internal audit (e.g., Finan ce
and Accounts) and his reporting should lie directly to the Audit Committee.
Besides, the offer letter also hinted at his role in “system automation” and “process re -
engineering” in the company. Assuming proposed roles in above areas can also mar his
independence. He was confused. “System automation” and “process re-engineering” are in
nature of operational responsibilities. How he can accept responsibilities in this regard?
Considering above, he thought it worthwhile to give a caveat to the company that he would
not be in a position to assume accountability of these areas. It was also made clear that he
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INTERNAL AUDIT 16.3 a
would not be able to take operational decisions in these areas which may be subject to
internal audit later on. He would be able to accept only limited operational role and that too
for a short duration.
The company gave a nod to both the issues flagged by him and position was accepted.
After accepting appointment, he adopted a risk-based approach for identifying important
audit areas. The company’s operations were myriad and diversified. It made sense to him to
adopt a system and process focused approach in conducting audit procedures. Such an
approach would go a long way in “error prevention.” His focus remained on preventing errors
at the first place. Such an approach strengthens company’s internal systems leading to
improvement in governance mechanisms.
1. INTERNAL AUDIT
The operation of many modern organisations have become complex with high volume of transactions
carried out at multiple locations with increasing dependency on technology. This has caused further
more delegation of authorities and
decentralisation of activities. Consequently, key
Assur stakeholders including Board of Directors, top
-ance
management, shareholders, lenders, investors
and government are concerned with the propriety
Insight of the day-to-day affairs of the organization and
reliability of the various financial and non-financial
Objectivity information being recorded and reported to the
stakeholders. Accordingly, the stakeholders get
internal audit conducted to obtain report on the
deficiency in internal control system and
underlying transactions for better governance of organization and take timely remedial actions
wherever needed.
The Institute of Chartered Accountants of India constituted the Internal Audit Standards Board
(IASB) as a non-standing technical board on February 5, 2004. The Internal Audit Standard Board
(earlier known as the Committee on Internal Audit) is constituted with the object of formulating
Standards on Internal Audit (SIAs), Guidance Notes on Internal Audit, continuously review the
Standards and Guidance Notes, and to formulate and review Implementation Guides, Technical
Guides, Practice Manuals, Studies and other papers, which may be issued under its own authority
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16.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
for guidance of the members, as felt appropriate by the Board. Besides, the IASB also undertakes
research and promote knowledge dissemination in the field of internal audit.
Definition of Internal Audit: As defined in Framework Governing Internal Audits, “Internal Audit
provides independent assurance on the effectiveness of internal controls and risk management
processes to enhance governance and achieve organisational objectives.”
The Framework also indicates the nature of internal audit services may go beyond assurance to
include an advisory (consulting) role to help an organization achieve its objectives, provided this
does not compromise the independence of the internal auditor. The internal auditing is not confined
to financial transactions only and include review of operational activities, underlying internal controls,
compliance to applicable laws and regulations. The objectives and scope of Internal Audit Function
as per SA 610, “Using the Work of an Internal Auditor” may include:
• Monitoring of internal controls; • Review of compliance with laws and
regulations
• Examination of financial and operating • Risk management
information
• Review of operating activities • Governance
Indicative Objectives & Scope of Internal Audit
Monitoring Examination of Review of Review of
financial and compliance Risk
of Internal operating Governance
operating with laws and management
Controls activities
information regulations
Example: Example: Example:
Performing Internal Audit Example:
Reviewing Evaluation Example:
three way of sales and
Inventory Example: Assessment of
matching of records, management
Management Review of Governance
purchase order, delivery of Risk
activities and compliance Process in the
receipt of records, sales Exposure for
appripriate with newly accomplishment
material and commission complex
handling to applicable of objectives on
vendor invoices for identifying financial
prevent Tax Regime. ethics and
before correctness of instruments
damages values.
approving revenue transactions
vendor payment recorded
Applicability of Provisions of Internal Audit: As per section 138 of the Companies Act, 2013,
following class of companies (prescribed in rule 13 of Companies (Accounts) Rules,2014) shall be
required to appoint an internal auditor which may be either an individual or a partnership firm or a
body corporate, namely-
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INTERNAL AUDIT 16.5 a
(a) every listed company;
(b) every unlisted public company having-
(i) paid up share capital of fifty crore rupees or more during the preceding financial
year; or
(ii) turnover of two hundred crore rupees or more during the preceding financial year;
or
(iii) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year; or
(iv) outstanding deposits of twenty-five crore rupees or more at any point of time during
the preceding financial year; and
c every private company having-
(i) turnover of two hundred crore rupees or more during the preceding financial year;
or
(ii) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year.
It is provided that when an existing company gets covered under any of the above criteria shall
comply with the requirements within six months of commencement of such applicability.
CASE STUDY 1
JKT Pvt. Ltd. having ` 40 lacs paid-up capital, `9.50 crores reserves and turnover of last three
consecutive financial years, immediately preceding the financial year under audit, being
` 49 crores, ` 145 crores and ` 260 crores, but does not have any internal audit system. In view
of the management, the internal audit system is not mandatory. Comment.
Applicability of Provisions of Internal Audit: As per section 138 of the Companies Act, 2013,
read with rule 13 of Companies (Audit and Auditors) Rules, 2014, every private company shall be
required to appoint an internal auditor or a firm of internal auditors, having
(i) turnover of two hundred crore rupees or more during the preceding financial year; or
(ii) outstanding loans or borrowings from banks or public financial institutions exceeding one
hundred crore rupees or more at any point of time during the preceding financial year .
© The Institute of Chartered Accountants of India
16.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Conclusion: In the instant case, JKT Pvt. Ltd. is having a turnover of ` 260 crores during the
preceding financial year which is more than two hundred crore rupees. Hence, the company has
the statutory requirement to appoint an Internal Auditor and mandatorily conduct an internal audit.
Who can be Appointed as an Internal Auditor?
As per section 138, the internal auditor shall either be a chartered accountant or a cost
accountant (whether engaged in the practice or not), or such other professional as may be
decided by the Board to conduct an internal audit of the functions and activities of the
company.
The internal auditor may or may not be an employee of the company.
To be effective, the internal auditor must be regarded as a part of the management and not
merely as an assistant thereto. Furthermore, he or she must have the authority to investigate
every organisational activity to meet the objectives and scope of the internal audit.
1. AB Pvt. Ltd. company, having outstanding loans and borrowings from banks
exceeding one hundred crore rupees, wants to appoint Mr. X, a practicing cost
accountant, as an internal auditor. Is the appointment of Mr. X valid?
Provision & Conclusion: According to the provision given in section 138 of the companies Act,
2013, the internal auditor shall either be a chartered accountant or a cost accountant (whether
engaged in the practice or not), or such other professional as may be decided by the Board to
conduct an internal audit of the functions and activities of the companies. Thus, Appointment of
Conclusion: Mr. X as an internal auditor of AB Pvt. Ltd is valid.
As per Standard on Internal Audit (SIA) 210 Managing the Internal Audit Function , the Internal Audit
Function performs a number of activities to achieve its objectives as outlined in its Charter (or Terms
of Engagement). A few of the critical activities are as follows:
(a) Define the overall plan, scope and methodology of the Internal Audit Function on a
periodic basis.
(b) Oversee and monitor various audit assignments, their proper planning, execution,
reporting of findings and subsequent closure of reported observations.
(c) Plan, acquire, engage and review the performance, training and development of
professional staff, talent and other resources to achieve its objectives.
(d) Identify, source, engage and manage external experts and technical solutions, if
required.
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INTERNAL AUDIT 16.7 a
(e) Communicate and engage with all key stakeholders regarding progress and
achievement of objectives.
(f) Develop and maintain a quality evaluation and improvement program.
With respect to the accounting function and financial records of the organisation, the
responsibilities of an Internal Auditor include:
to ascertain adequacy of system of internal control by a continuous examination of accounting
procedures, receipts and disbursements, and to provide adequate safeguards against misappropriation
of assets.
to operate independently of the accounting staff and must not in any way divest with any of the
responsibilities placed upon him.
Not to involve in the performance of executive functions in order that the objective outlook does not
get obscured by the creation of the vested interest.
to observe facts and situations and bring them to notice of authorities who would otherwise never
know them; also, critically appraise various policies of the management and draw its attention to any
deficiencies, wherever these require to be corrected.
to associate closely with management and keep knowledge up to date by being informed about all
important occurrences and events affecting the business, as well as the changes that are made in
business policies.
At all times, the internal auditor must enjoy an independent status.
At times, the Internal Auditor is exposed to a different type of risk to independence, whereby
management seeks active business support from the Internal Auditor.
Apart from providing assurance on internal controls over the operational activities of the
organization, the Internal Auditor may be sometimes assigned responsibility to provide advisory
inputs on governance activities such as risk management, framework of monitoring statutory
compliances, automation of activities, avenues of process re-engineering with increase operational
efficiency, code of ethics etc.
© The Institute of Chartered Accountants of India
16.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. MANAGEMENT FUNCTIONS AND SCOPE OF
INTERNAL AUDITING
Management is a process by which the affairs of an enterprise are conducted in such a manner that
its goals and objectives are attained through optimum utilisation of all available resources, within the
legal, social, economic and environmental constraints. To achieve optimum utilisation of resourc es
management should determine the goals and objectives of the concern, quantify them to the extent
possible, develop major policies and plans, implement them and exercise control over such
implementation.
In the case of Companies required to appoint an Internal Auditor as per Section 138 of the
Companies Act, 2013, Rule 13(2) of Companies (Accounts) Rules 2014, states: “The Audit
Committee of the company or the Board shall, in consultation with the Internal Auditor, formulate the
scope, functioning, periodicity, and methodology for conducting the internal audit.” Hence, in these
class of companies, the Audit Committee or the Board, in conjunction with management and the
Chief of Internal Audit, is expected to exercise the responsibility to formulate the obj ectives of
internal audit. In the case of other organisations not covered under Rule 13, those who appoint the
Internal Auditor (e.g., the owners, the promoters, the Board of Trustees, etc.) would generally define
the objectives of internal audit.
The internal auditor should, in consultation with those charged with governance, including the audit
committee, develop and document a plan for each internal audit engagement to help him conduct
the engagement in an efficient and timely manner.
Internal audit plan should be developed in such a manner that all the business processes covering
both financial as well as operational activities are reviewed by internal audit function within a defined
time cycle. Also, ensuring that appropriate consideration is made and adequate balance is ensured
to the following:
Risk underlying the business process
Value that the internal audit can provide to the organization
Effort involved in conducting the internal audit for a particular business process
Risk Appetite of the organization
Coverage of all auditable areas within the defined time range
In addition, each of the managerial functions should be reviewed by the internal auditor. The scope
of internal auditor’s work should also include a review of-
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.9 a
Internal Control System & Procedures
Custodianship & Safeguarding of Assets
Compliance with Policies, Plans, Procedures & Regulations
Relevance & Reliability of Information
Organisational Structure
Utilisation of Resources
Accomplishment of Goals & Objectives
On the basis of such review, the internal auditor should in his report, highlight the weaknesses
observed and give suggestions for improvement. We may now have a brief description o f each of
the above areas of review:
(i) Review of Internal Control System and Procedures -
(a) The review of internal control system and procedures involves assessing the design
and operational efficiency and effectiveness of the internal control system t o
strengthen the overall internal control environment of the entity. The objective to
review is to minimise the overall residual risk by suggesting the appropriate controls
to reduce the inherent risk.
2. Review of three-way matching internal control involves matching of
Purchase Orders, Goods Receipt Notes and Invoice to ensure all the
ordered quantity of the intended goods have been received and invoiced
accordingly. The failure of this internal control may involve over-invoicing, over-
payment, non-receipt, or under-receipt of goods.
As far as possible, controls should be in-built in the operating functions for prevention
or timely detection of the fraud and errors and minimize the cost of control.
3. The establishment of a separate credit control department would not
be justified if the objective of reducing credit risk and minimising debt
recovery period could be met through controls in-built in the accounting
and sales systems, especially in smaller and medium-sized concerns.
(b) Internal Control System should be reviewed considering the limitations of internal
controls, i.e., cost-benefit comparison, human errors, collusion, and abuse by process
owners.
© The Institute of Chartered Accountants of India
16.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. Collusion of payment authorizer and payment maker to over pay a
related party; those charged with governance themselves overriding the
internal controls with malafide intention, etc.
It should also be seen whether the internal controls were in use throughout the period
of intended reliance. A break-down in internal controls for a specific portion of intended
reliance would need special attention.
(ii) Review of Custodianship and Safeguarding of Assets -
➢ This involves verifying the existence of the assets.
➢ The internal auditor should review the segregation of duties is in place.
➢ The internal auditor should review the control systems to ensure that all assets are
accounted for fully. He should review the means used for safeguarding assets against
losses e.g. fire, improper or negligent activity, theft and illegal acts, etc.
➢ He should review the control systems for intangible assets e.g. the procedures relating
to credit control. Where an enterprise uses electronic data processing equipment, the
physical and systems control on processing facilities as well as on data storage should
be examined and tested.
5. The existence of intangible assets could be only an annual
subscription in the name of an entity, for example, an annual ERP
subscription.
(iii) Review of Compliance with Policies, Plans, Procedures and Regulations - It is essential
that the various functional segments of an enterprise comply with the relevant policies, plans,
procedures, laws and regulations so that the operations are carried out in a coordinated
manner. He should examine the system of periodical review of existing policies particularly
when there is a change in the method and nature of operations of the enterprise. By
combining the results of his review of the adequacy of the systems with the result of his
compliance tests, the internal auditor should be able to evaluate the effectiveness of the
former. He should point out specific weaknesses and suggest remedial action.
(iv) Review of Relevance and Reliability of Information - The internal auditor should review
the information systems to evaluate the reliability and integrity of financial and operating
information given to management and to external agencies such as governmental bodies,
investors, trade organisations, labour unions, etc. He should examine the accuracy and
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.11 a
reliability of financial and operational records. The usefulness of the reports as well as of the
records should be evaluated with reference to their costs. The internal auditor should examine
whether the reporting is by exception i.e. the reports highlight the significant and distinct ive
features. In case of automated management information system, where relevant information
used for critical decision making is generated from the computer system, then adequacy of
the controls build in the system should be reviewed to ensure data integrity and reliability of
such information.
(v) Review of the Organisation Structure - The internal auditor should conduct an appraisal of the
organisation structure to ascertain whether it is in harmony with the objectives of the enterprise
and whether the assignment of responsibilities is in consonance therewith. For this purpose:
➢ He should review the manner in which the activities of the enterprise are grouped for
managerial control. It is also important to review whether responsibility and authority
are in harmony with the grouping pattern.
➢ The internal auditor should examine the organisation chart to find out whether the
structure is simple and economical and that no function enjoys an undue dominance
over the others.
➢ He should particularly see that the responsibilities of managerial staff at headquarters
do not overlap with those of chief executives at operating units. He should examine
whether there is a satisfactory balance between the authority and responsibility of
important executives.
➢ The internal auditor should examine the reasonableness of the span of control of each
executive (the number of subordinates that an executive controls). He should examine
whether there is a unity of command i.e., whether each person reports only to one
superior.
➢ Where dual responsibilities cannot be avoided, the primary one should be specified
and the specific responsibility to each senior fixed. This must be made known to all
concerned.
➢ He should review adequate segregation of duties is considered while defining the
organization structure.
➢ Finally, he should evaluate the process of managerial development in the enterprise.
(vi) Review of Utilisation of Resources –
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16.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
➢ The internal auditor should check whether proper operating standards and norms have
been established for measuring the economical and efficient use of resources.
➢ They should be detailed enough to be identifiable with specific operating
responsibilities and should be capable of being used by operating personnel for
monitoring and evaluating their performance.
➢ The internal auditor should review the methods of establishing operating standards
and norms. He should carefully examine the assumptions made while setting the
standards to ensure that they are appropriate and necessary.
➢ Where there is a wide divergence between actual performance and the corresponding
standards, reasons may be considered. As a part of evaluating resources utilisation,
identifying the facilities which are under-utilized is an important function of the internal auditor.
6. For example, it may consist of under-utilized machines,
unoccupied storage space, huge cash or bank balances, idle
manpower, etc. While commenting on staffing, the internal auditor
should pay special attention to non-productive work being performed. This would
require an inquiry into the job descriptions of employees combined with an
intelligent observation of the work being done.
(vii) Review of Accomplishment of Goals and Objectives - The internal auditor should review
the overall objectives of the enterprise to evaluate whether they are clearly stated and are
attainable. The internal auditor should examine whether, to the extent possible, objectives
are expressed in precise quantifiable terms (both monetary and non-monetary) to facilitate
detailed planning to be made for achieving them. Budgeting forms an important part of such
planning. This will ensure that plans anticipate the problem areas. There should also be
sufficient flexibility in the plans to permit such improvements in their implementation, as would
benefit the enterprises as a whole.
3. INTEGRITY, OBJECTIVITY AND INDEPENDENCE OF
INTERNAL AUDITOR
There is a set of core principles fundamental to the internal audit function and activities. These basic
principles of internal audit are critical to achieving the desired objectives as set out in the Definition
of Internal Audit. The Basic Principles of Internal Audit are a set of core principles fundamental to
the function and activity of internal audit.
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INTERNAL AUDIT 16.13 a
1. The Internal Auditor shall be free from any undue influences which force him to deviate from
the truth. This independence shall be not only in mind but also in appearance. Also, the
internal auditor shall resist any undue pressure or interference in establishing the scope of
the assignments or the manner in which these are conducted and reported, in case these
deviate from set objectives.
The independence of the internal audit function as a whole, and the Internal Auditor within
the organisation, plays a large part in establishing the independence of the Internal Auditor.
The overall organisation structure of key personnel, the position and reporting of the Chief
Internal Auditor within this structure, along with the powers and authority which is derived
from superiors further establishes the independence of the Internal Auditor.
2. The Internal Auditor shall be honest, truthful and be a person of high integrity. He shall
operate in a highly professional manner and seen to be fair in all his dealings. He shall avoid
all conflicts of interest and not seek to derive any undue personal benefit or advantage from
his position.
3. The Internal Auditor shall conduct his work in a highly objective manner, especially in
gathering and evaluation of facts and evidence. He shall not allow prejudice or bias to
override his objectivity, especially in arriving at conclusions or reporting his opinion.
7. For example, to avoid any conflict of interest, the internal auditor should not
review an activity for which he was previously responsible. It is also expected from the
management to take steps necessary for providing an environment conducive to enable
the internal auditor to discharge his responsibilities independently and also report his findings
without any management interference.
8. For example, in the case of a listed company, the internal auditor may be required
to report directly to those charged with governance, such as the Audit Committee
instead of the Chief Executive Officer or the Chief Financial Officer. The internal auditor
should immediately bring any actual or apparent conflict of interest to the attention of the
appropriate level of management so that necessary corrective action may be taken.
TEST YOUR UNDERSTANDING 1
After an illustrious career in Indian Audit & Accounts Service for about 25 years, Parteek, a post
graduate in law, has taken voluntary retirement from government service. Being in fine spirits, he
wants to take responsibilities in corporate sector as Chief internal auditor. On looking at attractive
© The Institute of Chartered Accountants of India
16.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
compensation packages, he applied for such position in a leading listed company engaged in oil
refining business. The Board of company is keen on him due to his impressive credentials.
Can he be appointed in this leading position of said company?
TEST YOUR UNDERSTANDING 2
CA Deva is internal auditor of a listed company. The company wants to make sure that it is in
compliance with SEBI requirements at all times and it is never on the wrong side of law. It asks its
internal auditor to manage its compliance tracking system including directly corresponding with
regulator in this regard. The profile and scope of internal audit agreed at time of appointment
included “compliance with laws and regulations.”
Can he perform such type of activities in capacity of internal auditor of company?
4. QUALITIES OF INTERNAL AUDITOR
Internal auditor is required to objectively review overall governance and operational functions of the
organization and, is required to internal with various stakeholders and other employees of the
organisation. To perform his duties effectively, he is required to possess good knowledge of the
subject matter, underlying information system and good soft skills.
Some of the specialised knowledge and expertise that Internal Auditor should obtain are:
1. The internal auditor should have the special expertise necessary for evaluating management
control systems, especially financial and accounting controls.
2. Accounting and finance functions provide basic data for management control of an
enterprise. Therefore, the internal auditor must have accounting and financial expertise to
be able to discharge his duties.
3. The internal auditor is also expected to evaluate both financial and operational controls. This
requires a good knowledge of the operations of the organization, technology and commercial
practices of the enterprise.
4. He should also have a good knowledge of commerce, laws, taxation, cost accounting,
economics, quantitative methods and EDP systems.
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INTERNAL AUDIT 16.15 a
5. An understanding of the accounting software, ERP system and other applications being used
by the organization along with the knowledge of the basic controls related to Information
Technology.
6. An understanding of management principles and techniques is another essential
qualification of an internal auditor as also the ability to deal with people.
7. By his conduct the internal auditor should provide an assurance to the management that the
confidentiality of such information would be maintained
5. PERFORMING INTERNAL AUDIT ENGAGEMENT
Typical internal audit engagement comprises of following five steps:
Step 1 – Obtain knowledge of the Business and its Environment
Step 2 – Perform Audit Planning
Step 3 – Gather required information
Step 4 – Perform audit checks
Step 5 – Reporting of Internal Audit Issues
All of these steps are required to be performed while performing any Internal Audit engagement in
the same sequence. Let us see some of the major activities to be performed under each of these
steps:
Step 1 – Obtain knowledge of the Business and its Environment
Internal Auditor must conduct meetings with key stakeholders, Board of Directors and Key
management personals to obtain understanding of the organization’s business environment, its
operations, organization’s vision, mission and top management’s expectations from the audit
functions.
Internal auditor must obtain understanding of various business documents – Standard Operating
Procedures and Financial Statement Etc.
Internal auditor must also obtain understanding of the underlying Information Technology landscape,
various applications and ERP systems of the organization and Management Information System of
the organization.
© The Institute of Chartered Accountants of India
16.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Internal auditor must also obtain understanding of the regulatory landscape and various laws and
regulations that are applicable to the organization.
Step 2 – Perform Audit Planning
Internal Auditor must plan the audit engagement as per the Standard on Internal Audit (SIA) 310,
Planning the Internal Audit Assignment. Audit scope must be approved by Audit Committee and
Board of Directors.
Once approved, Internal Auditor must share detailed Audit Plan with the key managerial personals
and plan in advance the detailed schedule of the Internal Audit to be conducted.
Internal Auditor must conduct the opening meeting with key stakeholders before start of audit
engagement and share details of Information and System Access required to perform the audit.
Detailed work plan must be prepared by the audit managers and approved with Head of Internal
Audit / Chief Internal Auditor. The work plan must be prepared after performing the evaluation of all
major underlying risks in the process being reviewed and the audit checks to be performed to assess
the adequacy of the control environment to mitigate such risks.
Step 3 – Gather required information
Internal Auditor must obtain the required information and perform checks to ensure correctness and
integrity of information received. To the extent possible, Internal Auditor must obtain the information
directly from the source.
Adequate planning should be done and advance intimation should be made for any interim
information needed for performing audit checks.
Step 4 – Perform audit checks
Internal Auditor should collate all data and perform analytical procedures to identify key trends and
outliers. Analytical procedures should be performed in accordance with the Standard on Internal
Audit (SIA) 6, Analytical Procedures. To the extent possible, relevant analytical tools may be used
to perform review of the complete data for the audit period.
Wherever needed, Internal Auditor must select the sample in accordance with Standard on Internal
Audit (SIA) 5, Sampling.
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INTERNAL AUDIT 16.17 a
Detailed audit testing must be performed as per the audit work plan. Internal Auditor must ensure
adequate evidences must be collected and stores in accordance to Standard on Internal Audit (SIA)
320, Internal Audit Evidence
Internal Auditor must prepare detailed listed of the Identified audit issues and controls gaps. Interim
reports may be issued after proper review of the work performed as per the Standard on Internal
Audit (SIA) 350, Review and Supervision of Audit Assignments.
Adequate document of the internal audit work papers needs to be ensured as per Standard on
Internal Audit (SIA) 330, Internal Audit Documentation
Step 5 – Reporting of Internal Audit Issues
Internal Auditor must prepare a draft report of Internal Audit issues comprising of the business
process/ function reviewed as per scope, detailed audit coverage and exclusions, if any, audit period
covered during the audit, summary along with detailed issues over the gaps noted along with
implication of the business and recommendation to mitigate the identified gaps.
Management Action Plan should be agreed along with responsibility of action and timelines for
actions. Internal Auditor must also review the status of actions taken by the management against
the actions agreed during previous audits and report the status of such follow up in the audit report.
Internal Auditor should thereafter circulate Final Report and presentation his findings to the Audit
Committee. Internal auditor must adhere to Standard on Internal Audit (SIA) 360, Communication
with Management and Standard on Internal Audit (SIA) 370, Reporting Results while sharing the
result of internal audit with the stakeholders.
6. INTERNAL AUDIT REPORT
The internal auditor should carefully review and assess the conclusions drawn from the audit
evidence obtained, as the basis for his findings contained in his report and suggest remedial action.
However, in case the internal auditor comes across any actual or suspected fraud or any other
misappropriation of assets, it would be more appropriate for him to bring the same immediately to
the attention of the management.
As per Standard on Internal Audit (SIA) 370 Reporting Results, reporting of internal audit
results is generally undertaken in two stages:
© The Institute of Chartered Accountants of India
16.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
At the end of a particular audit assignment, an “Internal Audit Report” covering a
specific area, function or part of the entity is prepared by the Internal Auditor
highlighting key observations arising from those assignments. This report is
generally issued with details of the manner in which the assignment was
conducted and the key findings from the audit procedures undertaken. This
report is issued to the auditee, with copies shared with local and executive
management, as agreed during the planning phase.
On a periodic basis, at the close of a plan period, a comprehensive report of all
the internal audit activities covering the entity and the plan period is prepared by
the Chief Internal Auditor (or the Engagement Partner, in case of external service
provider). Such reporting is normally done on a quarterly basis and submitted to
the highest governing authority responsible for internal audits, generally the
Audit Committee. Some part of the aforementioned Internal Audit Reports may
form part of the periodic (e.g. Quarterly) report shared with the Audit Committee.
This Standard on Internal Audit (SIA) deals with the internal auditor’s responsibility to issue only the
first type of reports, the Internal Audit Report pertaining to specific audit assignments and not to t he
periodic (e.g. Quarterly) reporting for the whole entity as per the Annual/Quarterly audit plan.
On the basis of the internal audit work completed, the Internal Auditor shall issue a clear, well
documented Internal Audit Report which includes the following key elements:
(a) An overview of the objectives, scope and approach of the audit
assignments;
(b) The fact that an internal audit has been conducted in
accordance the Standards of Internal Audit;
(c) An executive summary of key observations covering all
important aspects, and specific to the scope of the assignment;
(d) A summary of the corrective actions required (or agreed by
management) for each observation; and
(e) Nature of assurance, if any, which can be derived from the
observations.
The content and form of the Internal Audit Report are to be established by the Internal Auditor based
on his best professional judgement, in consultation with the auditee and, if necessary, with inputs
from other key stakeholders. No internal audit report shall be issued in final form unless a written
draft of the report has previously been shared with the auditee.
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.19 a
The internal audit report shall be issued within a reasonable time frame from the completion of the
internal audit work.
1. Basis of Internal Audit Report: Each internal audit report is prepared on the basis of the
audit procedures conducted and the analysis of the audit evidence gathered. Conclusions
reached shall be based on all the findings rather than on a few deviations or issues noted. Controls
operating effectively have their own importance and should be acknowledged, while the risk and
significance of observations noted have a role to play in prioritising the matters to be reported.
2. Conducted in Accordance with SIAs: Where the internal audit is conducted in compliance
with the Standards of Internal Audit, (within the Framework governing Internal Audits), and the
internal auditor can substantiate the same with supporting evidence and documentation, the
internal audit report shall include a statement confirming that “the internal audit was conducted in
accordance with the Standards of Internal Audit issued by the Institute of Chartered Accountants
of India”.
3. Content and Format of Internal Audit Report: The manner in which the internal audit report
is drafted and presented is a matter of professional judgment and choice and could be influenced
by the preferences of the recipients. The SIA does not mandate any particular format or list of
contents since the Internal Auditor is expected to exercise his best professional judgement on
matters regarding how and what to report. Where some level of assurance is being provided, the
form and content of the report shall be as per SIA 380, “Issuing Assurance Reports”. A typical
internal audit report should include the following:
Audit Scope performed
Audit period Covered
Executive Summary
Summary of the critical findings
Detailed audit findings with elaboration on business impact and root cause of such issues
Rating of the highlighted issues (E.g High / Medium / Low) in accordance to the rating
criteria approved by Audit Committee
Audit recommendation to improve control environment and address the highlighted finding
Response received from the responsible functional authority containing action plan and
target timelines for action
© The Institute of Chartered Accountants of India
16.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
4. Documentation: To confirm compliance of audit procedures with this SIA, the list of
documents required is as follows:
(a) Copies of draft and final internal audit reports to be maintained,
appropriately cross referenced to specific observations.
(b) If appropriate, management action plans may be counter signed
by respective management personnel.
6.1 Follow-up
As per SIA 390 Monitoring and Reporting of Prior Audit Issues, the Chief Internal Auditor is
responsible for continuously monitoring the closure of prior audit issues through timely
implementation of action plans included in past audits. This shall be done with a formal monitoring
process, elements of which are pre-agreed with management and those charged with governance.
The responsibility to implement the action plans remains with the management.
In monitoring and reporting of prior audit issues, the responsibility of the Internal Auditor is usually
in the form of an “Action Taken Report (ATR) of previous audits”.
The term “Monitoring and Reporting” used in this Standard refers to the periodic tracking
of issues raised during prior audits and evaluation of the corrective actions undertaken by
the auditee to resolve them and to report any open and pending matters to the management
and those charged with governance (e.g. the Audit Committee).
The internal auditor should review whether follow-up action is taken by the management on the basis
of his report. If no action is taken within a reasonable time he should draw the management’s
attention to it. Where the management has not acted upon his suggestions or not implemented his
recommendations, the internal auditor should ascertain the reasons thereof.
Where the management has accepted his recommendations and initiated the necessary action, the
internal auditor should periodically review the manner and the extent of implemen tation of the
recommendations and report to the management highlighting the recommendations which have not
been implemented fully or partly.
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.21 a
7. RELATIONSHIP BETWEEN INTERNAL AND EXTERNAL
AUDITORS
The scope and objective of internal audit are dependent upon the size and structure of
the entity and the requirements of its management. As stated earlier the internal auditor
operates in various areas such as review of the accounting system and internal control;
examination of financial and operating information for the benefit of management, the
examination of the economy, efficiency and effectiveness of operations including non -
financial controls of various tangible assets of the entity. While operating in these areas,
there is a lot of overlap between the work of internal auditors and external auditors.
The work done by the internal auditor has an important bearing on the work performed by
the statutory auditor as evaluation done by the internal auditor in respect of internal
controls, reliability of financial information, verification of assets , etc. is also required to
be done by the external auditor. The function of an internal auditor is an integral part of
the system of internal control.
It is a statutory requirement too as per section 138 of the Companies Act, 2013 where the
Audit Committee of the company or the Board shall, in consultation with the Internal
Auditor, formulate the scope, functioning, periodicity and methodology for conducting the
internal audit.
However, it is obligatory for a statutory auditor to examine the scope and effectiveness of
the work carried out by the internal auditor. For the purpose, he should examine the
Internal Audit Department of the organisation, the strength of the internal audit staff, their
qualification and their powers.
The extent of independence exhibited by the internal auditor in the discharge of his duties
and his status in the organisation are important factors for determining the effective ness
of his audit. But so far, the practice of audit being conducted jointly by the internal auditors
is of great assistance to statutory auditors.
The external auditor should, as part of his audit, evaluate the internal audit function to the
extent he considers that it will be relevant in determining the nature, timing and extent of
his compliance and substantive procedures. Depending upon such evaluation, the
external auditor may be able to adopt less extensive procedures than would otherwise be
required.
© The Institute of Chartered Accountants of India
16.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Difference Between Internal & External Auditors
BASIS FOR INTERNAL AUDIT EXTERNAL AUDIT
COMPARISON
1. Performed by Internal audit is performed by an It is an audit function performed by
independent internal auditing the independent body which is not
function within the organisation or a part of the organization.
by external body.
2. Examination The Internal auditor examines the The External auditor examines the
adequacy of operational controls of Accuracy and Validity of Financial
the organisation. Statements.
3. Appointment The Internal auditor is appointed by The External auditor is appointed
the Audit Committee or Board of by the Members.
Directors.
4. Users of Report Generally, internal audit report is The user of external audit report is
used by top Management and Stakeholders.
referred by statutory auditor.
6. Reporting Internal Audit Report provides The opinion is provided on the
weakness in internal controls and truthfulness and fairness of the
effectiveness of the operational financial statement of the
activities. company.
7. Status of The Internal auditor could be an The External auditor is
Auditor employee of the company. mandatorily not an employee of
the company.
SA 610 “Using the work of an Internal Auditor” deals with certain aspects of relationship
between internal and external auditors.
7.1 Determining Whether, in Which Areas, and to What Extent the Work
of the Internal Audit Function Can Be Used
Evaluating the Internal Audit Function:
Evaluation of IA Function Scope of IA Function Objective of Evaluation of IA
includes: • Review of Internal controls. Function
• Appraisal activity. • Examination of financial and • Evaluate & improve the
• Examining / Evaluating adequacy Operational records and effectiveness of Internal Controls.
and effectiveness of internal transactions.
controls. • Review of Operating Activities
• Review of regulatory Laws &
Compliances.
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INTERNAL AUDIT 16.23 a
7.2 Determining the Nature and Extent of Work of the Internal Audit
Function that Can Be Used
The external auditor shall not use the work of the internal audit function if the external auditor
determines that the function’s organizational status and relevant policies and procedures do not
adequately support the objectivity of internal auditors; the function lacks sufficient competence or
the function does not apply a systematic and disciplined approach, including quality contr ol.
The external auditor shall consider
Nature & scope of work done & its
Determining the relevance to overall Strategy &
Nature & Extent of Audit Plan 1.Objectivity of the
work of Internal internal audit functions.
Audit function that 2.Level of competence
can be used Determine adequacy of Internal
of internal audit function.
Audit work for external auditors
purpose 3.Whether a systematic
& disciplined approach
is applied
including quality control.
7.3 Determining Whether, in Which Areas, and to What Extent Internal
Auditors Can Be Used to Provide Direct Assistance
Amount of judgement wrt:
The E.A. a) Planning & performing relevant audit procedures
shall b) Evaluation of the audit evidence gathered.
Nature & consider
Extent of : Assessed risk of material misstatement
work that
can be Evaluation of existence & significance of threats .
assigned to
Internal Making significant judgements in the audit
auditors
providing The E.A. shall not Relate to higher assessed risks of material
Direct use internal misstatement where the judgement required is more
Assistance auditors to provide than limited.
direct assistance to
perform Relate to work which is reported to management or
procedures: TCWG by Internal audit function
Relate to decisions the E.A. makes in accordance
with SA 610.
(A brief overview of using Direct Assistance from Internal Auditors by External Auditors)
© The Institute of Chartered Accountants of India
16.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The external auditor shall evaluate whether, in aggregate, using internal auditors to provide direct
assistance to the extent planned, together with the planned use of the work of the internal audit
function, 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.
7.4 If the External Auditor uses Internal Auditors to Provide Direct
Assistance on the Audit, the External Auditor shall include in the
Audit Documentation
(a) The evaluation of the existence and significance of threats to the objectivity of the internal
auditors, and the level of competence of the internal auditors used to provide direct
assistance;
(b) The basis for the decision regarding the nature and extent of the work performed by the
internal auditors;
(c) Who reviewed the work performed and the date and extent of that review in accordance with
SA 230 Audit Documentation;
(d) The written agreements obtained from an authorized representative of the entity and the
internal auditors; and
(e) The working papers prepared by the internal auditors who provided direct assistance on the
audit engagement.
Finally, in India, even the statute has now recognised that internal audit is necessary for the efficient
running of companies. Thus, a review of the internal audit function in specified companies has
become a statutory responsibility for the statutory auditor.
[Note: Student are advised to refer SA 610 Using the work of Internal Auditor for more details,
SA 610 is reproduced in Auditing Pronouncements.]
Illustration 2
The Managing Director of X Ltd is concerned about high employee attrition rate in his company. As
the internal auditor of the company he requests you to analyze the causes for the same. What factors
would you consider in such analysis?
Solution
The factors responsible for high employee attrition rate are as under:
(i) Job Stress & work life imbalance;
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.25 a
(ii) Wrong policies of the Management;
(iii) Unbearable behaviour of Senior Staff;
(iv) Safety factors;
(v) Limited opportunities for promotion;
(vi) Low monetary benefits;
(vii) Lack of labour welfare schemes;
(viii) Whether the organization has properly qualified and experienced personnel for the various
levels of works?
(ix) Is the number of people employed at various work centres excessive or inadequate?
(x) Does the organization provide facilities for staff training so that employees and workers keep
themselves abreast of current techniques and practices?
8. INTERNAL AUDIT AS A MANAGEMENT FUNCTION
Management is a process by which the affairs of an enterprise are conducted in such a manner that
its goals and objectives are attained through optimum utilisation of all available resources, within the
legal, social, economic and environmental constraints. At the most fundamental level, management
functioning is a set of five general functions: planning, organizing, staffing, directing and controlling.
While the first five functions of planning, organizing, staffing and leading are critical attribut es to
create and grow stakeholder’s wealth whist controlling is the critical function that is key to preserve
stakeholder’s wealth.
As per the revised definition of the term ‘Internal Audit’ as per para 3 of the ICAI’s Framework
Governing Internal Audits, “Internal audit provides independent assurance on the effectiveness of
internal controls and risk management processes to enhance governance and achieve
organisational objectives”. Accordingly Internal Auditor is expected to critically evaluate the
management activities and advise them on the areas of improving internal controls and manage
business and operational risks effectively by recommending appropriate mitigating controls.
Internal Audit is an important element of management controlling function, it helps management to
set up appropriate systems and processes in place to mitigate risk while remaining independent to
the operations. Internal Auditor is expected to report on the identified gaps and areas of weak
© The Institute of Chartered Accountants of India
16.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
internal control, further he is expected to identify the root cause of the problems and suggest
appropriate mitigating steps and strengthen the internal controls environment of the organization.
Accordingly, Internal Audit is seen as an important function that helps management to achieve
organization goals and perform its function in an orderly manner.
9. AUDIT TRAIL
Audit Trail (or Edit Log) is a visible trail of evidence enabling one to trace information contained in
statements or reports back to the original input source. Audit trails are a chron ological record of the
changes that have been made to the data. Any change to data including creating new data, updating
or deleting data that must be recorded.
Records maintained as audit trail may include the following information:
when changes were made i.e., date and time (timestamp)
who made the change i.e., User Id
what data was changed i.e., data/transaction reference; success/failure
Audit trails may be enabled at the accounting software level depending on the features available in
such software or same may be captured directly in the database underlying such accounting
software.
In order to demonstrate that the audit trail feature was functional, operated and was not disabled, a
company would have to design and implement specific internal controls (predominantly IT controls)
which in turn, would be evaluated by the auditors, as appropriate. An illustrative list of internal
controls which may be required to be implemented and operated are given below:
Controls to ensure that the audit trail feature has not been disabled or deactivated.
Controls to ensure that User IDs are assigned to each individual and that User IDs are not
shared.
Controls to ensure that changes to the configurations of the audit trail are authorized and logs
of such changes are maintained.
Controls to ensure that access to the audit trail (and backups) is disabled or restricted and
access logs, whenever the audit trails have been accessed, are maintained.
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INTERNAL AUDIT 16.27 a
Controls to ensure that periodic backups of the audit trails are taken and archived as per the
statutory period specified under the provisions of the Act.
TEST YOUR UNDERSTANDING 3
Up Down Limited is in doldrums since last two years. The demand for its products has declined
drastically. The statutory auditor is of the view that situation has put into question going concern
assumption of the company. Its internal auditor has helped management in devising a strategy to
deal with such risks and come out of the situation. The plan includes venturing into different produ ct
lines using same plant with minor modifications. Further, internal auditor has also prepared
estimates of revenue generation along with cash flows.
Can statutory auditor place total reliance on work performed by internal auditor in this regard?
Key Takeaways
Internal Audit provides independent assurance on the effectiveness of internal controls and
risk management processes to enhance governance and achieve organisational objectives.
It is mandatory for all listed companies, unlisted public companies/private companies fulfilling
certain criteria to appoint internal auditor in accordance with provisions of Section 138 of
Companies Act, 2013 and relevant rules.
The internal auditor shall either be a chartered accountant or a cost accountant (whether
engaged in the practice or not), or such other professional as may be decided by the Board
to conduct an internal audit of the functions and activities of the company in terms of section
138 of Companies Act, 2013. He may or may not be employee of the company.
In such companies specified in section 138 of the Companies Act, 2013, the Audit Committee
or the Board, in conjunction with management and the Chief of Internal Audit, is expected to
exercise the responsibility to formulate the objectives of internal audit.
Basic principles governing an internal audit include independence, integrity and objectivity.
Each internal audit report is prepared on the basis of the audit procedures conducted and the
analysis of the audit evidence gathered. Conclusions reached shall be based on all the
findings rather than on a few deviations or issues noted.
Reporting of internal audit results is generally undertaken in two stages- At the end of a
particular audit assignment, an “Internal Audit Report” covering a specific area, function or
part of the entity is prepared by the Internal Auditor highlighting key observations arising from
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16.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
those assignments. Further, on a periodic basis, at the close of a plan period, a
comprehensive report of all the internal audit activities covering the entity and the plan period
is prepared by the Chief Internal Auditor (or the Engagement partner, in case of external
service provider). Such reporting is normally done on a quarterly basis and submitted to the
highest governing authority responsible for internal audits, generally the Audit Committee.
The internal auditor should review whether follow-up action is taken by the management on
the basis of his report. If no action is taken within a reasonable time he should draw the
management’s attention to it. Where the management has not acted upon his suggestions or
not implemented his recommendations, the internal auditor should ascertain the reasons
thereof.
The work done by the internal auditor has an important bearing on the work performed by the
statutory auditor as evaluation done by the internal auditor in respect of internal controls,
reliability of financial information, verification of assets, etc. is also required to be done by the
external auditor.
It is obligatory for a statutory auditor to examine the scope and effectiveness of the work
carried out by the internal auditor. For the purpose, he should examine the Internal Audit
Department of the organisation, the strength of the internal audit staff, their qualification and
their powers.
The extent of independence exhibited by the internal auditor in the discharge of his duties
and his status in the organisation are important factors for determining the effective ness of
his audit.
The external auditor should, as part of his audit, evaluate the internal audit function to the
extent he considers that it will be relevant in determining the nature, timing and extent of his
compliance and substantive procedures.
The external auditor shall not use the work of the internal audit function if th e external auditor
determines that the function’s organizational status and relevant policies and procedures do
not adequately support the objectivity of internal auditors; the function lacks sufficient
competence or the function does not apply a systematic and disciplined approach, including
quality control.
Standards on Internal audit are recommendatory in nature.
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INTERNAL AUDIT 16.29 a
APPENDIX
The following Standards on Internal Audit are recommendatory in nature. The Standards shall
become mandatory from such date as notified by the council:
Section I: Preface
Preface to the Framework and Standards on Internal Audit
Section II: Framework
Framework Governing Internal Audits
Section III: Basic Principles
Basic Principles of Internal Audit
Section IV: Standards on Key Concepts (100 Series)
SIA 110: Nature of Assurance
SIA 120: Internal Controls
Section V: Standards on Internal Audit Management (200 Series)
SIA 210: Managing the Internal Audit Function
SIA 220: Conducting Overall Internal Audit Planning
SIA 230: Objectives of Internal Audit
SIA 240: Using the Work of an Expert
Section VI: Standards on the Conduct of Audit Assignments (300 - 400 Series)
SIA 310: Planning the Internal Audit Assignment
SIA 320: Internal Audit Evidence
SIA 330: Internal Audit Documentation
SIA 350: Review and Supervision of Audit Assignments
SIA 360: Communication with Management
SIA 370: Reporting Results
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16.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
SIA 390: Monitoring and Reporting of Prior Audit Issues
Section VII: Standards on Internal Audit (As on July 1, 2013)
SIA 5: Sampling
SIA 6: Analytical Procedures
SIA 7: Quality Assurance in Internal Audit
SIA 11: Consideration of Fraud in an Internal Audit
SIA 13: Enterprise Risk Management
SIA 14: Internal Audit in An Information Technology Environment
SIA 17: Consideration of Laws and Regulations in an Internal Audit
SIA 18: Related Parties
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Write a short note on Internal Audit Report.
2. State the important aspects to be considered by the External auditor in the evaluation of the
Internal Audit Function.
3. AB Pvt. Ltd. company has outstanding loans or borrowings from banks exceeding one
hundred crore rupees wants to appoint an internal auditor. Please guide him for the
applicability of the same and who can be appointed as an internal auditor and what work
would be reviewed by him.
4. Moon Ltd. of which you are the Statutory Auditor, have an internal audit being conducted by
an outside agency. State the factors that weigh considerations in opting to make use of direct
assistance of the internal auditors for the purpose of statutory audit.
5. Mr. A is appointed as a statutory auditor of XYZ Ltd. XYZ Ltd is required to appoint an internal
auditor as per statutory provisions given in the Companies Act, 2013 and appointed Mr. B as
its internal auditor. The external auditor Mr. A asked internal auditor to provide direct
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INTERNAL AUDIT 16.31 a
assistance to him regarding evaluating significant accounting estimates b y the management
and assessing the risk of material misstatements.
(a) Discuss whether Mr. A, statutory auditor, can ask direct assistance from Mr. B, internal
auditor as stated above in view of auditing standards.
(b) Will your answer be different if Mr. A asks direct assistance from Mr. B, internal auditor
with respect to external confirmation requests and evaluation of the results of external
confirmation procedures?
6. The XYZ Ltd has to appoint Mr. A as Chief Internal Auditor to lead the internal audit function
for the Company. The Managing Director of the Company has asked the HR head to define
the reporting structure of the Chief Internal Auditor, so that he can discharge his duties
objectively? Suggest the ideal reporting structure of the Chief Internal Auditor that HR head
may propose to the Managing Director?
7. The XYZ Ltd is has appointed Mr. A to conduct their internal audit for new financial year. The
Audit committee requested Mr. A to present their Internal Audit plan for next financial year?
What approach would Mr. A follow to prepare the internal audit plan for next year?
8. The XYZ Ltd is has appointed Mr. A to conduct their internal audit for new financial year. The
Audit committee requested Mr. to perform detailed analysis of their expenses in previous
year and report all risks and underlying gaps? What audit approach should Internal Auditor
follow to identify such gaps?
9. The XYZ Ltd is has appointed Mr. A to conduct their internal audit for new financial year. The
Audit committee requested Mr. to present detailed report on their finding and areas where
immediate action is needed to mitigate critical risks? What should be the content of internal
audit report to address this requirement of the Audit Committee?
10. The XYZ Ltd is has appointed Mr. A to conduct their internal audit for new financial year. The
Audit committee requested Mr. A to present their analysis on the implementation of
recommendation of previous audit report and highlight critical areas which need immediate
attention of Audit Committee? What should be the steps followed by internal auditor to
address this requirement of Audit Committee?
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16.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Answers to Test Your Understanding
1. As per section 138 of Companies Act, 2013 the internal auditor shall eith er be a chartered
accountant or a cost accountant (whether engaged in the practice or not), or such other
professional as may be decided by the Board to conduct an internal audit of the functions and
activities of the company.
The Board can appoint any professional as may be decided by it. The applicant in question
is a law post graduate and he has spent 25 years of his career in Indian Audit & Accounts
Service. Therefore, he has got the necessary experience and skills required for the said
vacancy. The Board would be in a position to appoint such a competent and experienced
person in the field of auditing as its Chief Internal auditor.
2. The Internal Auditor does not assume any responsibility to manage or operate the compliance
framework or to take compliance related decisions. It is not responsibility of the Internal
Auditor to execute or resolve compliance related risks (e.g., engaging directly with regulators,
etc.).
Although internal audit function provides independent assurance to enhance governance
(which includes compliance with laws and regulations), it does not assume operational
responsibility of its compliance framework. It is the responsibility of the management. He is
responsible for auditing the compliance framework and not managing it. Similarly, he does
not accept compliance related risks like directly engaging with regulator.
3. The greater the judgment needed to be exercised in planning and performing the audit
procedures and evaluating the audit evidence, the external auditor will need to perform more
procedures directly because using the work of the internal audit function alone will not provide
the external auditor with sufficient appropriate audit evidence.
The appropriate use of going concern assumption requires significant judgment on part of
statutory auditor.
Therefore, statutory auditor cannot place total reliance on internal auditor’s work in this regard
and he should perform more procedures directly.
Hints /Answers to Theoretical Questions
1. Refer para 6.
2. Evaluation of Internal Audit Functions by External Auditor: The external auditor’s general
evaluation of the internal audit function will assist him in determining the extent to which he
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.33 a
can place reliance upon the work of the internal auditor. The external auditor should document
his evaluation and conclusions in this respect. The important aspects to be considered in this
context are:
(a) Organisational Status - Whether internal audit is undertaken by an outside agency
or by an internal audit department within the entity itself, the internal auditor reports to
the management. In an ideal situation, his reports to the highest level of management
and are free of any other operating responsibility. Any constraints or restrictions
placed upon his work by management should be carefully evaluated. In particular, the
internal auditor should be free to communicate fully with the external auditor.
(b) Scope of Function - The external auditor should ascertain the nature and depth of
coverage of the assignment which the internal auditor discharges for management. He
should also ascertain to what extent the management considers, and where
appropriate, acts upon internal audit recommendations.
(c) Technical Competence - The external auditor should ascertain that internal audit
work is performed by persons having adequate technical training and proficiency. This
may be accomplished by reviewing the experience and professional qualifications of
the persons undertaking the internal audit work.
(d) Due Professional Care - The external auditor should ascertain whether internal audit
work appears to be properly planned, supervised, reviewed and documented. An
example of the exercise of due professional care by the internal auditor is the existence
of adequate audit manuals, audit programmes and working papers.
3. Applicability of Internal Audit: Section 138 of the Companies Act, 2013 states that every
private limited company is required to conduct internal audit if its outstanding loans or
borrowings from banks or public financial institutions exceeding one hundred crore rupees or
more at any point of time during the preceding financial year.
In view of above provisions, AB Pvt. Ltd. is under compulsion to conduct internal audit as its
loans or borrowings are falling under the prescribed limit.
Who can be appointed as Internal Auditor- The internal auditor shall either be a chartered
accountant or a cost accountant, whether engaged in practice or not, or such other
professional as may be decided by the Board to conduct internal audit of the functions and
activities of the companies.
The internal auditor may or may not be an employee of the company.
Work to be reviewed by Internal Auditor- Refer Para 2.
4. Refer Para 7.3
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16.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
5. (a) Direct Assistance from Internal Auditor: As per SA 610 “Using the Work of Internal
Auditor”, the external auditor shall not use internal auditors to provide direct assistance
to perform procedures that Involve making significant judgments in the audit.
Since the external auditor has sole responsibility for the audit opinion expressed, the
external auditor needs to make the significant judgments in the audit engagement.
Significant judgments include the following:
• Assessing the risks of material misstatement;
• Evaluating the sufficiency of tests performed;
• Evaluating the appropriateness of management’s use of the going concern
assumption;
• Evaluating significant accounting estimates; and
• Evaluating the adequacy of disclosures in the financial statements, and othe r
matters affecting the auditor’s report.
In view of above, Mr. A cannot ask direct assistance from internal auditors regarding
evaluating significant accounting estimates and assessing the risk of material
misstatements.
(b) Direct Assistance from Internal Auditor in case of External Confirmation Procedures:
SA 610 “Using the Work of Internal Auditor”, provide relevant guidance in determining
the nature and extent of work that may be assigned to internal auditors. In determining
the nature of work that may be assigned to internal auditors, the external auditor is
careful to limit such work to those areas that would be appropriate to be assigned.
Further, in accordance with SA 505, “External Confirmation” the external auditor is
required to maintain control over external confirmation requests and evaluate the
results of external confirmation procedures, it would not be appropriate to assign these
responsibilities to internal auditors. However, internal auditors may assist in
assembling information necessary for the external auditor to resolve exceptions in
confirmation responses.
6. HR Head need to evaluate multiple options and identify most suitable option in light of the
relevant provisions, guidance and overall governance of the organization. HR head also need
to evaluate different option for his administrative reporting and various options for functional
reporting of Chief Internal Auditor. The possible options to be considered and evaluated
© The Institute of Chartered Accountants of India
INTERNAL AUDIT 16.35 a
include Board of Directors, Audit Committee, Managing Director of the Company, Chief
Executive Officer or Chief Financial Officer.
As per section 138 of the Companies Act 2013, the internal auditor shall either be a chartered
accountant or a cost accountant (whether engaged in the practice or not), or such other
professional as may be decided by the Board to conduct an internal audit of the functions and
activities of the company.
As per the revised definition of the term ‘Internal Audit’ as per para 3 of the ICAI’s Framework
Governing Internal Audits, “Internal audit provides independent assurance on the
effectiveness of internal controls and risk management processes to enhance governance
and achieve organisational objectives”.
Refer para 3.1, The Internal Auditor shall be free from any undue influences which force him
to deviate from the truth. This independence shall be not only in mind but also in appearance.
Also, the internal auditor shall resist any undue pressure or interference in establishing the
scope of the assignments or the manner in which these are conducted and reported, in case
these deviate from set objectives.
As per the requirement of the above stated provision, Chief Internal Auditor need to be
independent of the operational activities and report of Audit Committee / Board of Directors
to enjoy his true status of independent auditor. He may administratively report to CEO or
Managing Director for his administrative reporting purpose or any other similar authority till
the time it is approved by Board of Directors and it does not impact his independence to be
able to perform his duties and report to audit committee / Board of Director independently.
7. Refer para 2.0.
The internal auditor should, in consultation with those charged with governance, including the
audit committee, develop and document a plan for each internal audit engagement to help
him conduct the engagement in an efficient and timely manner.
Internal audit plan should be developed in such a manner that all the business processes
covering both financial as well as operational activities are reviewed by internal audit function
within a defined time cycle. Also, ensuring that appropriate consideration is made and
adequate balance is ensured to the following:
➢ Risk underlying the business process
➢ Value that the internal audit can provide to the organization
➢ Effort involved in conducting the internal audit for a particular business process
© The Institute of Chartered Accountants of India
16.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
➢ Risk Appetite of the organization
➢ Coverage of all auditable areas within the defined time range
8. Refer para 5.0
9. Refer para 6.0
As per Standard on Internal Audit (SIA) 370 Reporting Results, reporting of internal audit
results is generally undertaken in two stages:
➢ At the end of a particular audit assignment, an “Internal Audit Report” covering a
specific area, function or part of the entity is prepared by the Internal Auditor
highlighting key observations arising from those assignments. This report is generally
issued with details of the manner in which the assignment was conducted and the key
findings from the audit procedures undertaken. This report is issued to the auditee,
with copies shared with local and executive management, as agreed during the
planning phase.
➢ On a periodic basis, at the close of a plan period, a comprehensive report of all the
internal audit activities covering the entity and the plan period is prepared by the Chief
Internal Auditor (or the Engagement Partner, in case of external service provider).
Such reporting is normally done on a quarterly basis and submitted to the highest
governing authority responsible for internal audits, generally the Audit Committee.
Some part of the aforementioned Internal Audit Reports may form part of the periodic
(e.g. Quarterly) report shared with the Audit Committee.
Accordingly, a typical internal audit report should include the following:
• Audit Scope performed;
• Audit period Covered;
• Executive Summary;
• Summary of the critical findings;
• Detailed audit findings with elaboration on business impact and root cause of
such issues;
• Rating of the highlighted issues (E.g High / Medium / Low) in accordance to the
rating criteria approved by Audit Committee;
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INTERNAL AUDIT 16.37 a
• Audit recommendation to improve control environment and address the
highlighted finding;
• Response received from the responsible functional authority containing action
plan and target timelines for action.
10. Refer para 6.1
As per SIA 390 Monitoring and Reporting of Prior Audit Issues, the Chief Internal Auditor is
responsible for continuously monitoring the closure of prior audit issues through timely
implementation of action plans included in past audits. This shall be done with a formal
monitoring process, elements of which are pre-agreed with management and those charged
with governance. The responsibility to implement the action plans remains with the
management.
In monitoring and reporting of prior audit issues, the responsibility of the Internal Auditor is
usually in the form of an “Action Taken Report (ATR) of previous audits”.
To address the requirement of Audit Committee in the given situation, Internal Aud itor should
assess the action taken against the previous audit findings and report a summary of the action
taken by the management. Typical Action Taken Report may include the following:
➢ Reference to the previous audit reporting containing the reported issues
➢ Implementation Action agreed by the management along with target implementation
date
➢ Status of action taken by management. The same may be classified under
Implemented / Not Implemented
➢ Residual risk and rating for any unimplemented action
➢ Audit findings not implemented for long period of time
➢ Any critical audit finding that require immediate action for action or implementation
© The Institute of Chartered Accountants of India
CHAPTER 17
7
DUE DILIGENCE,
INVESTIGATION &
FORENSIC ACCOUNTING
LEARNING OUTCOMES
After studying this chapter, you will be able to:
Know the concept of Due Diligence, Investigation and Forensic Accounting.
Differentiate between Audit and Investigation.
Know the steps to be taken at the time of Investigation.
Understand the purpose of Due diligence and content of its report.
Gain knowledge of FAIS, Forensic Accounting Investigation Report.
© The Institute of Chartered Accountants of India
17.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Due Diligence Investigation Forensic Acounting
• Purpose • Steps in Investigation • Meaning
• Classification • Special Issues in • Fraud and Procedures
• Work Approach to Due Investigations • FAIS
Diligence • Audit V/s. Investigation • Foresnic Accounting
• Content of Due Investigation Report
Diligence Report
K, a CA final student, had an inkling of “Due Diligence”, “Investigation” and “forensic
accounting”. The terms sounded familiar to him but he lacked knowledge about fine
distinctions among these. “Due Diligence” broadly means taking care before entering into
agreement or transaction with a party which a reasonable person ought to take. Can it be
performed by anyone? Of course. It is not an exclusive activity bracketed for Chartered
Accountants.
“Investigation” is aimed at establishing a fact or a happening or assessing a situation.
Reasons for investigation are varied. Like, a Chartered accountant may be engaged to
discover whether a fraud has occurred or to conduct an investigation where an entity
proposes to buy a business. Its purpose is specific. It is not in nature of general prudence
and care.
“Forensic accounting” relates to use of professional accounting skills in matters involving
the possibility of a fraud in order to collect relevant evidence and facts which could help
support an expert view for potential or actual civil or criminal litigation. The evidence should
be suitable for use in court of law or before a regulatory body.
He was reading a report about a Surat based company whose forensic accounting was
conducted by an IBA (Indian Banks’ Association) empanelled firm. The facts of the company
made interesting reading. It was engaged in importing raw diamonds and exporting diamonds
after finishing besides catering to domestic market. The said company was availing credit
facilities consisting of `250 crore from a consortium of bankers consisting of 5 banks. The
credit facilities consisted of cash credit limit, packing credit limit, Bills purchased limit, LCs
issued and term loans. The account was declared NPA due to failure to meet repayment
obligations, devolved LCs and overdrawn accounts. The company had also trade transactions
with its sister concerns.
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.3
How should Forensic Professional have proceeded with? The approach in a forensic
accounting is on gathering facts and evidence and a critical examination of all the evidence
with respect to violations. It includes review of data over period of time to identify red flags
and use of computer assisted techniques to find digital evidence stored in the system.
Review of documentation and gathering market intelligence is next crucial step. Interviews
with identified employees can be of great help.
It would also include answer to the questions like whether funding availed by the company
from banks was required. It may turn out that credit requirements of the borrower were not
assessed properly, and company was provided credit facilities disproportionate to its
requirements. It would require analysis of PCL and bills purchased facilities to understand
the purpose. There may be forex transactions not in accordance with imports and exports.
Transactions with sister concerns would require to be analysed for probable fund diversion
and siphoning off. It would help in digging out trail for end use of funds.
He was surprised to learn that Standards exist in this field too. Forensic Accounting and
Investigation Standards (FAIS) enhance quality of forensic accounting and investigation
services rendered by Chartered Accountants.
1. DUE DILIGENCE REVIEW
Due Diligence is used to investigate and evaluate a business opportunity, verify Agreements,
encumbrances on the assets, Assets – their title and ownership, intellectual Property, Health, Safety
and Environment Laws, etc. It implies a general duty to exercise care in any transaction. Most legal
definition of due diligence describes it as a measure of prudence activity, or assiduity, as is properly
to be expected from, and ordinarily exercised by, a reasonable and prudent person under the
particular circumstance, not measured by any absolute standard but depends on the relative facts
of the special case.
Due diligence is a process of investigation, performed by investors, into the details of a potential
investment such as an examination of operations and management and the verification of material
facts. It entails conducting inquiries for the purpose of timely, sufficient and accurate disclosure of
all material statements/information or documents, which may influence the outcome of the
transaction. Due diligence involves a careful study of the financial as well as non-financial
possibilities for successful implementation of restructuring plans.
Due diligence involves an analysis carried out before acquiring a controlling interest in a company
to determine that the conditions of the business conform with what has been presented about the
target business. Also, due diligence can apply to recommendation for an investment or advancing a
loan/credit.
© The Institute of Chartered Accountants of India
17.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Due Diligence may also be required to be performed in cases of corporate restructuring, venture
capital financing, lending, leveraged buyouts, public offerings, disinvestment, corporatisation, etc.
Sometimes, in a restructuring exercise, while the unit may remain within a group, it may pass from
under the charge of one management team to that of another team. This situation also gives rise to
the need for a due diligence review.
One such emerging area is around mandatory human rights and environmental due diligence. The
OECD Due Diligence Guidance for Responsible Business Conduct (RBC) set out the expectation
that how an enterprises can carry out risk-based due diligence. Under OECD RBC due diligence
standards, enterprises are expected to carry out risk-based due diligence to identify, prevent,
mitigate and account for how they address actual and potential adverse impacts to people, society
and the planet.
DIFFERENCE BETWEEN DUE DILIGENCE AND AUDIT
It needs be underlined that due diligence is different from audit. Audit is an independent examination
and evaluation of the financial statements on an organization with a view to express an opinion
thereon. Whereas due diligence refers to an examination of a potential investment to confirms all
material facts of the prospective business opportunity. It involves review of financial and non-
financial records as deemed relevant and material. Simply put, due diligence aims to take the care
that a reasonable person should take before entering into an agreement or a transaction with another
party.
2. IMPORTANCE OF DUE DILIGENCE
When a business opportunity first arises, it continues throughout the talks, initial data collection and
evaluation commence. Thorough detailed due diligence is typically conducted after the parties
involved in a proposed transaction have agreed in principle that a deal should be pursued and after
a preliminary understanding has been reached, but prior to the signing of a binding contract.
The purpose of due diligence is to assist the purchaser or the investor in finding out all the care that
a reasonable person can, about the business he is acquiring or investing in prior to completion of
the transaction including its critical success factors as well as its strength and weaknesses.
In addition, it may expose problems or potential problems that can be addressed in the price
negotiations or by dealing suitable clauses in the contractual documentation, in particular, warranty
and or indemnity provisions.
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.5
There are many reasons for carrying out due diligence including:
To confirm that the business is what it appears to be;
To identify potential ‘deal killer’ defects in the target company and avoid a bad business
transaction;
To gain information that will be useful for valuing assets, defining representations and
warranties, and/or negotiating price concessions; and
To verify that the transaction complies with investment or acquisition criteria.
3. CLASSIFICATION OF DUE-DILIGENCE
Due Diligence can be sub-classified into discipline-wise exercises in following manner:
(i) Commercial/Operational Due Diligence: It is generally performed by the concerned acquire
enterprise involving an evaluation from commercial, strategic and operational perspectives.
For example, whether proposed merger would create operational synergies.
(ii) Financial Due Diligence: It involves analysis of the books of accounts and other information
pertaining to financial matters of the entity. It should be performed after completion of
commercial due diligence.
(iii) Tax Due Diligence: It is a separate due diligence exercise but since it is an integral
component of the financial status of a company, it is generally included in the financial due
diligence. The accountant has to look at the tax effect of the merger or acquisition.
(iv) Information Systems Due Diligence: It pertains to all computer systems and related matter
of the entity.
(v) Legal Due Diligence: This may be required where legal aspects of functioning of the entity
are reviewed.
1. The legal aspects of property owned by the entity or compliance with various
statutory requirements under various laws.
(vi) Environmental Due Diligence: It is carried out in order to study the entity’s environment, its
flexibility and adaptiveness to the acquirer entity.
(vii) Personnel Due Diligence: It is carried out to ascertain that the entity’s personnel policies
are in line or can be changed to suit the requirements of the restructuring.
© The Institute of Chartered Accountants of India
17.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Due Diligence
• Commercial or
Operational
• Financial
• Tax
• Information Systems
• Legal
• Environmental
• Personnel
Financial Due Diligence
At times, the financial due diligence review is interpreted as complete due diligence review since it
is supposed to ascertain the financial implications of all the other due diligence reviews. This is,
however, not appropriate. The term 'financial due diligence' should be used with caution. Unless the
scope of financial due diligence to be performed is wide enough to cover all the aspects, it should
not be confused with overall due diligence review.
It can be understood from the foregoing that the role of financial due diligence commences only after
a price has been agreed for the business or a restructuring plan is framed. The initial price and other
decisions are taken on the basis of net worth as well as trend of profitability of the target company,
with an assumption that all contingent liabilities that may impact the future of the business have
been recorded. The principal objective of financial due diligence, therefore, is usually to look behind
the veil of initial information provided by the company and to assess the benefits and costs of the
proposed acquisition/merger by inquiring into all relevant aspects of the past, present and future of
the business to be acquired/merged with.
In order to achieve its objective, the due diligence process can include any or all of the
following objectives for individual areas of the verification:
♦ Brief description of the history of business
♦ The background and standing of promoters
♦ Accounting policies and practices followed by the organization
♦ Management information systems
♦ Details of management structure
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♦ Trading results both past and the recent past
♦ Assets and liabilities as per latest balance sheet
♦ Current status of Income tax assessments including appeals pending against tax liabilities
assessed by tax authority.
♦ Cash flow patterns
♦ Brief description of commercial and/or other activities carried out by the organization
♦ The projection of future profitability
If a full-fledged financial due diligence is conducted, it would include the following matters,
inter alia, in its scope:
(a) Brief history of the target company and (b) Accounting policies;
background of its promoter;
(c) Review of financial statements; (d) Taxation;
(e) Cash flow; (f) Financial Projection;
(g) Management and employees; (h) Statutory Compliance.
(a) Brief history of the target company and background of its promoters - The accountant
should begin the financial due diligence review by looking into the history of the company and the
background of the promoters.
The details of how the company was set up and who were the original promoters has to be gone
into, before verification of financial data in detail. An eye into the history of the target company may
reveal its turning points, survival strategies adopted by the target company from time to time, the
market share enjoyed by the target company and changes therein, product life cycle and adequacy
of resources. It could also help the accountant in determining whether, in the past, any regulatory
requirements have had an impact on the business of the target company. Broadly, the accountant
should make relevant enquiries about the history of target's business products, markets, suppliers,
expenses, operations. This could, inter alia, include the following:
♦ Nature of business(es)
2. Manufacturer/ trader, wholesaler,
financial services, import/export.
♦ Location of production facilities, warehouses, offices.
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17.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
♦ Employment
3. By location, supply, wage levels, union contracts, pension commitments,
government regulation.
♦ Products or services and markets
4. Major customers and contracts, terms of payment, profit margins, market
share, competitors, exports, pricing policies, reputation of products, warranties,
order book, trends, marketing strategy and objectives, manufacturing processes.
♦ History of the business with important suppliers of goods and services
5. Long-term contracts, stability of supply, terms of payment, imports, methods
of delivery such as "just-in-time".
♦ Inventories
6. Locations,
Quantities.
♦ Franchises, licenses, patents.
♦ Important expense categories.
♦ Research and development.
♦ Foreign currency assets, liabilities and transactions.
♦ Legislation and regulation that significantly affect the entity.
♦ Information systems.
(b) Accounting policies - The accountant should study the accounting policies being followed
by the target company and ascertain whether any accounting policy is inappropriate.
The accountant should also see the effects of the recent changes in the accounting policies. The
target company might have changed its accounting policies in the recent past keeping in view its
intention of offering itself for sale.
The overall scope has to be based on the accounting policies adopted by the management. The
accountant has to look at any material effect of accounting policies on the overall profitability and
their correctness. It is reiterated that the accountant should have a detailed look at all material
changes in Accounting Policies in the period subjected to review very carefully.
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.9
The accountant's report should include a summary of significant accounting policies used by the
target company, that changes that have been made to the accounting policies in the recent past, the
areas in which accounting policies followed by the target company are different from those adopted
by the acquiring enterprise, the effect of such differences.
(c) Review of Financial Statements - Before commencing the review of each of the aspect
covered by the financial statements, the accountant should examine whether the financial
statements of the target company have been prepared in accordance with the Statute
governing the target company, Framework for Preparation and Presentation of the Financial
Statements and the relevant Accounting Standards. If not, the accountant should record the
deviations from the above and consider whether it warrant an inclusion in the final report on due
diligence.
After having an overall view of the financial statements, as mentioned in the above paragraphs, the
accountant should review the operating results of the target company in great detail. It is
important to make an evaluation of the profit reported by the target company. The reason being that
the price of the target company would be largely based upon its operating results.
The accountant should consider the presence of an extraordinary item of income or expense
that might have affected the operating results of the target company.
It is advisable to compare the actual figures with the budgeted figures for the period under review
and those of the previous accounting period. This comparison could lead the accountant to the
reasons behind the variations. It is important that the trading results for the past four to five years
are compared and the trend of normal operating profit arrived at.
The normal operating profits should further be benchmarked against other similar companies.
Besides the above, and based on the trend of operating results, the accountant has to advise the
acquiring enterprise, through due diligence report, on the indicative valuation of the business.
In the case of many enterprises, the valuation is mainly based on the value of net worth only. For
valuation of immovable properties and plant, if required, the assistance of expert valuers could also
to be taken. The exercise to evaluate the balance sheet of the target company has to take into
consideration the basis upon which assets have been valued and liabilities have been recognised.
The net worth of the business has to be arrived at by taking into account the impact of over/under
valuation of assets and liabilities. The accountant should pay particular attention to the valuation of
intangible assets.
The objective of the Due Diligence exercise will be to look specifically for any hidden
liabilities or over-valued assets.
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17.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
7. Hidden Liabilities:
The company may not show any show cause notices which have not matured into
demands, as contingent liabilities. These may be material and important.
The company may have given “Letters of Comfort” to banks and Financial Institutions.
Since these are not “guarantees”, these may not be disclosed in the Balance sheet of the
target company.
The Company may have sold some subsidiaries/businesses and may have agreed to take
over and indemnify all liabilities and contingent liabilities of the same prior to the date of
transfer. These may not be reflected in the books of accounts of the company.
Product and other liability claims; warranty liabilities; product returns/discounts; liquidated
damages for late deliveries etc. and all litigation.
Tax liabilities under direct and indirect taxes.
Long pending sales tax assessments.
Pending final assessments of customs duty where provisional assessment only has been
completed.
Agreement to buy back shares sold at a stated price.
Future lease liabilities.
Environmental problems/claims/third party claims.
Unfunded gratuity/superannuation/leave salary liabilities; incorrect gratuity valuations.
Huge labour claims under negotiation when the labour wage agreement has already
expired.
Unresolved labour litigations
8. Over-Valued Assets:
Uncollected/uncollectable receivables.
Obsolete, slow non-moving inventories or inventories valued above NRV; huge inventories
of packing materials etc. with name of company.
Underused or obsolete Plant and Machinery and their spares; asset values which have been
impaired due to sudden fall in market value etc.
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Assets carried at much more than current market value due to capitalization of
expenditure/foreign exchange fluctuation, or capitalization of expenditure mainly in the
nature of revenue.
Litigated assets and property.
Investments carried at cost though realizable value is much lower.
Investments carrying a very low rate of income / return.
Infructuous project expenditure/deferred revenue expenditure etc.
Group Company balances under reconciliation etc.
Intangible assets of no value.
(d) Taxation - Tax due diligence is a separate due diligence exercise but since it is an integral
component of the financial status of a company, it is generally included in the financial due diligence.
It is important to check if the company is regular in paying various taxes to the Government. The
accountant has to also look at the tax effects of the merger or acquisition.
(e) Cash Flow - A review of historical cash flows and their pattern would reflect the cash
generating abilities of the target company and should highlight the major trends. It is important to
know if the company is able to meet its cash requirements through internal accruals or does it have
to seek external help from time to time.
It is necessary to check that:
(a) Is the company able to honor its commitments to its trade payables, to the banks, to
government and other stakeholders?
(b) How well is the company able to turn its trade receivables and inventories?
(c) How well does it deploy its funds?
(d) Are there any funds lying idle or is the company able to reap maximum benefits out of
the available funds?
(e) What is the investment pattern of the company and are they easily realisable?
(f) Financial Projections - The accountant should obtain from the target company the
projections for the next five years with detailed assumptions and workings. He should ask the target
company to give projections on optimistic, pessimistic and most likely bases.
9. The accountant evaluates the appropriateness of assumption used in the
preparation and presentation of financial projections. If, the accountant is of the opinion
that as assumption used by the target company is unrealistic, the accountant should
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17.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
consider its impact on the overall valuation of the company. He should offer his comments on all
the assumption, highlighting those which, in his opinion are not inappropriate. In case he feels
the projections provided by the target company are not achievable or aggressive he has to
mention this in his report. He should thoroughly check the arithmetical accuracy of the calculations
made for financial projections.
(g) Management and Employees - In most of the companies which are available for take over
the problem of excess work force is often witnessed. It is important to work out how much of the
labour force has to be retained. It is also important to judge the job profile of the administrative and
managerial staff to gauge which of these matches the requirements of the new incumbents. Due to
complex set of labour laws applicable to them, companies often have to face protracted litigation
from its workforce, and it is important to gauge the likely impact of such litigation.
10. It is important to see if all employee benefits like Provident Fund (P.F.), Employees
State Insurance (E.S.I.), Gratuity, leave and Superannuation have been properly paid/
provided for/funded. In case of un-funded Gratuity, an actuarial valuation of the liability
has to be obtained from a reputed actuary.
The assumptions regarding increase in salaries, interest rate, retirement etc. have to be gone into
to see if they are reasonable. It is also necessary to see if the basic salary /wage considered for the
valuation is correct and includes all elements subject to payment of Gratuity. In the case of PF, ESI
etc. the accountant has to see if all eligible employees have been covered.
It is very important to consider the pay packages of the key employees as this can be a crucial factor
in future costs. One has to carefully look at Employees Stock Option Plans; deferred compensation
plans; Economic Value Addition and other performance linked pay; sales incentives that have been
promised etc. It is also important to identify the key employees who will not continue after the
acquisition either because they are not willing to continue or because they are to be transferred to
another company within the 'group' of the target company.
(h) Statutory Compliance - During a due diligence this is one aspect that has to be investigated
in detail. It is important therefore, to make a list of laws/ statues that are applicable to the entity as
well as to make a checklist of compliance required from the company under those laws. If the
company has not been regular in its legal compliance it could lead to punitive charges under the
law. These may have to be quantified and factored into the financial results of the company.
© The Institute of Chartered Accountants of India
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TEST YOUR UNDERSTANDING 1
CA. Y is employed with a leading private sector BDFP Bank posted in NOIDA branch. One of the
existing borrowers has approached branch with a proposal to sanction fresh term loan of `5 crore
with commensurate increase in working capital credit facilities relating to expansion of its garment
manufacturing unit. While performing due diligence, he notices that company was formed just two
years ago and had availed term loan of ` 10 crore and cash credit facilities of `5 crore respectively.
Its sales have increased from ` 25 crores in first year to `45 crores in year just ended. It is
generating cash profits and is timely servicing its debts.
The borrower was earlier catering to domestic market. However, now it is in process of procuring
export orders and working assiduously in this regard. The expansion plans are in line with
development in area of marketing relating to exports.
However, there are a large number of units catering to domestic and export market of garments in
NOIDA, Delhi and surrounding areas. There is also demand slump in biggest US market.
Besides, the unit is family-based and relies upon marketing skills of its main promoter. There is lack
of well-paid qualified staff with the borrower to deal effectively with its customers both domestic as
well as foreign.
He starts jotting down and elaborating above points. Identify what he is trying to do as part of due
diligence.
4. WORK APPROACH TO DUE DILIGENCE
The purchase of business in many instances is the largest and most expensive assets purchase in
life time and therefore some caution should be exercised through the due diligence process.
Therefore, assessing the businesses fair value passes through.
Reviewing and reporting on the financials submitted by the target company.
Assessing the business first hand by a site visit (if applicable).
Working through the due diligence process with the acquisitioning company or investor by
defining the key areas.
Helping prepare an offer based on completion of due diligence.
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17.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Discovering the correct strategy is always challenging, and even more so during challenging
economic circumstances. Each situation is unique. The variables are numerous, including factors
such as company age, markets, geography, price levels, competitive dynamics, to name but a few.
But when a company and its products are turned to match market needs and expectations-that is,
the decision makers and influencers involved in purchase decision-exceptional changes in
performance can occur. However, comprehensive model that describes this approach to the work
is illustrated in the figure below:
Diagnose
Define Defend
Discover Delivery
Design
Figure: Six-Dimensional Process Framework
5. HOW TO CONDUCT DUE DILIGENCE
Start with an open mind. Do not assume that anything wrong will be found and look for it.
What needs to be done is to identify trouble spots and ask for explanations.
Get the best team of people. If you do not have a group of people inside your firm that can
do the task (e.g. lack of staff, lack of people who know the new business because you are
acquiring a business in an unrelated area, etc.), there are due diligence experts that you can
hire. When hiring such professionals, look for their experience record in the industry.
Get help in all areas like finance, tax accounting, legal, marketing, technology, and any others
relevant to the assignment so that you get a 360-degree view of the acquisition candidate.
Talk to customers, suppliers, business partners, and employees are great resources.
Take a risk management approach. So, while you want to do your research, you also want
to make sure that you do not antagonise the team of people of the target company by bogging
them down with loads of questions.
Prepare a comprehensive report detailing the compliances and substantive risks/issues.
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.15
6. CONTENTS OF A DUE DILIGENCE REPORT
The contents of a due diligence report will always vary with individual circumstances. Following
headings are illustrative:
Example of Headings of a Due Diligence Report
♦ Executive Summary
♦ Introduction
♦ Background of Target company
♦ Objective of due diligence
♦ Terms of reference and scope of verification
♦ Brief history of the company
♦ Share holding pattern
♦ Observations on the review
♦ Assessment of management structure
♦ Assessment of financial liabilities
♦ Assessment of valuation of assets
♦ Comments on properties, terms of leases, lien and encumbrances.
♦ Assessment of operating results
♦ Assessment of taxation and statutory liabilities
♦ Assessment of possible liabilities on account of litigation and legal proceedings against
the company
♦ Assessment of net worth
♦ Interlocking investments and financial obligations with group / associates companies,
amounts receivables subject to litigation, any other likely liability which is not provided for
in the books of account
♦ SWOT Analysis
♦ Comments on future projections
♦ Status of charges, liens, mortgages, assets and properties of the company
♦ Suggestion on ways and means including affidavits, indemnities, to be executed to cover
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17.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
unforeseen and undetected contingent liabilities
♦ Suggestions on various aspects to be taken care of before and after the proposed
merger/acquisition.
7. INVESTIGATION
The term investigation implies a systematic and in-depth examination or inquiry
to establish a fact or to evaluate a specific situation. In other words, investigation
means inquiry into facts". Professional accountants are often required to
investigate the accounts or the related matters and records of the enterprise.
The term investigation may be defined as an examination of books and records
preliminary to financing or for any other specified purpose, sometimes differing in scope from the
ordinary audit. Thus, investigation covers areas of financing decisions, investment decisions, fraud
or profitability determination or cost determination etc.
7.1 Audit versus Investigation
Investigation differs substantially from an audit assignment. Audit aims at collection of sufficient
appropriate audit evidence to enable the auditor to form a judgement and express an opinion on the
financial statements or other data under examination. An investigation, on the other hand, requires
special in-depth examination of the particular records or transaction with the objective of establishing
a part or happening or assessing a particular situation. The scope of audit is broad based and
general in nature whereas investigation is narrow and specific.
The difference is tabulated below:
Basis of Difference Investigation Audit
(i) Objective An investigation aims at The main objective of an audit is
establishing a fact or a to verify whether the financial
happening or at assessing a statements display a true and
particular situation. fair view of the state of affairs
and the working results of an
entity.
(ii) Scope The scope of investigation may The scope of audit is wide and
be governed by statute or it may in case of statutory audit the
be non- statutory. scope of work is determined by
the provisions of relevant law.
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.17
(iii) Periodicity The work is not limited by rigid The audit is carried on either
time frame. It may cover several quarterly, half-yearly or yearly.
years, as the outcome of the
same is not certain.
(iv) Nature Requires a detailed study and Involves tests checking or
examination of facts and sample technique to draw
figures. Investigation is evidences for forming a
voluntary in nature. judgement and expression of
opinion. It is mandatory for
companies.
(v) Inherent No inherent limitation owing to Audit suffers from inherent
Limitations its nature of engagement. limitation.
(vi) Evidence It seeks conclusive evidence. Audit is mainly concerned with
prima- facie evidence.
(vii) Observance of It is analytical in nature and Is governed by compliance with
Accounting Principles requires a thorough mind, generally accepted accounting
capable of observing, collecting principles, audit procedures and
and evaluating facts. disclosure requirements.
(viii) Appointing Agency Even third party can appoint Auditor is appointed by owner/
Investigator shareholders of company/
enterprise
(ix) Reporting The outcome is reported to the The outcome is reported to the
person(s) on whose behalf owners of the business entity.
investigation is carried out.
The approach to an investigation is different from that followed in an audit. An investigation involves
a more detailed examination of the selected areas than what is required in an audit. An investigation
seeks substantive and, in some case, even conclusive evidence as compared to audit which mainly
relies on persuasive evidence.
An investigator does not accept a stated fact as correct until it is substantiated. An auditor, in the
absence of suspicious circumstances, relies on stated facts or figures. An auditor has to see whether
the method of valuation and other accounting policies have been properly made in the financial
statements or not. An investigator, however, is not bound by accounting conventions, policies and
disclosure requirements. An auditor does not suspect unless circumstances are there to arouse
suspicion, while an investigator approaches the work with a frame of mind to suspect, verify and
satisfy.
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17.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The auditor seeks to report what he finds in the normal course of examination of the accounts
adopting generally followed techniques unless circumstances call for a special probe: fraud, error,
irregularity, whatever comes to the auditor’s notice in the usual course of checking, are all looked
into in depth and sometimes investigation results from the prima facie findings of the auditor.
8. STEPS IN INVESTIGATION
As investigation involves a variety of situations, it is not possible to lay down any standardised
procedure. However, usually, an investigation requires the following steps in order of sequence:
1. Determination of 3. Examination and
objectives and 2. Formulation of the study of various
establishment of investigation records by reference
scope of programme. to appropriate
investigation. evidence.
4. Analysis, processing 5. Preparation of
and interpretation of report and drawing up
findings. of conclusions.
Diagram showing Sequence of Steps for Investigation
Step 1: Determination of objectives and establishment of scope of investigation
At the stage of acceptance of the assignment, the investigator should be absolutely clear about what
is sought to be achieved by the investigation. If instructions from the client leave matters vague and
non-specific, it would be proper for the investigator to have the matters discussed and obtain clearly
written instructions covering the object, the scope and purpose of investigations and the issues
incidental thereto.
The period to be covered under investigation should be clearly specified. The results of investigation
are often seriously affected owing to change in circumstances which have occurred since it was
contemplated, e.g., devaluation, import restrictions, starting of a new division, etc. Therefore, the
purpose of the investigation should be borne in mind while determining the period which an
investigation should cover.
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Step 2: Formulation of the investigation programme
It is not possible to draw up one programme to serve different types of investigations which a
professional accountant is called upon to carry out, for their scope and content have to be
determined on a consideration of circumstances peculiar to each business or situation. The
investigation programme should be drawn up having regard to:
(a) The nature of the business
(b) The structure of business organization
(c) The instructions from the client embodying the objectives and scope of work
(d) The consequent scope and depth of investigation
(e) The necessity to extend the investigation into books and records belonging to others.
(f) The investigator should concentrate on areas considered relevant rather than to undertake a
wide-ranging verification.
The programme should also be flexible so that knowledge gained with the progress of work can be
used to extend, reduce or modify the extent and areas of checking.
11. In case of an investigation on suspected payment of wages to ghost workers, the
investigator should scan the areas having a bearing on the determination of wages and
payments thereof. He should concentrate on time and job cards, appointment and
terminatio of workers, attendance records, internal controls, internal checks, and preparation of
wage sheets, withdrawal of money from bank for payment of wages and the actual disbursement
of wages.
A conscious effort in investigation programming should be devoted to localise the enquiry into the
relevant areas and, for that purpose, the initial wider base of inquiry should be gradually narrowed
and fixed at a level that is meaningful. Matters not found to have a bearing on the subject matter of
investigation should be gradually and progressively eliminated. This procedure alone will enable an
in-depth examination of the matters relevant to the investigation.
Step 3: Collection of Evidence
Through examination, the investigator would be gathering relevant evidence connected with the
matters to be investigated. In the course of examination of the documents and records, the
investigator may require to obtain oral explanations from various personnel of the concerned
business. In case his client is a person external to the business, it may be necessary for the
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17.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
investigator to get the matter formally agreed to by the business through the client. The investigator
should look for the most convincing evidence; he should seek and examine all the available evidence
and by a process of elimination and corroboration, should endeavour to reach at the truth of the
matter. He, unlike the auditor, is not to restrict himself to prima facie evidence ordinarily available.
He should examine it and if circumstances demand should try to obtain evidence that may have to
be specifically procured. The investigating accountant can take help of external experts/ persons
like, related parties outside the organization, valuation experts etc. to obtain specific evidence.
Further, the work of investigating accountant should ensure that the process of obtaining evidence
does not interfere with the regular work of client.
12. In the matter of valuation of land, he should definitely have regard to the available
evidence as per records of the business and records of any bid received for the land.
In addition, he should have regard to the prices at which land was sold or purchased
in the neighbourhood around the same time. This may require him to obtain evidence even by
going to the land registration office. He may also call for the report of experts in land valuation.
Step 4: Analysis and Interpretation of Findings
Careful analysis and correlation of facts and figures will be necessary before the investigator can
reach his conclusion. The conclusion should be well reasoned, backed by established facts and
evidenced by proper records/ data. He must analyse the data objectively on the basis of evidence
gathered by him and should not draw conclusions according to pre-conceived notions. While
interpreting the figures, the investigator must keep in mind various factors e.g. the political and
economic considerations, competition faced by the business, historical pattern of the data, nature of
the business, etc. The interpretation should be brief, clear and free from doubts.
Step 5: Reporting of findings
Like all other work of an accountant, an investigation results in a report. It is submitted and
addressed to the party at whose instance the investigation has been carried out. The nature of the
report is governed mainly by two factors –
(a) The instructions given by the client as regards the special aspects of the business which are
required to be investigated;
(b) The findings of the investigating accountant/ investigator.
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.21
The important issues to be kept in mind by the investigator while preparing his report
are as follows:
(i) The report should not contain anything which is not relevant either to highlight the nature
of the investigation or the final outcome thereof.
(ii) Every word or expression used should be properly considered so that the possibility of
arriving at a different meaning or interpretation other than the one intended by the
investigator can be minimized.
(iii) Relevant facts and conclusions should be properly linked with evidence.
(iv) Bases and assumptions made should be explicitly stated. Reasonableness of the bases
and assumptions made should be well examined and care should be taken to see that
none of the bases and assumptions can be considered to be in conflict with the objective
of the investigation. For example, in an investigation into over-stocking of raw materials,
inventories and spares etc. it should not be assumed that the ordering levels indicated
on bin cards provide fair guidance about acquisition of further materials. Also, since
investigation is a fact-finding assignment, assumptions should be made only when it is
unavoidably necessary.
(v) The report should clearly spell out the nature and objective of the assignment accepted
its scope and limitations, if any.
(vi) The report should be made in paragraph form with headings for the paragraphs. Any
detailed data and figures supporting any finding may be given in Annexures.
(vii) The report should also state restrictions or limitations, if any, imposed on the instructions
given by the client. Preferably the reasons for placing such restrictions and their impact
on the final result should also be stated.
(viii) The opinion of the investigator should appear in the final paragraph of the report.
Due to non-availability of standardised procedure and lack of professional guidance, investigation
calls for extreme care, caution and circumspection on the part of the investigator in exercising his
judgement and discretion. Investigation often has a characteristic of very intimate and direct
involvement of parties whose interest may be affected. Therefore, unlike auditing, chances of one
or the other of the parties challenging the finding of the investigation are far greater.
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17.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
9. SPECIAL ISSUES IN INVESTIGATIONS
Investigations broadly range between two extremes; on the one hand there are those in respect of
which complete accounts, documents, records and other information are available, and on the other,
those in respect of which little information, besides published accounts and statistical data, is
available. Then again, investigation may cover the whole of accounting or may relate to only a part
or parts of accounting as may be specified. Some more issues often arise in investigation. They are
stated below:
(a) Whether an investigator is required to undertake a cent per cent verification approach
or whether he can adopt selective verification - The answer to this question depends on
the exact circumstances of the case under investigation. If the investigator has to establish
the amount of cash defalcated by the cashier, he has probably no option but to carefully
examine all the cash vouchers and related records. On the other hand, if he is to arrive at the
profitability of a concern, he may verify constituent transactions on a selective basis taking
extreme care to see that no material transaction that affects profit has remained concealed
from his eyes. In investigation, it is always safer to go by statistically recognised sampling
methods than to depend on the so-called “test checks” where circumstances permit selective
verification.
(b) Whether the investigator can put reliance on the already audited statement of account-
Here also no dogmatic views are possible. If the investigation has been launched because of
some doubt in the audited statement of account, no question of reliance on the audited
statement of account arises. However, if the investigator has been requested to establish
value of a business or a share or the amount of goodwill payable by an incoming partner,
ordinarily the investigator would be entitled to put reliance on audited materials made
available to him unless, in the course of his test verification, he finds the audit to have been
carried on very casually or unless his terms of appointment clearly require to test everything
afresh.
It was held in the case of Short & Compton v. Brackert (1904) that an accountant, when
making an investigation for an incoming partner, was entitled to assume that the figures
appearing in the books were correct.
In another case, Mead v. Ball Baker & Co. (1911), it was held that an accountant, when
acting as an adviser to a proposed investor in a limited company, was not expected to
check errors in stock sheets and the omission of liabilities.
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These cases were decided long time ago. Therefore, much reliance cannot be placed on
them. It is, therefore, desirable for the investigator to ascertain from the client, in advance,
in writing, whether the audited statements of account produced to him should be taken as
correct.
If the statements of account produced before the investigator were not audited by a qualified
accountant, then of course there arises a natural duty to get the figures in the accounts
properly checked and verified. However, when the accounts produced to the investigator have
been specially prepared by a professional accountant, who knows or ought to have known
that these were prepared for purposes of the investigation, he could accept them as correct
relying on the principle of liability to third parties settled in the famous Hedley Byrne’s case.
Nevertheless, it would be prudent to see first that such accounts were prepared with
objectivity and that no bias has crept in to give advantage to the person on whose behalf
these were prepared.
(c) Whether an investigator necessarily requires assistance of expert - Often an investigator
may feel the necessity of obtaining views and opinions of experts in various fields to properly
conduct the investigation. It would be therefore, proper for the investigator to get the written
general consent of his client, to refer special matters for views of different expertsat the
beginning of investigation and he should settle the question of costs for obtaining the views
and other related implications.
(d) Investigation out of disputes and conflicting claims - Cases for investigation sometimes
arise out of disputes and conflicting claims. It is needless to emphasise that the investigator
should remain above disputes or conflicting claims and be alert to the possibilities of the
information or documents made available to him to be prejudiced. Even the client, overtly or
covertly, may try to influence his reports. A seller of a business or controlling shares may
request him to see that he gets the most favourable price. Similarly, if he is appointed by the
buyer, he may be requested to deliberately depress the value. The investigator should keep
him scrupulously professional and should keep the interest of all the involved parties in view.
This is a challenging task and probably no other professional work offers this much of
challenge. This work is exciting too and requires not only the best of skill but of a high degree
of maturity and experience.
(e) Basis of opinion of an investor- The investigator should refrain from issuing speculative
opinion. He should confine his opinion to the established facts and nothing more. If the facts,
as conveyed through the books, records, papers and other evidence, are not capable of being
properly established, he should not express an opinion or, if at all he expresses any opinion,
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he should qualify the opinion by clearly stating the reasons therefor. This problem may
particularly arise in cases where incomplete books and records are produced for
investigation.
(f) Whether an investigator can make futuristic statements – Even if the appointing
authority is willing to obtain a futuristic statement, the investigator should refuse to be
futuristic. He may assume that the established trend in the business will continue in the near
future, in the absence of any contrary evidence, in arriving at the present value of a business.
He, however, should not project the trend into any future years to establish a value.
(g) Whether to retain working papers or not - Another important precaution is that the
investigating accountant should retain in his files full notes of the work carried out, copies of
schedules and all working papers, annexures, facts, figures, record of conversations and the
like. Also, the working papers should link up the figures as shown by the books of business
with the final figures produced by the investigating accountant. Wherever required the
investigator should take representation letter from the appointing authority. In the absence
thereof, he would not be able to explain the figures when he is called upon to give evidence
in a court of law to support his figures; for quite often the conclusions of the accountant are
challenged by parties whose interest is adversely affected by his findings, for example, when
the value of shares of a company taken over by the Government has been determined by
him. This will also be of immense help to the investigator in correlating facts and events and
later in drafting the report.
10. SPECIAL ASPECTS IN CONNECTION WITH BUSINESS
INVESTIGATIONS
We discuss below the factors to be considered by a professional accountant while carrying out the
investigation for attaining satisfactory results:
(a) Studying the overall picture - In such a business investigation, it is of utmost importance
first to have an overall picture of the position of the business which is being investigated before the
details are gone into. This is because figures are only symbols; and it is impossible to interpret them
intelligently without knowledge of the background in which they have emerged.
13. For investigating the accounts of a group of companies, it would not be possible
to know the manner in which the profits had emerged in the past unless a chart is
prepared, showing the relationship of different companies comprising the group;
whether as subsidiaries or not, the nature of transactions entered into by one unit in the group
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with another or others and the terms on which this has been done. Further, it is important to know
whether the business is engaged in the manufacture of one or two important lines of products, is
principally processing materials or is concerned only with the sale of a single product. Also,
whether it is a business which depends for its success on imported raw materials or supply of
parts and components from ancillary businesses or uses indigenous materials and parts which
are manufactured locally.
14. If the business is labour - intensive, its future profitability would be dependent on
availability of skilled labour and relations of the management with the trade unions.
Labour relations thus can affect the future profitability of the business. The method of
distribution of products, either through wholesalers or retailers also must be examined. Apart from
these preliminary enquiries, the investigating accountant should study:
(i) the character of management;
(ii) the economic and political forces to which the business is subject; and
(iii) the position it enjoys in the market as against its competitors.
At times, political or economic factors also may affect the fortunes of a business; for example, labour
disturbances, changes in government policies in the matter of levy of excise and custom duties,
imports, etc. It is, therefore necessary that the impact of all these factors should be studied and their
effect on the business judged on a consideration of the profits in the past. For studying the economic
and financial position of the business, the following should be considered:
(i) The adequacy or otherwise of fixed and working capital. Are these sufficient for the growth of
the business?
(ii) What will be the trend of the sales and profits in the future? Establishing the trend of sales,
product-wise and area-wise will ordinarily help in drawing a conclusion on whether the trend
will be maintained in the future.
(iii) Whether the profit which the business could be expected to maintain in the future would yield
an adequate return on the capital employed?
(iv) Whether the business is operating at its 100 percent capacity or improvements can be made
to reach at full productivity?
(b) Statement of Profit and Loss - To study the Statement of Profit and Loss of a concern, it is
necessary to consider each item, included therein, in relation to the corresponding items in the
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Statement of Profit and Loss of the previous years. It is therefore, necessary that a summary, in a
columnar form, should be prepared of the balances included in the Statement of Profit and Loss of
the business for a period, say of 5 to 7 years.
In the foregoing summary, in the place of figures of opening and closing inventories, the figures of
inventory consumed, for each product, in different years should be entered. It should also be verified
that the inventories have been valued on a consistent basis throughout the period under review. If
there has been a change, the values of inventories should be adjusted. Further, in the summary, the
gross profit ratios and the ratios showing the relationship between various items of expenses and
sales should be entered. The trend of these ratios should be examined and, if there is a wide
divergence in them, an explanation for the same should be sought. In the preparation of the summary
attention should also be paid to the following matters:
Turnover - The figures of sales should be broken down between the various products sold to show
variations in turnover of individual products from year to year. In this way, it would be possible to find out
the products the sales of which have been increasing and those the sales of which have been falling.
By reference to the list of customers, in the Order Books, it should be ascertained whether the
business has a very large turnover with a few customers or a small turnover with several customers.
The Order Books should also be examined to find out if fictitious sales have been entered in any
year to boost up profits. If so, the figures of sales of the year or years should be adjusted.
If the business consists of activities which are dissimilar in operation, like manufacturing and agency,
then apart from splitting the income between the two sources, expenses should also be apportioned
between them to separately arrive at the figures of profit from each of the activities.
Wage structure - The method of computing wages and the rates of wages should be examined. On
occasions a business may have to pay higher wages than those prevailing in other business in the
same neighborhood in pursuance of an industrial award. Another factor which is important to
consider in this connection is the relationship of the business with its workers/ labour unions. A
business which has suffered several industrial disputes, strikes, etc. and has had its working
interrupted by them frequently cannot be expected to prosper unless a proper settlement is reached
with workers’ unions.
Depreciation and Maintenance - The charge on account of depreciation and maintenance of
machinery and other assets included in the accounts of different years should be compared to verify
that depreciation has been provided from year to year on a consistent basis and that it is adequate.
Also, the necessary adjustment in the depreciation charge should be made if it is the practice of the
company to write off the assets on a renewal basis.
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Further, if assets have been revalued, it should be confirmed that depreciation on the increased
valuation has been adjusted. Generally, with age, the cost of maintenance of assets should increase.
If it has not, the reason thereof should be ascertained.
In case of leasehold property, it should be ascertained whether an adequate provision has been
made for the dilapidation charge which may be payable at the end of the lease.
Further, compliance of relevant AS should also be verified.
Managerial Remuneration - It should be verified that the remuneration payable to various members
of managerial personnel is not excessive in relation to the profits of the business after taking into
account the time devoted by each of them. However, it could also be that no or only a nominal
remuneration has been charged in the accounts. In either case, an adjustment should be made to
arrive at true profitability of the concern. Further, in case of company, requirement of relevant section
of Companies Act, 2013 is to be seen. It has to be assured that calculation of profit for arriving at
the remuneration is correct.
Exceptional and non-recurring items - It is customary to adjust exceptional items in the summary
of Statement of Profit and Loss in order that they may not obscure the trend of the profits. In the
matter of non-recurring items, it is necessary to remember that adjustments are to be made in
respect of exceptional items which do not recur from year to year or can be considered exceptional
having regard to their materiality or periodicity.
In this connection, it is worthwhile to examine the income tax assessment orders of the business to
find out the items which have been treated as revenue but have been considered inadmissible by
the taxing authority. Where the effect of these has been abnormal on the tax paid by the company
from year to year, suitable adjustments should be made in the figures of taxes paid, as well as in
the assets amounts. Likewise, adjustments should be made in respect of exceptional profits and
losses like, profit or loss on sale of obsolete asset.
Repairs and maintenance - It is one of the recurring expenses of a business. Occasionally it is
noticed that this expenditure is unduly heavy in some of the years, while quite low in some others.
Generally, companies, as a matter of routine undertake major repairs, overhauls and maintenance
programme at an interval of 3 or 4 years while running repairs and maintenance continue in the
usual manner which gives rise to fluctuating charges in the accounts unless periodic major expenses
are treated as deferred expenditure.
Besides, due to wrong allocation of expenses between capital and revenue, repair charges may
appear to be heavy or low. If fluctuating and abnormal charges for repairs is noticed, it would be the
duty of the investigating accountant to scrutinise this head thoroughly to establish correct and normal
charge for repairs.
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Unusual year - A company’s record of profitability may show a trend of increasing or decreasing
profit or loss or it may be highly erratic and fluctuating. Where a definite trend is discernible, the job
of the investigating accountant is somewhat simplified. He can adopt recent years’ record of
profitability as the basis for estimating future maintainable profit having regard to the inflationary
state in the economy. But if the same is fluctuating, there would be more demand on judgement of
the accountant in selecting the period to be covered for estimation of profitability. In such cases it
may even be necessary to take into consideration results of past 9 to 10 years with a view to iron
out the fluctuation. If, however, it is noticed that results of one or more years under scrutiny were
materially vitiated by exceptional factors like a long-term industrial dispute, natural calamities,
pandemic, fire, war, ravage etc., the investigating accountant should eliminate such year / years
from consideration altogether since they do not reflect the results obtained through normal business.
(c) Balance Sheet - Fixed Assets - Fixed assets, usually, are shown in accounts at cost less
depreciation but the accounts do not show the ages of different assets. It is desirable, therefore, to
obtain age analysis of various items of fixed assets. Assets which are old or are obsolete would
naturally have to be replaced. It should be seen that their values are not in excess of the value of
service that they could be expected to render to the business during the balance period of their
active life and the amount they would fetch on sale as scrap. Title deeds should be verified to
ascertain the extent of enterprise’s ownership in such assets, like land and building jointly owned by
two or more companies or their subsidiaries.
In addition, from a study of the maintenance expenses incurred from year to year, it should be judged
whether the assets have been properly maintained. If not, it might be necessary to incur heavy
expenditure on repairs to put them in a proper working order. In such a case, an allowance for this
factor should be made in the value of assets. More particularly, it should be seen that if ass ets have
been revalued, the increased depreciation charge has been adjusted against profit. Further,
investigator has to assure whether assets whose recoverable amount is less than carrying amount
are impaired and requirement of AS 28, “Impairment of Asset”, has been complied.
Investments -Investments should be broadly classified into long term investments and current
investments. A current investment is by its nature readily realisable and is intended to be held for
not more than one year. All other investments are long term investments.
Current investments are valued on the basis of lower of cost and fair value determined either on an
individual investment basis or by category of investment but not on an overall basis.
Long-term investments are usually carried at cost. However, when there is a permanent decline in
the value of long-term investments, the carrying amount should be reduced to recognise the decline.
The carrying amount of long-term investments is determined on an individual investment basis.
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Interest, dividends and rentals receivable in connection with investment are generally regarded as
income. However, in some cases, such receipts represent recovery of cost and should therefore be
reduced from, the cost of investment (e.g. dividend out of pre-acquisition profits).
Inventories - It should be seen that inventories have been valued consistently and that the basis of
valuation was such that the value placed on inventories did not include any element of profit. Also,
there should be due allowance for damaged, obsolete and slow-moving inventories. In some cases,
physical verification of inventories is necessary where the inventories belonging to the entity are
held by other parties. Examine the appropriateness of valuation of work in progress as disclosed in
the books.
Trade Receivables - In assessing their value, the following should be taken into account:
(i) Whether provision for bad debts have been made in the years in which the relevant sales
took place instead of in the year in which they have been written off, except when debts have
had to be written off on account of a slump or a fall in international prices, during a period
subsequent to the period in which sales had taken place.
(ii) The length of the credit period allowed or any excessive discounts allowed throughout the
period under investigation, to determine whether it has been necessary to increase
continually the credit period in order to affect the sales. If it has been so, it would indicate
that the demand for the goods manufactured by the concern in the market has been
diminishing gradually.
(iii) Debts should be classified according to their age. This would disclose the character of the
parties with whom the company trades and the amount of working capital that will be
necessarily blocked on this account in the course of business. Determine Debtors to Sales
Ratio.
Other liquid assets - It should be ascertained that the assets so described are readily realisable.
Money with a bank in liquidation should be taken only to the extent guaranteed by Deposit Insurance
Scheme.
Idle assets -On a scrutiny, it may appear that certain assets are remaining idle and are not being
properly applied in the business. These may come from all sections of assets. For example, certain
plant and machinery may have been put to use after a considerable period of time after acquisition.
Some of the fixed assets may be awaiting installation even at the valuation time. The company may
hold large cash and bank balances, not warranted by the need of the business. Then again, there
may be instances of obsolete and slow-moving inventories of large value in the accounts of the
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company. It would be the duty of the investigating accountant to eliminate these idle assets, if any,
after proper identification from the net worth of the business. However, proper value of these assets
may be separately added to the value of the business.
Liabilities - The important matter to investigate in this regard is whether those are stated fully or
understated or overstated. In other words, whether the profits of the business have been inflated by
suppression of liabilities or there are any free reserves included in the liabilities. In either case, an
adjustment would be necessary. Secondly, it should be ascertained that liabilities are not unduly
large or are not outstanding for a long time, in such cases, it would be necessary to pay off some of
them which would cause a drain on the liquid resources of the concern. The fact should be stated in
the report.
Taxation - Orders in respect of assessments completed should be studied and it should be verified
that an adequate provision has been made in respect of liabilities for taxes which have not been
assessed. Also, it should be seen that in the past there has been no reopening of assessments. If
so, the company may be liable for an undisclosed sum of taxes plus penalties. Any temporary tax
benefit should also be disregarded.
Capital - In this regard, it is necessary to ascertain:
(i) Whether the capital is well balanced. This would not be the case if the number of debentures
and preference share capital are disproportionately large as compared to the equity capital.
Low equity capital would handicap the company in raising further equity capital, on favourable
terms for financing the business or to pay off capital commitment. Further, when the capital
is highly geared, it would affect the value of the equity capital;
(ii) That the amount of capital is reasonable compared to the value of fixed assets and the
amount of working capital required. The terms associated with the issue of the capital should
also be studied; restriction on transferability of shares usually depresses the value of share
and of the business.
(d) Interpretation of figures - Fixed Assets - The amount of capital expenditure which would
be necessary in the future for the continuation of the business, in its existing stage, should be
assessed having regard to the under-mentioned factors:
(i) the amount required for the replacement of assets when these would become worn out or
obsolete;
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(ii) the expenditure which will be necessary to replace obsolete machinery by more sophisticated
machinery for manufacturing different types of goods for which there is demand.
Turnover - In assessing the turnover which the business would be able to maintain in the future, the
following factors should be taken into account:
(i) Trend: Whether in the past sales have been increasing consistently or they have been
fluctuating. A proper study of this phenomenon should be made.
(ii) Marketability: Is it possible to extend the sales into new markets or that these have been
fully exploited? Product wise estimation should be made.
(iii) Political and economic considerations: Are the policies pursued by the Government likely to
promote the extension of the market for goods to other countries? Whether the sales in the
home market are likely to increase or decrease as a result of various emerging economic
trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the same
field or if products which would sell in competition are placed on the market at cheaper price?
Is the demand for competing products increasing? Is the company’s share in the total trade
constant or has it been fluctuating?
Working Capital - In making assessment of the working capital requirements in the future, the
following matters should be taken into account:
(i) Has the ratio of inventory to turnover been increasing and if so, is it a continuing or only a
temporary trend?
(ii) Are the trade payables being paid promptly or is there a backlog which will have to be dealt
with?
(iii) What will be the effect on inventory, trade receivables and trade payables, if the turnover is
increased or if new products are introduced?
Estimating Future Maintainable Profits - Fluctuations in profits during the years under review
should be examined after adjusting the profits for extraneous factors, if any, that had given rise to
fluctuations to determine whether the factors responsible for the fluctuations were temporary or was
likely to recur in future. A statement should be prepared showing separately the profits after
depreciation earned in each of the years during the period under review, after making adjustments
therein, if considered necessary, as regards factors which have been responsible for any
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extraordinary increase in profits. If the percentage of profits before taxation to capital has been
stable or has been increasing, it would indicate that the business would continue to earn the same
rate of profit as it has done in the past. If, on the other hand, the percentage has been falling, and
there is no evidence that the factors responsible therefore have ceased to operate, investment of
further capital in the business would not be commercially advisable.
11. TYPES OF INVESTIGATION
The different types of investigation that a chartered accountant is usually called upon to carry out
are given hereunder:
Types of Investigation
Statutory Non-statutory
Investigation on behalf of an incoming
partner
Investigation into the Investigation of ownership
affairs of a company of a company (Section 216)
Investigation for valuation of shares in
private companies
By inspector through an order of
the Central Government (Section Investigation on behalf of a bank / Financial
210) Institution proposing to advance loan to a
company
By Serious Fraud Investigation
Office (Section 212) Investigation of frauds
Other cases Investigation on behalf of an individual or a
(Section 213) firm proposing to buy a business
Investigation in connection with review of
profit / financial forecast
Statutory - By an inspector under Sections 210, 212, 213 and 216 of the Companies Act, 2013 –
discussed in details in Self-Paced Module Set A.
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Non-statutory - These are listed as under:
(a) Investigation on behalf of an incoming partner.
(b) Investigation for valuation of shares in private companies.
(c) Investigation on behalf of a bank proposing to advance loan to a company.
(d) Investigation of frauds.
(e) Investigation on behalf of an individual or a firm proposing to buy a business.
(f) Investigation in connection with review of profit/financial forecast.
11.1 Investigation on behalf of an Incoming Partner
The general approach of the investigating accountant in this type of investigation would be more or less
similar, irrespective of the nature of business of the firm-manufacturing, trading or rendering a service.
Primarily, an incoming partner would be interested to know whether the terms offered to him are
reasonable having regard to the nature of the business, profit records, capital contribution, personal
capability of the existing partners, socio-economic setting, etc., and whether he would be capable
of deriving continuing benefit by the way of return on capital to be contributed and remuneration for
services to be rendered, which can be justified by the overall economic conditions prevailing and
other considerations considering his own personality and achievements. In addition, he would be
interested to ascertain whether the capital to be contributed by him would be safe and applied
usefully.
Broadly, the steps involved are the following:
(a) Ascertainment of the history of the inception and growth of the firm.
(b) Study of the provisions of the deed of partnership, particularly for composition of partners,
their capital contribution, drawing rights, retirement benefits, job allocation, financial
management, goodwill, etc.
(c) Scrutiny of the record of profitability of the firm’s business over a suitable number of years,
with usual adjustments that are necessary in ascertaining the true record of business
profits. Particular attention should, however, be paid to the nature of partners’
remuneration, which may be excessive or inadequate in relation to the nature and
profitability of the business, qualification and expertise of the partners and such other
factors as may be relevant.
(d) Examination of the asset and liability position to determine the tangible asset backing for
the partner’s investment, appraisal of the value of intangibles like goodwill, know how,
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patents, etc. impending liabilities including contingent liabilities and those pending for tax
assessment. In case of firms rendering services, the question of tangible asset backing
usually is not important, provided the firm’s profit record, business coverage and standing
of the partners are of the acceptable order.
(e) Position of orders at hand and the range and quality of clientele should be thoroughly
examined, which the firm is presently operating.
(f) Position and terms of loan finance would call for careful scrutiny to assess its usefulness and
implication for the overall financial position; reason for its absence or negative impact should
be studied.
(g) It would be interesting to study the composition and quality of key personnel employed
by the firm and any likelihood of their leaving the organisation in the near future.
(h) Various important contractual and legal obligations should be ascertained and their nature
studied. It may be the case that the firm has standing agreement with the employees as
regards salary and wages, bonus, gratuity and other incidental benefits. Full impact of
such standing agreements would be gauged before a final decision is reached.
(i) Reasons for the offer of admission to a new partner should be ascertained and it should
be determined whether the same synchronises with the retirement of any senior partner
whose association may have had considerable bearing on the firm’s success.
(j) Appraisal of the record of capital employed and the rate of return. It is necessary to have
a comparison with alternative business avenues for investments and evaluation of
possible results on a changed capital and organisation structure, if any, envisaged along
with the admission of the partner.
(k) It would be useful to have a firsthand knowledge about the specialisation, if any, attained
by the firm in any of its activities.
(l) Manner of computation of goodwill on admission as also on retirement, if any, should be
ascertained.
(m) Whether any special clause exists in the deed of partnership to allow admission in future
of a new partner, who may be specified, on concessional terms.
(n) Whether the incomplete contracts which will be transferred to the reconstituted firm will
be a liability or a loss.
It would always be worthwhile to remember that, in a partnership, personal considerations count
predominantly over other considerations and assessment of standing of the firm, standing and
reliability of other partners, their personal reputation and the goodwill enjoyed by the
products/services of the firm are important.
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On the basis of the broad frame of considerations as given above, the investigating accountant
should devise his own considerations in each case which may be quite diverse. Additional
considerations may come up in the case of service-rendering firms where profit and business record,
goodwill of the firm and of individual partners would assume greater significance.
Again, in the case of industrial firms, the network of customers, their scatter, size, etc., would be
relevant for consideration.
11.2 Investigation for Valuation of Shares in Private Companies
The importance should be given on various purposes for which such a valuation is necessary, the
different bases on which valuation is possible and the variety of economic factors, on a
consideration whereof the price so determined needs to be adjusted.
The necessity for valuation of shares of a private company arises, for under the Companies Act,
a private company must restrict the transfer of its shares. In consequence, the shares of a private
company do not have a free market in which their prices could be determined by interaction of the
forces of supply and demand.
In respect of equity shares, there are two main methods of valuation. According to the first method,
value is determined on the basis of net worth of the company. The amount of net worth is divided
by the number of shares comprising the equity capital to arrive at the value for one share. When
this method is followed, goodwill of the business, and non-trading assets (like investments) based
on the estimated future maintainable profit, is included among the assets to arrive at the amount
of net worth. According to the second method, the average profit earned by the business during
the preceding 5 to 7 years is computed. Afterwards, on the assumption that the same would
continue to be earned in the future, the value of business is calculated by capitalising it at a
reasonable rate of interest. If the rate assumed is high, the value of the business would be smaller.
Correspondingly, it would be high if the rate of interest applied is low. A provision of the risk factor
and restriction on transfers in the value of shares is made by varying the rate of interest applied.
The rate of return that an investor expects to earn in a business of the type in which the company
is engaged, is ascertained from the prices of the shares of companies engaged in a similar
business quoted on the stock exchange.
The value of preference shares is estimated on the basis of the yield on preference shares of
companies engaged in a similar trade or industry after making allowance for factors like restriction
on transferability, average rate of earnings as compared to the rate of dividend, etc.
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Special features -
Net worth basis
(a) Each asset should be revalued on taking into account its utility to the business as a going
concern. The value of different assets, on a revaluation, may be either more or less in
comparison to their book values.
16. The book value of safes and furniture in the case of a bank is usually much
less as compared to their utility. On the other hand, the book value of intangible
assets, e.g., leasehold rights, patents, goodwill, etc., in case of an industrial
concern may be higher in comparison with the advantage which accrues to it from these
assets. In both the cases, the assets should be revalued at their replacement cost i.e., the
cost of similar assets at the prevailing market price, reduced by the amount of depreciation
which they would have suffered, if they were in use during the period that the
corresponding assets have been in use. But the cost adopted, in cash, should be the cost
of the assets as were originally purchased or that of their substitutes considered more
suitable in the circumstances of the case.
(b) The value of goodwill of a business is primarily dependent on its capacity to earn super-profit
and the period over which these are expected to arise. The super profits that the business
would earn in the future are estimated on the basis of profits earned in the past, after making
an allowance therein for the continuation or otherwise of favourable factors, which in the past
had enabled the business to earn super-profits. This is usually a difficult matter since, for the
purpose, it is necessary to analyse the trend of economic, social and political forces which
have an impact on the profitability of the business.
17. The installed capacity must be viewed against future national requirements
on taking into account the government’s licensing policy. Again, government
policies like controls over selling price or advantages of marketing through its
own organisations will have to be considered since any change therein might seriously
affect the profit structure. Therefore, to determine the impact of these factors, the
accountant must have knowledge of the company’s working and experience of the
business in general.
Yield basis
(a) The value of shares on yield basis is arrived at on the basis of present value of the right to
receive dividends in the future. Since dividends can be paid only out of profits, in this case
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.37
also, it is necessary to determine the amounts of profits which the company would be earning
in future as well as the amounts thereof which would be distributed as dividend from year to
year. In short, it is an exercise of projecting the trend of profits and predicting the policy that
the company might follow in the matter of declaration of dividends.
(b) The rate at which the amount of dividends should be capitalised is decided on taking into
account the risk that shareholders are taking in the matter of declaration of dividends being
continued in future, assessed in the background of past history of the company, the amount
of reserves the company possesses, both secret and those disclosed in its books, future
prospects of the line of manufacture or trade in which the company is engaged and the impact
of various social and political factors that are likely to emerge on the company’s profitability.
Since the effect of these factors is reflected in the prices at which the shares of companies
engaged in similar trades and businesses are quoted on the Stock Exchange, the
investigating accountant should consider them. This would help him to know the rate at which
their dividends were being capitalised. He should adopt the average rate of return expected
by investors in the shares of such companies but it should be applied only after making due
allowance for the factors peculiar to the case, such as restrictions on transfer of shares,
majority holding, etc. In any valuation of shares, with the transfer of shares control is also to
pass, a separate value should be ascertained for the control and added to the value otherwise
obtained either on net worth basis or yield basis.
11.3 Investigation on behalf of a Bank/ Financial Institution Proposing to
Advance/Loan to a Company
A bank is primarily interested in knowing the purpose for which a loan is required, the sources from
which it would be repaid and the security that would be available to it, if the borrower fails to pay
back the loan. On these considerations, the investigating accountant, in the course of his
enquiry, should attempt to collect information on the under-mentioned points:
(i) The purpose for which the loan is required and the manner in which the borrower
proposes to invest the amount of the loan.
(ii) The schedule of repayment of loan submitted by the borrower, particularly the
assumptions made therein as regards amounts of profits that will be earned in cash and
the amount of cash that would be available for the repayment of loan to confirm that they
are reasonable and valid in the circumstances of the case. Institutional lenders now-a-
days rely more, for repayment of loans, on the annual profits and loss, and on the values
of assets mortgaged to them.
(iii) The financial standing and reputation for business integrity enjoyed by directors and
officers of the company.
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17.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(iv) Whether the company is authorised by the Memorandum or the Articles of Association
to borrow money for the purpose for which the loan will be used.
(v) The history of growth and development of the company and its performance during the
past 5 years.
(vi) How the economic position of the company would be affected by economic, political and
social changes that are likely to take place during the period of loan.
(viii) Whether any loan application to any other Bank or Financial Institution was made, and
if so, the reasons for rejection thereof.
To investigate the profitability of the business for judging the accuracy of the schedule of
repayment furnished by the borrower, as well as the value of the security in the form of assets
of the business already possessed and those which will be created out of the loan, the
investigating accountant should take the under-mentioned steps:
(a) Prepare a condensed income statement from the Statement of Profit and Loss for the
previous five years, showing separately therein various items of income and expenses, the
amounts of gross and net profits earned and taxes paid annually during each of the five years.
The amount of maintainable profits determined on the basis of foregoing statement should be
increased by the amount by which these would increase on the investment of borrowed funds.
(b) Compute the under-mentioned ratios separately and then include them in the statement to
show the trend as well as changes that have taken place in the financial position of the
company:
(i) Sales to Average Inventories held.
(ii) Sales to Fixed Assets.
(iii) Equity to Fixed Assets.
(iv) Current Assets to Current Liabilities.
(v) Quick Assets (the current assets that are readily realisable) to Quick Liabilities.
(vi) Equity to Long Term Loans.
(vii) Sales to Book Debts.
(viii) Return on Capital Employed.
(c) Enter in a separate part of the statement the break-up of annual sales product-wise to show
their trend.
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.39
Steps involved in the verification of assets and liabilities included in the Balance Sheet of the
borrower company which has been furnished to the Bank - The investigating accountant should
prepare schedules of assets and liabilities of the borrower and include in the particulars stated below:
(a) Fixed assets - A full description of each asset its gross value, the rate at which depreciation
has been charged and the total depreciation written off. In case the rate at which depreciation
has been adjusted is inadequate, the fact should be stated. In case any asset is encumbered,
the amount of the charge and its nature should be disclosed. In case an asset has been
revalued recently, the amount by which the value of the asset has been decreased or
increased on revaluation should be stated along with the date of revaluation. If considered
necessary, he may also comment on the revaluation and its basis.
(b) Inventory - The value of different types of inventories held (raw materials, work-in-progress
and finished goods) and the basis on which these have been valued.
Details as regards the nature and composition of finished goods should be disclosed. Slow-
moving or obsolete items should be separately stated along with the amounts of allowances,
if any, made in their valuation. For assessing redundancy, the changes that have occurred in
important items of inventory subsequent to the date of the Balance Sheet, either due to
conversion into finished goods or sale, should be considered.
If any inventory has been pledged as a security for a loan the amount of loan should be
disclosed.
(c) Trade Receivables, including bills receivable - Their composition should be disclosed to
indicate the nature of different types of debts that are outstanding for recovery; also whether
the debts were being collected within the period of credit as well as the fact whether any
debts are considered bad or doubtful and the provision if any, that has been made against
them.
Further, the total amount outstanding at the close of the period should be segregated
as follows:
(i) debts due in respect of which the period of credit has not expired;
(ii) debts due within six months; and
(iii) debts due but not recovered for over six months.
If any debts are due from directors or other officers or employees of the company, the
particulars thereof should be stated. Amounts due from subsidiary and affiliated concerns, as
well as those considered abnormal should be disclosed. The recoveries out of various debts
subsequent to the date of the Balance sheet should be stated.
© The Institute of Chartered Accountants of India
17.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(d) Investments - The schedule of investments should be prepared. It should disclose the date
of purchase, cost and the nominal and market value of each investment. If any investment is
pledged as security for a loan, full particulars of the loan should be given.
(e) Secured and Unsecured Loans - Debentures and other secured loans should be included
together in a separate schedule. Against the debentures and each secured loan, the amounts
outstanding for payments along with due dates of payment should be shown. In case any
debentures have been issued as a collateral security, the fact should be stated. Particulars
of assets pledged or those on which a charge has been created for re-payment of a liability
should be disclosed. Details of loans proposed to be obtained from Promoters/ Directors/
Related Parties should be stated separately. In case any unsecured loan is to be repaid prior
to repayment of Bank loan, its terms and conditions should be verified.
(f) Provision of Taxation - The previous year’s up to which taxes have been assessed or
assessment order received should be ascertained. If provision for taxes not assessed
appears to be inadequate, the fact should be stated along with the extent of the shortfall.
(g) Other Liabilities - It should be stated whether all the liabilities, actual and contingent, are
correctly disclosed. Also, an analysis according to ages of trade payables should be given to
show that the company has been meeting its obligations in time and has not been depending
on trade credit for its working capital requirements.
(h) Insurance - A schedule of insurance policies giving details of risks covered, the date of
payment of last premiums and their value should be attached as an annexure to the
statements of assets, together with a report as to whether or not the insurance-cover appears
to be adequate, having regard to the value of assets.
(i) Contingent Liabilities - By making direct enquiries from the borrower company, from
members of its staff, perusal of the files of parties to whom any loan has been advanced for
example, those of machinery suppliers and the legal adviser. The investigating accountant
should ascertain particulars of any contingent liabilities which have not been disclosed. In
case, there are any, these should be included in a schedule and attached to the report.
11.4 Investigation of Frauds
In the Companies Act, 2013 meaning of fraud has been considered in two specific sections viz.
Section 143(10), where the SAs specified by the ICAI are deemed to be the auditing standards for
purposes of the Act, which, inter alia, define fraud, and in Section 447, where punishment for fraud
has been prescribed.
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.41
Fraud has been defined in paragraph 11(a) of SA 240, “The Auditor’s responsibilities Relating to
Fraud in an Audit of Financial Statements” as ‘an intentional act by one or more individuals among
management, those charged with governance, employees, or third parties, involving the use of
deception to obtain an unjust or illegal advantage.’
In the context of stating the provisions for punishment for fraud, Section 447 of the Act has explained
the term ‘fraud’ as “fraud in relation to affairs of a company or any body corporate, includes any act,
omission, concealment of fact or abuse of position committed by any person or any other person
with the connivance in any manner, with intent to deceive, to gain undue advantage from, or 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.”
This Section further explains the terms ‘wrongful gain’ and ‘wrongful loss’ to mean the gain by
unlawful means of property to which the person gaining is not legally entitled; and the loss by
unlawful means of property to which the person losing is legally entitled, respectively.
11.4.1. Types of Frauds
Frauds may broadly be categorized as –
Fraudulent Financial Reporting – Mis-appropriation of Assets – Corruption
Alteration or falsification of Embezzlement of receipts in Conflict of
records & documents respect of written-off Interest
Misrepresentation in or accounts – Skimming or Cash Bribery
intentional omission of events, Larceny
Illegal
transactions or information Stealing physical assets or Gratuities
Intentional misapplication of intellectual properties
Money
accounting principles Introduction of fictitious Laundering
Fictitious Journal Entries vendors
Adjusting assumptions and Payroll Schemes – Ghost
changing Judgments Employees, Falsified Wages,
& Commission Schemes
Omitting, advancing or
delaying the recognition of Reimbursement Schemes –
events or transactions. Mischaracterised Expenses,
Multiple Reimbursement, &
Abnormal Year End
Fictitious Expenses
Transactions.
Using entities assets for
Improper Asset Valuation
personal use.
Overstatement of Revenue or
Understatement of Liabilities
© The Institute of Chartered Accountants of India
17.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Fraudulent Entries - Sales Frauds - Collection Frauds – Expenses Frauds –
• Late entry • Price enhancement • Defalcation of • Entering ineligible
• No entry • Omission to make receipt contributions to charity discount
of sale of scrap. funds • Overcharging expenses
• Part entry • Crediting donation to loan
• Billing and sales reversals • Falsification of documents
• Inserting wrong entries to in amusement parks. accounts.
divert attention • Untimely payment
• Food production yield ratio • Rental collected in cash • Introduction of fictitious
in hotels and suppression but not recorded. vendor.
of Revenue. • Unnecessary/ huge
• Using or hiring assets of provisioning of expenses.
the company in lean
period
• Omission in preparation of
dispatch note for sale
• Sale of Assets recorded
as Income
• Cash sale adjusted as
credit sale.
• Writing off a good debt as
bad & irrecoverable
Payroll Frauds – Data Frauds –
•Extra number of employees • Change in computer data
•Extra hours • Destroy, suppress or insert records
•Calculation of net pay by transferring • Using open fields in computerized
rounding off amount to personal account. accounting system
•Not deactivating the retired employees’ IDs
•Fictitious employees/ workers paid salary.
Technology related Frauds – Banking related Frauds - Others –
• Employing hostile Software • Forged Signatures • Teaming and Lading
Programs or malware attacks • Cheque Frauds - Alteration in • Process houses mixing inferior
• Phishing mails amounts, Alteration in accounts quality material to sale good
• Vishing – Voice Mail titles, Kite flying quality material
• Smishing - Text messages • Cash lending during working • Pilferage and theft in super
• Whaling – Targeted phishing on hours markets
high network individuals • Missing notes in bundles • Selling classified information,
• Card duplications • Use of same notes bundles by • Withholding information from
• Stealing confidential data two branches customer about free product
• Wrong posting in other accounts schemes, discount and
• Misuse of sensitive stationery concession.
• ATM transaction misuse • Enhancement of performance
• Using PINs of debit card/credit • Taking advantage of disaster or
card holder natural calamity.
• Advances - inflated stock • Trust FDs
statements, inflated projections, • Fictitious journal entries to inflate
forged/duplicate land expenses or income.
documents, L/Cs
© The Institute of Chartered Accountants of India
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Corruption
Conflicts of Illegal Economic
Bribery
Interest Gratuities Extortion
Purchasing Invoice
Scheme Kickback
Sales
Bid Rigging
Schemes
Financial Statement Fraud
Net Worth/Net Income Net Worth/Net Income
Overstatements Understatements
Timing Differences Timing Differences
Fictitious revenues Understated Revenues
Concealed liabilities and expenses Overstated liabilities and expenses
Improper Asset Valuations Imporper Asset Valuations
Improper Disclosures Improper Disclosures
© The Institute of Chartered Accountants of India
Asset Misappropriation
Inventory and All Other
Cash
Assets
Theft of Cash Theft of Cash Fraudulent
Misuse Larceny
on Hand Receipts Disbursements
Expenses Check and Assets
Cash Billing Payroll Register
Skimming Reimbursement Payment requisition
Larceny Schemes Schemes Disbursement
Schemes Tempering and transfers
Mischaracter
Refunds and Shell Ghost Forged False Sales
Sales Reveivables ised False Voids
Other Company Employee Maker & Shipping
Expenses
Non- Forged Purchasing
Write-off Falsified Overstated False
Unrecorded Accomplice Endorsemen and
Schemes Wages Expenses Refunds
Vendor t Receiving
Lapping Personal Commission Fictitious Altered Unconcealed
Undestaded
Schemes Purchases Schemes Expenses Payee Larceny
Multiple Authorised
Unconcealed
reimbursements maker
Source: Occupational Fraud 2022: A Report to the Nations
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.45
Frauds may be classified as defalcations involving misappropriation, either of money or that of
goods, and manipulation of accounts not involving a defalcation. The detections of manipulations of
accounts being one of the objects of an audit, for the detection of frauds perpetrated for
misappropriating either money or goods, knowledge of the various circumstances under which these
may be committed and that of different forms they take is essential. On this account, a brief
description thereof at different level is given below:
1. Fraud for Personal Gains
Bribery: Money, gift or other favours offered to procure (often illegal or dishonest) action or
decision in favour of the giver. These are also relatable to contract fraud or procurement fraud
and are, generally, out of books transactions. The auditor normally conducts a propriety audit
over the veracity of the transactions and review of any undue favours to vendors.
When money, gift or other favours are offered to public official to influence an official act of
government then such kind of Bribery is called Official Bribery. In contrast to Commercial
Bribery or favours to vendors, in case of Official Bribery, Company usually is criminally
prosecuted.
2. Corporate Frauds/ Irregularities
(i) Advance Billing: Advance billing is a situation where the company officials indulge in
booking fictitious sales in anticipation of actual sales. This results in misrepresentation
of revenue in the books thereby misleading financers and stakeholders. When the
management treats borrowings from money lenders as customer advances in the
books against sale orders or for adjusting bills receivables, the fraudulent act gets
unnoticed for an extended period. This situation results in a death knell for the
corporation as the company is dragged into an irredeemable debt trap.
Use of Shell Company, false vendors, purchases of personal nature booked as official
expenses enable falsification of accounts and diversion of funds for purposes other
than an intended purpose. These could also be mechanism for employees or cartel of
employees engaging in personal gain at the cost of the company. In the former incident
this could be termed as management fraud.
(ii) Shell/ Dummy Company Schemes: Generally, represents a fictitious company or a
‘paper company’ to transfer profits or funds from the main company. This could also
involve fictitious bills (mostly for services rendered or consultancy charges that cannot
be corroborated) which are used in the name of dummy companies diverting the funds
taken from banks and financial institutions.
© The Institute of Chartered Accountants of India
17.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The books could be falsified by wrong classification of expenses, inflating the expense
claims, fictitious expenses or multiple reimbursements. A review of controls, normally,
leads to the uncovering of expense booking that are prima facie not incurred.
(iii) Money-Laundering Activities: As per the Prevention of Money-Laundering Act,
2002, “whosoever directly or indirectly attempts to indulge or knowingly assists or
knowingly is a party or is actually involved in any process or activity connected with
the proceeds of crime and projecting it as untainted property shall be guilty of offence
of money-laundering.”
The person indulging in money laundering looks for avenues with weak banking
controls for converting illegal money into the banking system. Any excess credit in the
bank accounts that does not belong to the customer or is parked for a temporary period
should raise suspicion of such activities. This person indulging in money laundering
activity looks for avenues to enter into ‘benami’ (could be called ‘proxy’ name lending)
transactions. Companies with extensive cash handling and inadequate control over
source of money or involved in remittance of money for import/ export of goods etc.
are susceptible to money laundering activities.
3. Fraud at Operational Level Employees
(i) Tampering of Cheques/Drafts/On-line payments/receipts: Tampering of cheques,
payee name being altered, or preparation of cheques without the same being issued
to payee, etc., are methods that may also lead to falsification of accounts.
On-line payments generally are considered a transparent mechanism to prevent the
above frauds. The ATM is a popular technological advancement that has inherent
control gaps. For example, credit cards once swiped the transaction is put through in
the system without the need for a signature of the payer. Similarly, unauthorised
credits in bank accounts through ATMs are an immense source of threat to recipients
including bribery allegations, unless they lodge a complaint with the bankers or the
regulatory authorities in a prompt manner of such unauthorised credits to their
accounts/or company bank accounts.
Care should be taken that the name of the payee in the payment transactions in books
and cheque issued therein for payment is not fabricated to wrongly codify and book
against an improper account head.
(ii) Off Book Frauds: In off book frauds, the fraud perpetrator misappropriates the cash
before these are recorded in the books or before the sale is recorded in the books.
© The Institute of Chartered Accountants of India
DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.47
These frauds are difficult to unearth as the cash or collection is taken off before the
accounting entries are made in the books. This situation arises especially in
unorganized markets and in rural economies where banking habits are relatively under
developed. These are difficult to establish due to absence of audit trails and are more
prevalent in businesses that have extensive cash dealings. These are difficult to
uncover as the means adopted could include printing of receipts/ bills outside the
system.
The above fraudulent schemes can be established based on circumstantial evidence
or validation through external sources such as, customer balance confirmations
(where feasible) and customer copy of the receipts or other documents that are
retained by them. These are also further supplemented by external evidence in the
form of background checks and surveillance mechanism. Verification of all the receipts
and issues of stock recorded in stock register is another way to identify this type of
fraud.
(iii) Cash Misappropriation: Cash is misappropriated after the accounting entries are
already passed in the books. These are identified through surprise checks and through
shortages in cash balances. These occur when there are delays in accounting of cash
collections and there are no laid down cash flow controls. Unaccounted money in any
form in an entity is a serious red flag in uncovering of irregularities. Improper daily fund
monitoring mechanism is another factor that results in creating unauthorised float by
employees in their personal account or in fictitious surrogate (proxy) entities by
fraudsters.
(iv) Teeming and Lading: This is also achieved through cash deposits or cheques
collected from customers being overlapped with the collections from subsequent
customers and the amount collected is diverted to personal account. Reconciliation of
customer accounts at a single point of time and confirmation from customers for
amounts outstanding in their accounts helps in identifying any leakage in collections.
(v) Fraudulent Disbursements: Fraudulent disbursements or reimbursements take
place either by issuing or submission of false bills, or personal expense bills being
converted into official expenses bills. The other method that is resorted to by the
perpetrator of fraud is to inflate the refunds due to a customer and skim the excess
refunds.
(vi) Expense Reimbursement Schemes: These fraudulent schemes involve employees
resorting to treating their personal expenses as incurred for business purpose and
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17.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
claiming reimbursement. In some cases, employees may get reimbursed by third
parties (such as distributors) as well as by claiming these expenses from the company.
Multiple expense claims based on duplicate bills or photostat copies.
(vii) Payroll Fraud: The payroll fraud could include payment to non-existent employees or
in a contractual arrangement inflating of the manpower resources than those actually
deployed while billing the client. It may also include showing higher pay than actual
disbursement to employees/ workers, etc. The process would require a detailed review
of statutory declarations/filings under various labour law statutes including disclosures
in financial statements of retirement benefits such as P.F, Gratuity and
Superannuation benefits from an evidence gathering perspective.
(viii) Commission Schemes: The salesman exaggerates the sales through fictitious
billings to earn higher commission or alter the sales prices of the products sold from
those stipulated by the company or share the sales volumes achieved with other
employees to share higher commission. Commission schemes in mega deals backed
by legal documents are often tools used to camouflage kickbacks. These are often
difficult to uncover and would need to be supplemented by the monetary trails across
entities and geographies.
Procedure for Investigation of Fraud: Before proceeding to investigate frauds of the
type afore mentioned, the investigating accountant should ascertain the exact duties
of the person concerned who is suspected to have committed a fraud; his relationship
to the general routine of the office, and the circumstances in which any known
instances of defalcation have come to light. Such an enquiry would give a clue to
promising avenues of investigation. Greater the authority of the individual suspected
of a fraud, wider would be the field which would have to be covered by the
investigation. At times, an accountant is called upon to investigate a suspected fraud,
the details or the nature whereof is not known. In such a case, for localising the source
of the fraud, the investigating accountant will have to study the financial and
accounting structure of the organisation. As a first step, he should examine the line of
responsibility between the various members of the staff. He should have a look at the
system of internal control in operation for spotting out the weaknesses, if any, that may
exist in it. Relying on the above study, he should direct his enquiry towards those
aspects of the business where there has been excessive control in the hands of single
persons/ employee, without any supervision by any other person/ employee or, any
other inherent weakness that may be in existence in the system.
© The Institute of Chartered Accountants of India
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Some of the situations in which money may be embezzled and the various forms that such
frauds usually take place alongwith their investigation procedure include the following:
(a) Cash receipts - In cases like holding back cash sales, collections by travelling salesmen,
V.P.P receipts, or casual receipts, e.g., sales of scrap, recoveries out of debts written off
earlier, etc., the amount or amounts of receipts embezzled may be subsequently covered up
by the perpetrator adopting one or other of the under-mentioned devices:
(i) Issuing a receipt to the payee for the full amount collected and entering only a part of
the amount on the counterfoil.
(ii) Showing a larger cash discount than actually allowed.
(iii) Adjusting a fictitious credit in the account of a customer for the value of goods returned
by him.
(iv) Adjusting a cash sale as a credit sale, and raising a debit in the account of the
customer.
(v) Writing off a good debt as bad and irrecoverable to cover up the amount collected
which has been misappropriated.
(vi) Short-debiting the customer’s account in the ledger with an intention to withdraw the
difference when the full amount payable by him is collected.
(vii) Under-casting the receipts side of the Cash Book or over-casting the payment side.
(viii) Carrying over a shorter total of the receipts from one page of the Cash Book to the
next or over-carrying the total of the payment from one page of the Cash Book to the
next with a view to covering up misappropriation; either short banking of cash
collection or a part of the amount of withdrawal from the bank.
Verification of Cash Receipts: On the assumption that some of these may have been
diverted before being entered in the books, evidence as regards income received from
different sources should be scrutinised, e.g., inventory, sales summaries, rental registers,
correspondence with customers, advices of travelling salesmen and counterfoils or receipts.
Carbon copies of receipts marked ‘duplicate’, should be scrutinised to confirm that they are
in fact copies of receipts issued earlier. In addition, by recalling paying-in-slips from the bank
the details of cash deposited on each day should be compared with those shown in the Cash
Book. The record of sales of scrap of waste paper, that of collection of rents from labourers
temporarily accommodated in the company’s quarters, that of refunds of amounts deposited
with the electric supply co., or any other Government authorities should be examined for
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17.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
finding out if any of these amounts have been misappropriated. Cash sales should be
vouched in detail. Recoveries from customers and sundry parties should be checked with the
copies of receipts issued to them; deductions made on account of cash discounts should be
reviewed. All withdrawals from the bank should be checked by reference to corresponding
entries in the bank pass book.
(b) Inflating cash payment – Cash payment frauds may be in the form of:
(i) Making double payment of an invoice or paying a false invoice.
(ii) Paying personal expenses out of the business by falsifying details. e.g., showing
betting losses as advertisement charges.
(iii) Withdrawing unclaimed credit balances of customers or amounts falsely credited in
the accounts of parties.
(iv) Falsely adjusting a refund in the account of a customer and withdrawing the credit
balance.
(v) Wrong totalling of the wage sheets and misappropriating the excess amount withdrawn
from the bank for payment of wages.
Verification of Cash Payments: All the evidence as regards cash payments made, including
acknowledgement by parties for payments shown to have been made to them, should be
carefully scrutinised. In the case where a figure appears to have been erased or altered on
the receipts issued by the party, on reference to the party concerned, the actual amount paid
to him should be confirmed. The same procedure should be adopted in respect of amounts
acknowledged on blank papers. All payments by bearer cheques should be examined. The
system of recording of wages should be reviewed, specially as regards possible over-totalling
of wage sheets, and entries in them of dummy workmen. The system of ordering and receiving
goods should be reviewed so as to confirm that no payment has been made in respect of
supplies which have not been received. Confirmations should be obtained from partners or
Directors in respect of amounts shown to have been paid to them.
The Petty Cash Book should be vouched and totaled. Special attention should be paid to
payments made on account of salaries and wages; confirmation should be obtained from the
management that all payments of such salaries and wages were made to persons who were
actually in the service of the company. All the withdrawals from the bank should be checked
by reference to entries in the bank’s pass book. All the bills receivable or payable should be
checked by reference to the Bills Books.
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(c) Frauds through suppliers’ ledger -
(i) Adjusting fictitious or duplicate invoices as purchases in the accounts of suppliers and
subsequently misappropriating the amounts when payments are made to the suppliers
in respect of these invoices.
(ii) Suppressing the Credit Notes issued by suppliers and withdrawing the corresponding
amounts not claimed by them.
(iii) Withdrawing amounts unclaimed by suppliers, for one reason or another by showing
that the same have been paid to them.
(iv) Accepting purchase invoices at prices considerably higher than their market prices
and collecting the excess amount, paid in cash, from the suppliers.
Verification of balances in suppliers’ ledger - The Purchase Journal should be vouched
by reference to entries in the Goods Inward Book and the suppliers’ invoices to confirm that
amounts credited to the accounts of suppliers were in respect of goods, which were duly
received and the suppliers’ accounts had been credited correctly. All the suppliers should be
requested to furnish statements of their accounts to see whether or not any balance is
outstanding or due so as to confirm that allowances and rebates given by them have been
correctly adjusted and were duly authorized by the authorized person/ officer. Examine the
system of internal control in relation to purchase orders issued and identify possibilities of
collusion with suppliers.
(d) Customers’ ledger -
(i) By the ‘teeming and lading’ method, i.e., misappropriating the amount collected from
a customer and crediting his account by the amount paid by him only when an amount
is subsequently collected from another customer; repeating this practice with several
items collected and depositing back the amount or amounts so misappropriated before
the close of the year.
(ii) Misappropriating the amount collected from a customer and subsequently adjusting
his account by crediting the amount on account of allowance or a rebate for excess
price charged.
(iii) Crediting the amount received from a customer to the account of another customer
and subsequently withdrawing the amount wrongly credited.
Verification of balances in customers’ ledger: Special attention should be paid to
allowances adjusted on account of goods returned or difference in price or on any other
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17.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
account as well as to amounts written off as bad debts. To confirm that the accounts of
customers have been debited in respect of goods supplied to them, entries in the Order Book
should be cross-checked with those in the Sales Day Book where the same is kept. The
investigating accountant should obtain confirmation of customers in respect of the amounts
standing in their accounts. Those of them who have no balance in their accounts should be
requested to confirm the statement of their account (which should be sent to them) for
ascertaining that the entries shown therein were genuine.
(e) Inventory Frauds-Inventory frauds are many and varied but here we are concerned with
misappropriation of goods and their concealment.
(i) Employees may simply remove goods from the premises.
(ii) Theft of goods may be concealed by writing them off as damaged goods, etc.
(iii) Inventory records may be manipulated by employees who have committed theft so that
book quantities tally with the actual quantities of inventories in hand.
(iv) Inflating the quantities issued for production is another way of defalcating raw
materials and store items.
(v) Stocks actually dispatched but not entered in sales/ debtor’s account.
Verification Procedure for Defalcation of inventory - It may be of trading stock, raw
materials, manufacturing stores, tools or of other similar items (readily) capable of conversion
into cash. The loss may be the result of a theft by an employee once or repeatedly over a
long period, when the same have not been detected. Such thefts usually are possible through
collusion among a number of persons. Therefore, for their detection, the entire system of
receipts, storage and dispatch of all goods, etc. should be reviewed to localise the weakness
in the system.
The determination of factors which have been responsible for the theft and the establishment
of guilt would be difficult in the absence of: (a) a system of inventory control, and existence
of detailed record of the movement of inventory, or (b) availability of sufficient data from which
such a record can be constructed. The first step in such an investigation is to establish the
different items of inventory defalcated and their quantities by checking physically the
quantities in inventory held and those shown by the Inventory Book. Investigating accountant
should ascertain the exact duties of persons handling the stocks received in and issued from
store for production/ sale or any other purpose. Identify the excessive control in the hands of
a single person, without any supervision as it will widen the scope of investigation.
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Afterwards, all the receipts and issues of inventory recorded in the Inventory Book should be
verified by reference to entries in the Goods Inward and Outward Registers and the
documentary evidence as regards purchases and sales. This would reveal the particulars of
inventory not received but paid for as well as that issued but not charged to customers.
Further, entries in respect of returns, both inward and outward, recorded in the financial books
should be checked with corresponding entries in the Inventory Book. Also, the totals of the
Inventory Book should be checked. Finally, the shortages observed on physical verification
of inventory should be reconciled with the discrepancies observed on checking the books in
the manner mentioned above. In the case of an industrial concern, issue of raw materials,
stores and tools to the factory and receipts of manufactured goods in the godown also should
be verified with relative source documents.
Defalcations of inventory, sometimes, also are committed by the management, by diverting a
part of production and the consequent shortages in production being adjusted by inflating the
wastage in production; similar defalcations of inventories and stores are covered up by
inflating quantities issued for production. For detecting such shortages, the investigating
accountant should take assistance of an engineer. For that he will be more conversant with
factors which are responsible for shortage in production and thus will be able to correctly
determine the extent to which the shortage in production has been inflated. In this regard,
guidance can also be taken from past records showing the extent of wastage in production in
the past. Similarly, he would be able to better judge whether the material issued for production
was excessive and, if so to what extent. The per hour capacity of the machine and the time
that it took to complete one cycle of production, also would show whether the issues have
been larger than those required.
11.4.2 Indicators of Fraud
Several indications of possible frauds can be listed as follows :-
i. Discrepancies in Accounting Records including non-recording or partial recording or
incorrect recording or delayed recording of amounts, misclassifications, etc.
ii. Conflicting or missing evidence including missing documents, altered documents,
significant unexplained items in reconciliations, discrepancies between entity’s records
and confirmations received etc.
iii. Unacceptable management responses such as – denial of access to
records/facilities/employees, undue time pressure to resolve complex issues, unusual
delays in providing requested information, denial for use of Computer Assisted Audit
Techniques, unwillingness to address identified deficiencies in internal control etc.
iv. Other indications such as – Accounting Policies in variance with Industry Norms, Frequent
changes in accounting estimates etc.
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17.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The Fraud Diamond: Considering the Four Elements of Fraud:Many frauds, especially some of
the multibillion-dollar ones, would not have occurred without the right person with the right
capabilities in place. Opportunity opens the doorway to fraud, and incentive and rationalization can
draw the person toward it. But the person must have the capability to recognize the open doorway
as an opportunity and to take advantage of it by walking through, not just once, but time and time
again. This give rise to the fourth element of fraud.
Fraud Diamond i.e. four elements of fraud is a theory which was established by David T. Wolfe and
Dana R. Hermanson. Under this Wolfe and Hermanson classified the indicators of fraud into 4
categories
Fraud Diamond: Four Elements of Fraud
• Incentive: I want to, or have a need to, commit fraud.
• Opportunity : There is a weakness in the system that the right person could exploit. Fraud
is possible.
• Rationalization: I have convinced myself that this fraudulent behavior is worth the risks.
• Capability: I have the necessary traits and abilities to be the right person to pull it off. I have
recognized this particular fraud opportunity and can turn it into reality.
A pictorial depiction of the Fraud Diamond is as follows:
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11.4.3 Responses to Fraud
SA 330 states the auditor’s responses to assessed risks. It requires auditor to assign and supervise
personnel taking into account of the knowledge, skill and ability of the individuals, evaluation of
selection and application of accounting policies by the entity and incorporation of an element of
unpredictability in the selection of the nature, timing and extent of audit procedure.
Response to the risks related to management override of controls includes Testing the
appropriateness of journal entries and other adjustments made in preparation of the Financial
Statements, review of accounting estimates for biases and also review the significant transactions
that are outside the normal course of business for the entity or that otherwise appear to be unusual.
Auditor need to assessed fraud risk factors for material misstatement or misappropriation of assets
due to fraud, such as incentive / pressures, opportunities and attitudes /rationalizations.
The responses to fraud will include communications to management and with those charged with
governance, communication to regulatory and enforcement authorities and appropriate
documentation on his assessment of the risks of material misstatement.
Auditor’s ability to detect fraud depends on factors such as –
─ the skillfulness of the perpetrator
─ the frequency & extent of manipulation
─ the degree of collusion involved
─ the relative size of Individual amounts manipulated; and
─ the seniority of those individuals involved.
Detection of Fraud depends upon effectiveness of Audit Procedure. Detection risk, however, can
only be reduced, not eliminated.
TEST YOUR UNDERSTANDING 2
A company has installed an Effluent treatment plant (ETP) in compliance with pollution control
regulations of the state government. The authority structure in the company is fairly decentralized
and top management of the company has given considerable leeway to different departments for
meeting their manpower requirements in accordance with emerging and changing needs from time
to time. Of late, the top management has grown suspicious over manpower expenditure in section
maintaining and beautifying area around ETP. There is a system in the company where time cards
are punched by all employees to mark attendance.
Suggest any one procedure you would perform as an investigator to bring out the facts.
© The Institute of Chartered Accountants of India
17.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
11.5 Investigation on behalf of an Individual or Firm Proposing to Buy a
Business
Scope of investigation - The objective of such an investigation is to collect such information as
would enable the purchaser to decide whether it is worthwhile to buy the business and if so, for what
amount. The investigation should proceed broadly on the same lines as for valuation of shares.
Additional matters which must receive the attention of the investigating accountant on which, if
appropriate, information to the client should be given.
(A) In case of proprietary concerns or partnerships -
(i) Reasons for the sale of the business and the effect on turnover and profits that there
would be on retirement of the present proprietor (or partners).
(ii) The length of lease under which the premises are held, the prospects of its renewal or
extension.
(iii) The unexpired period of any patents owned by the vendors.
(iv) The age of the present managerial staff and the prospects of continuing in service
under the new proprietorship and the possible liability, not already provided for that
would arise as regards payment of pensions or gratuities in case of old and aged
employees/ retrenched employees.
(v) If the bulk of sales are made to customers whose number is small, the profitability of
the business would be greatly shaken on withdrawing their support. This would be an
element of weakness which should be investigated as it might affect future profitability.
(vi) The valuation that could be placed on goodwill to determine whether that appearing in
the book is less or more; if none is included to determine the amount that should be
included, if at all.
(B) If the business belongs to a limited company -The vendors’ interest in this case will be
purchased by the acquisition of shares. On that account, the following additional matters
would also require consideration:
(i) The authorised and issued capital of the company.
(ii) Whether there is any uncalled liability on the shares.
(iii) If the capital is divided into different classes of shares - the rights that are attached to
each class.
(iv) Particulars of dividends paid in the past and the amounts thereof which are in arrear
(on cumulative preference shares).
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(v) If there are any mortgages/ charge created on the assets appearing in the company’s
books, a search should be made in the Register of Charges in the office of the
Registrar of Companies.
(vi) The price at which the shares are being offered. If the company is a public company,
the price will usually be in excess of market price quoted on the Stock Exchange, but
in the case of unquoted shares particularly where the company whose shares are
being acquired is a private company, a valuation will have to be placed on the shares
for the purpose of purchase.
11.6 Investigation in connection with review of Profit/Financial Forecasts
There are many investigations which involve an examination of future profits like,
(1) Profit reports can be required as part of a general investigation into the purchase of a
business or,
(2) By banks and financial institutions with regard to project cash flow and profitability statements
for appraisal of loan applications submitted by the intending borrowers.
All forecasts depend, to a large extent, on the nature of the business with its numerous and
substantial uncertainties. Therefore, such forecasts are not capable of verification by the reporting
accountants in the same way as financial statements which present the results of a completed
accounting period. Normally, such situations involve special review as these depart from the
auditor’s traditional role of expressing an opinion in relation to past events.
12. FORENSIC ACCOUNTING
The number of fraudulent activities and ambiguous financial activities have been accelerating all
over the world. Consequently, businesses are exposed to risks of fraudulent activities. With all of
the recent corporate accounting scandals at Parmalat, Xerox Corporation, and Satyam Computer
Services, and all the high-profile corporate frauds at Enron, WorldCom, and HealthSouth followed
by Bernie Madoff’s colossal ponzi scheme, the media has made Forensic Accounting and Forensic
Accounting into a growth industry.
Forensic Accounting has established itself as dynamic and strategic tool in combating corruption,
financial crimes and frauds through investigations and resolving allegations of fraud and
embezzlement. Thus, a new area, known as Forensic Accounting, was needed to detect the frauds
in companies that suspected fraudulent transactions.
© The Institute of Chartered Accountants of India
17.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
“Forensic” means “suitable for use in the court of law”. Bologna said that it is the
application of financial skills and investigative mentality to unresolved issues, conducted
within the context of the rules of evidence. As an emerging discipline, it encompasses
financial expertise, fraud knowledge and a sound knowledge and understanding of
business reality and the working of legal system.
However, the definition of Forensic Accounting keeps on changing in response to the growing needs
of corporations. Simply stated, Forensic Accounting includes the use of accounting, accounting and
investigative skills to assist in legal matters.
Important Definitions:
Forensic: The word forensic comes from the Latin word forensis, meaning "of or before the
forum." It is -
Relating to, used in, or appropriate for courts of law or for public discussion or
argumentation.
Relating to the use of science or technology in the investigation and establishment of
facts or evidence in a court of law.
Forensic Accounting: The integration of accounting, auditing and investigative skills yields the
specialty known as Forensic Accounting. It is the study and interpretation of accounting evidence.
It is the application of accounting methods to the tracking and collection of forensic evidence, usually
for investigation and prosecution of criminal acts such as embezzlement or fraud.
Book definition: Forensic Accounting by Hopwood, Leiner, and Young
• Forensic accounting is the application of investigative and analytical skills for the purpose
of resolving financial issues in a manner that meets standards required by courts of law.
• Forensic accountants apply special skills in accounting, auditing, finance, quantitative
methods, certain areas of the law, research and investigative skills to collect, analyse and
evaluate evidential matter and to interpret and communicate findings.
Red Flag: Red flags are indicators or warning of any impending danger or inappropriate
behavior. Red flag does not necessarily indicate the existence of fraud however are indicators
that caution needs to be exercised while investigating the situations. Red flags are classified in
categories such as financial performance red flag, accounting system red flags, operational red
flags and behavioral red flags.
Forensic Accounting can be conducted in order to prosecute a party for fraud, embezzlement or
other financial claims. In addition, an audit may be conducted to determine negligence in addition,
an audit may be conducted to determine negligence.
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Example of Forensics
The Company received an anonymous handwritten letter through the mail in which there were
serious death threats against the CEO and his family. The letter alluded to the fact that bodily
harm may be inflicted on the Children of the CEO unless he took some specific action to send
a specific amount of cash in currency notes within a specified time period in such a manner
where the identity of the receiver was to remain unknown. The CEO immediately informed the
police who took the letter, and the envelope it came in, for “forensic analysis".
The lab undertaking the forensic work examined the paper used, the possibility of capturing
some fingerprints on the letter and envelope, scrutinise the manner in which the writing was
done, such as the ink used to find out the nature of the writing implement, deployed the
expertise of a handwriting expert to decipher the possibility of the writer etc. The police also
undertook an investigation of the possible suspects and collected various samples of hand-
writings of there suspects to allow the forensic experts to match the handwritings and shortlist
the most likely suspect.
All the above-mentioned techniques deployed to analyse the only clue available (letter and
envelope) are generally referred to as forensic work.
Example of Forensic Accounting
The Accounting Officer in the pharma company performs a regular reconciliation between the
physical inventory counted in the factory and the inventory as calculated by the books and
accounts. He takes the opening physical inventory as reconciled last month and adjusting for
purchases and sales during the month along with any production wastage/shrinkage etc. he
calculates the theoretical inventory at the close of the last day of the month. This time he noticed
a large discrepancy and after double checking the figures could not understand why he had a
large reconciliation variance.
To identify the reason of the variance, he undertook a review of the quantities of some of the
large inventory items to see if he could identify the variance in kilogram weight terms. He
noticed that some large expensive raw inventory items receipts during the month could neither
be located in the storeroom or the factory production floor. He tried to trace these receipts to
specific production runs to see if they had been used for making the medicines sold during the
month. Finally, he reviewed the wastage records to see if these had been discarded due to
quality control purposes. When he received no plausible explanation, he came to the conclusion
that there is a serious possibility of pilferage of these expensive raw materials and asked the
security head to investigate the matter during and after the time of receipt. This investigation
led the security people to review the CCTV footage and records during delivery to identify a
few instances of short delivery by the inward people.
This detailed analysis by the Accounting Officer was an example of some Forensic Accounting
techniques to identify a case of accounting fraud.
© The Institute of Chartered Accountants of India
17.60 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
How is a forensic accounting analysis different from an audit?
The general public believes that a financial auditor would detect a fraud if one were being perpetrated
during the financial auditor's audit. The truth, however, is that the procedures for financial audits are
designed to detect material misstatements, not immaterial frauds. While it is true that many of the
financial statements and frauds could have, perhaps should have, been detected by financial
auditors, the vast majority of frauds could not be detected with the use of financial audits. Reasons
include the dependence of financial auditors on a sample and the auditors' reliance on examining
the audit trail versus examining the events and activities behind the documents. The latter is simply
resource prohibitive in terms of costs and time.
There are some basic differences today between the procedures of Forensic Accounting and those
of financial auditors. In comparison, forensic accounting and audit differ in specific ways, as shown
below:
Key elements of the Statutory Audit are presented here:
OBJECTIVE: TRUE AND FAIR PICTURE
FOCUS: VERY GENERAL – AN OVERALL REVIEW OF
THE BOOKS OF ACCOUNT
STATUTORY AUDIT APPROACH: CONTROL TESTS OF TRANSACTIONS
AND SUBSTANTIVE TESTS OF BALANCES
• IT’S A LEGAL
MANDATE
• CONDUCTED ONLY TARGET: IDENTIFYH MATERIAL MIS – STATEMENTS
BY A CHARTERED IN FINANCIAL STATEMENTS
ACCOUNTANT
• EXPRESSION OF AN
SKILLS: TESTING & CHECKING, ANALYSIS, INQUIRY &
INDEPENDENT
OPINION OBSERVATION
• ON FINANCIAL
STATEMENTS PRESUMPTION: PROFESSIONAL SKEPTICISM, DUE
• AS PER ICAI PROFESSIONAL CARE
AUDITING
STANDARDS
OUTCOME: AUDIT REPORT OPINION (QUALIFICATION
– SUBJECT TO/EXCEPT FOR)
This shows clearly how the Statutory Audit is a legal mandate and designed to provide an overall
assurance to the shareholders of true and fair nature of the annual financial statements primarily
from a materiality perspective. Individual transactions and balances do not play a major role except
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in so far as they have a material impact on the overall financial statements. The Auditor has the
overall responsibility to issue his independent opinion without any influence from anyone.
Key elements of Forensic Accounting are presented here:
OBJECTIVE: DISCOVER FACTS AND EVIDENCE
FOCUS: NARROW – VALIDATE TRANSACTIONS AND
BALANCES
APPROACH: FOCUSED TESTING TO CONFIRM
SUSPICION / ALLEGATION
FORENSIC ACCOUNTING
• TO SUPPORT LEGAL
CASES TARGET: IDENTIFY / CONFIRM NATURE OF
• NON-CAs PERMITTED VIOLATION
• REPORT FINDINGS OF
EVIDENCE
SKILLS: SCRUTINY & ANALYSIS, FACT – FINDING,
DISCOVERED
INTERVIEWS
• PRIMARLY
FINANCIALS
• ICAI STANDARDS PRESUMPTION: NEUTRALITY
OUTCOME: PRESENT EVIDENCE TO A COURT OF LAW
– THEY SHALL JUDGE)!
This infographic shows how Forensic Accounting is a separate mandate altogether and designed
primarily to provide support to legal cases. The Forensic professional does not conduct an audit
using sample selection methodologies to perform substantive or compliance tests. The professional
undertakes a scrutiny and detailed examination of all transactions and balances relevant to the
mandate so that the evidence discovered is suitable for a court of law (i.e., in compliance with legal
requirements) where it can be challenged through cross examination by the defending party. No
audit report with any opinion is issued by the professional as his mandate is limited to present his
findings to a superior authority (e.g., a judge) who will examine these from a legal point of view to
establish whether the law has been violated or not.
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17.62 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
*In response to an event
Forensic *Financial investigation
Accounting *Finding used as evidence in court or to resolve disputes
*Mandatory
*Measures compliance with reporting standards
Audit •Obtain reasonable assurance that financial statements are free of
material misstatement
A Forensic Professional will often look for indications of fraud that are not subject to the scope of a
financial statement audit. Forensic Accounting has Investigative mentality" however auditing is
done with "professional scepticism". A Forensic Professional will often require more
extensive corroboration. A Forensic Professional may focus more on seemingly immaterial
transactions.
Sr. Particulars Other Audits Forensic Accounting
No.
1. Objectives Express an opinion as to Whether fraud has actually
‘True & Fair’ presentation taken place in books
2. Techniques Substantive & Compliance. Investigative, substantive or
Sample based in-depth checking
3. Period Normally for a particulars No such limitations
accounting period.
4. Verification of stock, Relies on the management Independent/verification of
Estimation realisable certificate/Management suspected/selected items
value of assets, Representation where misappropriation in
provisions, liability etc. suspected
5. Off balance sheet items Used to vouch the arithmetic Regulatory & propriety of
(like contracts etc.) accuracy & compliance with these transactions/contracts
procedures. are examined.
6. Adverse findings if any Negative opinion or qualified Legal determination of fraud
opinion expressed impact and identification of
with/without quantification perpetrators depending on
scope.
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13. FORENSIC PROFESSIONAL
A Forensic Professional is often retained to analyze, interpret, summarize and present complex
financial and business-related issues in a manner which is both understandable and properly
supported. Forensic Accountants Professional are trained to look beyond the numbers and deal with
the business reality of the situation.
A Forensic Professional must initially consider whether his/her firm has the necessary skills and
experience to accept the work. Forensic Accounting is highly specialized, and the work requires
detailed knowledge of fraud investigation techniques and the legal framework. Forensic Professional
needs to have an understanding on various frauds that can be carried off and how evidence need to
be collected.
Forensic Professional can be engaged in public practice or employed by insurance companies,
banks, police forces, government agencies and other organizations.
Forensic Accounting Services: An indicative list of services that can be provided by the
Professional in this area are as follows:
Financial Statement manipulations
Fund diversions/Asset tracing
Anti-Money laundering
Licence Fees/Dues/Tax Evasion
Related party transactions/valuations
Valuations/Estimations of loss/damage
Suspicious transactions under IBC (Insolvency and Bankruptcy Code)
A Forensic Professional is often involved in:
Providing
Computer Fraud Expert
Fraud
Forensics: Prevention: Testimony:
Detection:
Investigating Developing Either reviewing Assisting in legal
and analyzing computerized internal controls to proceedings,
financial applications to verify their including testifying
evidence, assist in the adequacy or in court as an
detecting recovery, providing expert witness and
financial frauds analysis and consultation in the preparing visual
and tracing presentation of development and aids to support trial
misappropriated financial implementation of evidence.
funds evidence; an internal control
framework aligned
to an organization's
risk profile
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17.64 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In order to properly perform these services a Forensic Professional must be familiar with legal
concepts and procedures and have expertise in the use of IT tools and techniques that facilitate data
recovery and analysis. In addition, a Forensic Professional must be able to identify substance over
form when dealing with an issue.
TEST YOUR UNDERSTANDING 3
X Limited engaged in manufacturing of floor coverings has taken a Product Liability Insurance policy
(PLI). Such a policy covers risk of liabilities for damages for bodily injury resulting from sale and
distribution of floor coverings by vendors of X Limited’s products. The policy is also subject to “claim
series” clause. A Claims Series event is a series of two or more claims arising from one specific
common cause which are attributable to the same fault in design or manufacture of products or to
the supply of the same products showing the same defect. A claim series event is deemed to be one
claim under the terms & conditions of PLI policy.
The company has been asked to shell out damages of `5 crore due to supply of faulty products to
one of its vendors. The vendor had sold floor coverings to a 5-star hotel which has alleged that
harmful chemicals used in dyeing of floor coverings have resulted in skin ailments to some of its
guests.
Being in capacity of Forensic Professional appointed by insurance company, what special issues
you would keep in mind while dealing with claims involving PLI policy covering such matters?
14. PROCESS OF FORENSIC ACCOUNTING
Each Forensic Accounting assignment is unique. Accordingly, the actual approach adopted and the
procedures performed will be specific to it. However, in general, many Forensic Accounting
assignments will include the steps detailed below.
Court
Reporting Proceedings
• Step 6
Perform • Step 5
Obtain Analysis
Relevant • Step 4
Develop
the Plan Evidence
Initialization
• Step 3
• Step 1 • Step 2
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Step 1. Initialization
It is vital to clarify and remove all doubts as to the real motive, purpose and utility of the assignment.
It is helpful to meet the client to obtain an understanding of the important facts, players and issues
at hand. A conflict check should be carried out as soon as the relevant parties are established. It is
often useful to carry out a preliminary investigation prior to the development of a detailed plan of
action. This will allow subsequent planning to be based upon a more complete understanding of the
issues.
Step 2. Develop Plan
This plan will take into account the knowledge gained by meeting with the client and carrying out the
initial investigation and will set out the objectives to be achieved and the methodology to be utilized
to accomplish them.
Step 3. Obtain Relevant Evidence
Depending on the nature of the case, this may involve locating documents, economic information,
assets, a person or company, another expert or proof of the occurrence of an event. In order to
gather detailed evidence, the investigator must understand the specific type of fraud that has been
carried out, and how the fraud has been committed. The evidence should be sufficient to ultimately
prove the identity of the fraudster(s), the mechanics of the fraud scheme, and the amount of financial
loss suffered. It is important that the investigating team is skilled in collecting evidence that can be
used in a court case within the stipulated time period, and in keeping a clear chain of custody until
the evidence is presented in court. If any evidence is inconclusive or there are gaps in the chain of
custody, then the evidence may be challenged in court, or even become inadmissible. Investigators
must be alert to documents being falsified, damaged or destroyed by the suspect(s).
Step 4. Perform the analysis
The actual analysis performed will be dependent upon the nature of the assignment and may involve:
• calculating economic damages;
• summarizing a large number of transactions;
• performing a tracing of assets;
• performing present value calculations utilizing appropriate discount rates;
• performing a regression or sensitivity analysis;
• utilizing a computerized application such as a spread sheet, data base or computer model;
and
• utilizing charts and graphics to explain the analysis.
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17.66 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Step 5. Reporting
Issuing an report is the final step of a forensic accounting. Accountant / Investigators will include
information detailing the fraudulent activity, if any has been found. The client will expect a report
containing the findings of the investigation, including a summary of evidence, a conclusion as to the
amount of loss suffered as a result of the fraud and to identify those involved in fraud. The report
may include sections on the nature of the assignment, scope of the investigation, approach utilized,
limitations of scope and findings and/or opinions. The report will include schedules and graphics
necessary to properly support and explain the findings.
The report will also discuss how the fraudster set up the fraud scheme, and which controls, if any,
were circumvented. It is also likely that the investigative team will recommend improvements to
controls within the organization to prevent any similar frauds occurring in the future.
Step 6. Court proceedings
The investigation is likely to lead to legal proceedings against the suspect, and members of the
investigative team will probably be involved in any resultant court case. The evidence gathered
during the investigation will need to be presented at court, and team members may be called to court
to describe the evidence they have gathered and to explain how the suspect was identified.
15. FORENSIC ACCOUNTING AND INVESTIGATION
REPORT
This Forensic Accounting and Investigation Standard (FAIS or “Standard”) 510 deals with the
responsibility of the Professional to issue a written report to the stakeholders at the conclusion of
the assignment.
Reporting results of the work procedures completed and the findings from those procedures, is the
concluding part of the assignment. Since one engagement may include multiple assignments,
multiple reports may have to be issued; one for each assignment.
1. Written Report: The Professional shall issue a written report which conveys the results of
the assignment clearly and accurately. The findings reported shall be based on evidence
gathered which are reliable and relevant. Thus, the Professional shall issue a written report
which is precise and unambiguous.
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2. Report addressee and distribution: The report shall be addressed to the Primary
Stakeholders and shared with other stakeholder(s) if required or otherwise permissible
3. Format or Content of Report: While no fixed form or content of the report is mandated by
this Standard, the report shall include certain key elements to enable the recipient to
understand the purpose of the assignment, the extent and scope of work performed by the
Professional, any limitations, assumptions or disclaimers, the facts and evidence gathered
and the conclusions drawn.
Where the form and content of the report is mandated by the stakeholders, or specified by
the statutory or regulatory requirements, the Professional shall report in line with those
requirements, while keeping in mind the key elements.
Key Elements of the Report: The Professional shall consider the inclusion of the following
key elements in the report (indicative list):
Title, addressee and distribution list (if any)
Scope and objectives of the assignment
Approach and broad work procedures undertaken
An Executive Summary of the results, covering all important aspects and the essence
of the findings
Reference to use of an expert, where applicable
The fact that the assignment has been conducted in accordance with FAIS, or any
material departures therefrom
List of findings supported by key evidences, sources of evidences, and other relevant
matter;
Assumptions, limitations and disclaimers of the assignment
Conclusions (if any) drawn from the assessment undertaken.
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17.68 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The fact
An that the List of
Executive assignment findings
Summary of has been supported Assumptions, Conclusions
Title, Approach Reference
Scope and the results, conducted by key limitations (if any)
addressee and broad to use of an
objectives covering all in evidences, and drawn from
and work expert,
of the important accordance sources of disclaimers of the
distribution procedures where
assignment aspects and with FAIS, evidences, the assessment
list (if any) undertaken applicable
the essence or any and other assignment undertaken.
of the material relevant
findings departures matter;
therefrom
4. Discussion of Draft report: Where the mandate of the engagement requires a discussion of
the findings with the subject party prior to finalisation, a summary of the responses received
from them shall be included in the report. Further, the Principles of Natural Justice requires
a discussion of the observations with the subject party. In some cases, this is done by the
Primary Stakeholders through their own internal processes (e.g., disciplinary committee,
show-cause notice, etc.). At times, the Professional is requested to incorporate the discussion
of draft findings as part of the interview process with the subject. Where the engagement
mandate requires a discussion of the draft findings with the subject party, any response
received from them shall be included in the written report issued by the Professional.
5. Assumptions and Limitations: The Professional shall list any relevant assumptions made
during the assignment having a significant bearing on the subject matter. In addition, the
Professional may encounter limitations that restrict the methodologies or procedures applied
in carrying out the assignment. Such limitations can be in the form of lack of (or limited)
management support, restricted (or denied) access to required records, information or
people, due to any reason such as court orders, short timelines, etc. These disclaimers would
be covered in the report as a key element of the report.
The report shall not express an opinion or pass any judgement on the guilt or innocence.
Determination of culpability is either a disciplinary process internal to the organization under
review, or a judicial process depending on the specific situation under review. The report can,
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at best, highlight the circumstances and facts that may aid a stakeholder decision or further
a civil or criminal investigation.
6. Reporting Timelines: The report shall be issued within reasonable time frame as per the
engagement terms. The Professional may be required to provide interim reports as per the
engagement terms which can be given to the extent practicable without compromising the
progress of the investigation. Such interim reports are also subject to this Standard.
16. OVERVIEW OF FORENSIC ACCOUNTING AND
INVESTIGATION STANDARDS (FAIS)
The Institute of Chartered Accountants of India (ICAI) was formed with many mandates, one of which
places a responsibility of “Ensuring Standards of Performance of its Members”. In keeping with this
obligation, the ICAI has recently published a full set of standards in the area of forensic science.
These are referred to as the “Forensic Accounting and Investigation Standards (FAIS for short). The
FAIS are issued to ensure that the ICAI members deliver high quality output in the area of Forensic
Accounting and Investigations.
The Framework Governing Forensic Accounting and Investigations (the “Framework”) lays down the
underlying principles and boundaries for undertaking such services. It aims to preserve and enhance
the quality of practice of a member of the Institute of Chartered Accountants (ICAI) performing
forensic accounting and investigation services. This Framework needs to be read in conjunction with
the Preface to the Forensic Accounting and Investigation Standards (FAIS).
The main objectives of the Framework are to: 1 Provide an overall understanding of Forensic
Accounting and Investigations and its key components; 2 Outline the manner in which these
components come together in an inter-related cohesive manner when providing such services; 3
Maintain and improve the quality of forensic accounting and investigation services.
The Framework establishes the structure which governs the professions of Forensic Accounting and
Investigations. It is based on the "Definition of forensic accounting and investigation" (as covered
under para 3, above), and the Code of Ethics forms the foundation of the Framework. It comprises
of four components inherent to the process of forensic accounting and investigations. These
components implicitly form part of the FAIS, even though they may not be mentioned explicitly in the
particular Standards. Hence, as explained in the Preface, they all are mandatory in nature, except
the Guidance which is recommendatory.
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17.70 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The four key components (forming the pillars) of the Framework are:
(i) Basic Principles of (iii) Standards on
Forensic Accounting (ii) Key Concepts. Forensic Accounting (iv) Guidance.
and Investigations. and Investigations.
A pictorial depiction of the Framework Governing Forensic Accounting and Investigations, in the
form of a pantheon, is presented below.
The Forensic Accounting and Investigation Standards (referred to as “FAIS” or the
“Standards”) at a broad level seek to provide:
(a) The Professionals with the minimum standards for undertaking forensic accounting and
investigation (FAI) assignments;
(b) The Users of FAI services with an indication of the quality of service that can be expected
from such engagements;
(c) The Regulators and Governmental agencies with an appreciation of what can be expected
from FAI services; and
(d) To everyone, guidance on matters of implementation and related practical issues.
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The Standards are intended to be principle-based, rather than rule based, thereby providing ample
room for professional judgment when applying such principles to unique situations and under specific
circumstances. The unique nature of forensic assignments would necessitate that the application of
forensic accounting and investigative skills, together with the use of digital forensic tools, may vary
depending on the nature of specific engagements.
If, for any reason, a member is unable to comply with any of the requirements of the FAIS, or if there
is a conflict between the Standards and other mandates, such as a statutory or regulatory
requirement, the FAI report (or such similar communication) should draw attention to the material
departures therefrom along with appropriate explanation.
The FAIS, as and when issued, will be classified, and numbered in a series format, as follows:
Forensic Accounting and Investigation Standards (FAIS)
100 Series:: Standards on Key Concepts
FAIS 110 : Nature of Engagement
FAIS 120 : Fraud Risk
FAIS 130 : Laws and Regulations
FAIS 140 : Applying Hypotheses
200 Series: Standards on Engagement Management
FAIS 210 : Engagement Objectives
FAIS 220 : Engagement Acceptance and Appointment
FAIS 230 : Using the Work of An Expert
FAIS 240 : Engaging with Agencies
FAIS 250 : Communication with Stakeholders
300 Series: Standards on Executing Assignments
FAIS 310 : Planning the Assignment
FAIS 320 : Evidence and Documentation
FAIS 330 : Conducting Work Procedures
FAIS 340 : Conducting Interviews
FAIS 350 : Review and Supervision
FAIS 360 : Testifying Before a Competent Authority
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17.72 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
400 Series: Standards on Specialised Areas
FAIS 410 : Applying Data Analysis
FAIS 420 : Evidence Gathering in Digital Domain
FAIS 430 : Loans Or Borrowings
500 Series: Standards on Reporting
FAIS 510 : Reporting Results
600 Series: Standards on Quality Control
FAIS 610 : Quality Control
Key Takeaways
Due Diligence implies a general duty to exercise care in any transaction. It is a measure of
prudence activity, or assiduity, as is properly to be expected from, and ordinarily exercised
by, a reasonable and prudent person under the particular circumstance, not measured by any
absolute standard but depends on the relative facts of the special case.
Due Diligence may also require to be performed in cases of corporate restructuring, venture
capital financing, lending, leveraged buyouts, public offerings, disinvestment, corporatisation,
etc.
Contents of a due diligence report vary with individual circumstances and the purpose of such
exercise.
Investigation implies a systematic and in-depth examination or inquiry to establish a fact or
to evaluate a specific situation. It is the systematic and critical examination of facts, records
and documents for a specific purpose.
Investigation differs substantially from an audit assignment. Audit aims at collection of
sufficient appropriate audit evidence to enable the auditor to form a judgement and express
an opinion on the financial statements or other data under examination. An investigation, on
the other hand, requires special in-depth examination of the particular records or transaction
with the objective of establishing a part or happening or assessing a particular situation. The
scope of audit is broad based and general in nature whereas investigation is narrow and
specific.
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Investigation by Chartered Accountants can be statutory or non-statutory. Non-statutory
investigations could include investigation of frauds or investigations in case of proposals to
buy a business etc.
Forensic accounting is the use of professional accounting skills in matters involving the
possibility of a fraud, in order to collect relevant evidence and facts which could help support
an expert view for potential or actual civil or criminal litigation. It is also called forensic
accounting.
Forensic accounting is different from audit of financial statements. A Forensic Professional
will often look for indications of fraud that are not subject to the scope of a financial statement
audit. Forensic accounting has investigative mentality" however auditing is done with
"professional skepticism". A Forensic Professional will often require more extensive
corroboration and may focus more on seemingly immaterial transactions.
Services of forensic accountants may be used by banks, insurance companies, government
agencies, courts and even by business community.
Forensic Accounting and Investigation Standards (FAIS) aim to preserve and enhance the
quality of practice of a member of the Institute of Chartered Accountants (ICAI) performing
forensic accounting and investigation services.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. Sri Rajan is above 80 years old and wishes to sell his proprietary business of manufacture of
specialty chemicals. Ceta Ltd. wants to buy the business and appoints you to carry out a due
diligence audit to decide whether it would be worthwhile to acquire the business.
What procedures you would adopt before you could render any advice to Ceta Ltd.?
2. An American Company engaged in the business of manufacturing and distribution of industrial
gases, is interested in acquiring a listed Indian Company having a market share of more than
65% of the industrial gas business in India. It requests you to conduct a “Due Diligence” of
this Indian Company and submit your Report. List out the contents of your Due Diligence
Review Report that you will submit to your USA based Client.
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17.74 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
3. KDK Bank Ltd., received an application from a pharmaceutical company for takeover of their
outstanding term loans secured on its assets, availed from and outstanding with a
nationalised bank. KDK Bank Ltd., requires you to make a due diligence audit in the areas of
assets of pharmaceutical company especially with reference to valuation aspect of assets.
State what may be your areas of analysis in order to ensure that the assets are not stated at
overvalued amounts.
4. “Due diligence is different from audit” – Explain the difference between due diligence and
audit.
5. PB Ltd. entered into a deal with SV Ltd. for buying its business of manufacturing wooden
products/ goods. PB Ltd. has appointed your firm for conducting due diligence review and
they want to know the cash generating abilities of SV Ltd. What points will you check in order
to ensure that the manufacturing unit of SV Ltd. will be able to meet the cash requirements
internally?
6. CA. Sanjana is acting as Credit manager in branch of DFC Bank Limited. A company has
approached the branch for a request to sanction credit facilities worth `10 crore for meeting
usual business requirements. It is a prospective new client. She checks past history of the
company, back ground of promoters & directors, shareholding pattern and nature of business.
Assessment of financial results of past years and future projections is also undertaken. She
also carries out SWOT analysis of the company.
Besides, assessment of net worth of directors is also undertaken. Status of CIBIL score and
position of name of promoters/directors in RBI defaulter list is also verified.
She also makes discreet inquiries from few clients of the branch engaged in similar line of
activity regarding credit worthiness of company, its promoters and directors.
Based on above-
(a) Identify activity being performed by CA Sanjana and discuss its nature.
(b) Would your answer be different if this activity was to be performed by a person not
qualified as a Chartered Accountant? Can a non-CA perform such activity? State
reason.
(c) Name any three other areas where identified activity can be undertaken.
7. A nationalised bank received an application from an export company seeking sanction of a
term loan to expand the existing sea food processing plant. In this connection, the General
Manager, who is in charge of Advances, approaches you to conduct a thorough investigation
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.75
of this limited company and submit a confidential report based on which he will decide
whether to sanction this loan or not.
List out the points you will cover in your investigation before submitting your report to the
General Manager.
8. What are the important steps involved while conducting Investigation on behalf of an Incoming
Partner?
9. Mr. Clean who proposes to buy the proprietary business of Mr. Perfect, engages you as
investigating accountant. Specify the areas which you will cover in your investigation.
10. In a Company, it is suspected that there has been embezzlement in cash receipts. As an
investigator, what are the areas that you would verify?
11. J Ltd. is interested in acquiring S Ltd. The valuation of S Ltd. is dependent on future
maintainable sales. As the person entrusted to value S Ltd., what factors would you consider
in assessing the future maintainable turnover?
12 MF. Ltd., engaged in the manufacturing of various products in its factory, is concerned with
shortage in production and there arose suspicion of inventory fraud. You are appointed by
MF Ltd. To evaluate the options for verifying the process to reveal fraud and the corrective
action to be taken. As an investigating accountant what will be your areas of verification and
the procedure to be followed for verification of defalcation of inventory?
13. In a Public Limited Company, it is suspected by the Management that there has been
embezzlement in supplier's ledger. As an auditor of the Company, you have been asked to
investigate the matter. What are the major areas that you would verify in this regard?
14. General objective of an audit is to find out whether the financial statements show true and
fair view. On the other hand, investigation implies systematic, critical and special examination
of the records of a business for a specific purpose.
In view of the above, you are required to brief out the difference between Audit and
Investigation.
15. Enumerate the steps to be undertaken in case of forensic accounting process.
16. Briefly discuss the key content of Forensic Accounting and Investigation Report.
17. ABC Ltd. is a listed company having turnover of ` 50 crores & plans expansion by installation
of new machines at new building-having total additional project cost of ` 20 crore.
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17.76 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Rupees (In crore) Purpose
10.0 - for Building
8.5 - for Machinery
1.5 - for Working Capital
20 Crore Total
Project gets implemented in 2022-23 and one of the accountants report to the Managing
Director that some suspicious transactions are noticed in the purchase of building material.
But the Management is confused as to whether they should get an audit or Forensic
Accounting done for the same. Advise Management about the difference in forensic
accounting and audit.
Answers to Test Your Understanding
1. As part of due diligence exercise, he is performing SWOT analysis of borrower. He is making
analysis of strengths, weaknesses, opportunities and threats (SWOT) pertaining to borrower.
Features such as rise in sales, generation of cash profits and timely service of debts represent
borrower strengths. Lack of well-paid qualified staff to deal effectively with its domestic and
foreign customers is an area of weakness. Entering into export market presents opportunity
for borrower and presence of large number of competitors and demand slump in US market
reflect threats.
2. The attendance record of employees pertaining to that section can be analysed with regards
to in and out time. Further, surprise visit to the site can be conducted to see the actual number
of workers at a point of time. It may reveal ghost workers. Discrepancies in attendance
records vis-à-vis actual number of workers present could reveal dummy workers. Such a visit
would also give indication of actual work done in the area and give an inkling of productivity
of employees.
3. (i) In claims involving product liability insurance policies, many documents are required
from third parties. The third party may be unwilling to provide relevant documents to
Forensic Professional concerning the very organization responsible for causing
damages.
(ii) Independence of Forensic Professional become paramount in such types of
assignments because it involves engagement with parties who are not directly claiming
from insurance company. Forensic Professional needs to resist any pressure or
interference in establishing the scope of the assignments or the manner in which the
work is conducted and reported.
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DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING 17.77
(iii) The company might be willing to negotiate it to salvage its reputation. It can lead to
additional complexities.
(iv) Quantification of legal liability under the policy can prove to be a challenging task and
it has to be determined in accordance with policy terms & conditions.
(v) Careful analysis of date of loss when first claim occurred in accordance with “claim
series” clause and whether the same falls under the policy
Hints /Answers to Theoretical Questions
1. Refer Financial Due Diligence given in Para 3.
2. Refer Para 6.
3. Refer Over-Valued Assets Part given in Para 3.
4. Refer Para 1.
5. In order to ensure that the manufacturing unit of SV Ltd. will be able to meet the cash
requirements internally, one is required to verify:
(a) Is the company able to honor its commitments to its trade payables, to the banks, to
the government and other stakeholders?
(b) How well is the company able to convert its trade receivables and inventories?
(c) How well the Company deploys its funds?
(d) Are there any funds lying idle or is the company able to reap maximum benefits out of
the available funds?
(e) What is the investment pattern of the company and are they easily realizable?
Refer Cash Flow in Para 3.
6. (a) The activity described in the situation is Due diligence. Due diligence is a measure of
prudence activity, or assiduity, as is properly to be expected from, and ordinarily exercised
by, a reasonable and prudent person under the particular circumstance, not measured by
any absolute standard but depending upon the relative facts of the case. It involves a
careful study of financial and non-financial possibilities. It implies a general duty to take
care in any transaction.
Due diligence is a process of investigation, performed by investors, into the details of a
potential investment such as an examination of operations and management and the
© The Institute of Chartered Accountants of India
17.78 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
verification of material facts. It entails conducting inquiries for the purpose of timely,
sufficient and accurate disclosure of all material statements/information or documents,
which may influence the outcome of the transaction. Due diligence involves a careful study
of the financial as well as non-financial possibilities for successful implementation of
restructuring plans.
Due diligence involves an analysis carried out before acquiring a controlling interest in a
company to determine that the conditions of the business conform with what has been
presented about the target business. Also, due diligence can apply to recommendation
for an investment or advancing a loan/credit.
(b) There would be no difference in answer if above activity was to be performed by a person
who is not a Chartered Accountant. The activity would remain due diligence. Due
diligence can be performed by any person. It is not necessary that due diligence can only
be carried out by a Chartered Accountant. As due diligence involves exercise of prudence
and general duty to take care in any transaction, it can be undertaken by any person.
(c) The areas where due diligence may be undertaken are: -
(i) Corporate restructuring
(ii) Venture capital financing
(iii) Public offerings
7. Refer Para 11.3.
8. Refer Para 11.1.
9. Refer Para 10 and 11.5.
10. Refer Cash Receipts embezzlement in Para 11.4.1.
11. In assessing the turnover which the business would be able to maintain in the future, the
following factors should be taken into account:
(i) Trend: Whether in the past, sales have been increasing consistently or they have been
fluctuating. A proper study of this phenomenon should be made.
(ii) Marketability: Is it possible to extend the sales into new markets or that these have
been fully exploited? Product wise estimation should be made.
(iii) Political and economic considerations: Are the policies pursued by the Government
likely to promote the extension of the market for goods to other countries? Whether
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the sales in the home market are likely to increase or decrease as a result of various
emerging economic trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the
same field or if products which would sell in competition are placed on the market at
cheaper price? Is the demand for competing products increasing? Is the company’s
share in the total trade constant or has it been fluctuating?
12. Refer Inventory Fraud in Para 11.4.1.
13. Refer Areas to be verified in case of embezzlement in supplier’s ledger in Para 11.4.1.
14. Refer Para 7.1.
15. Refer Para 14
16. Refer Para 15
17. Refer Para 12
© The Institute of Chartered Accountants of India
CHAPTER 18
7
SUSTAINABLE DEVELOPMENT
GOALS(SDG) & ENVIRONMENT,
SOCIAL AND GOVERNANCE (ESG)
ASSURANCE
LEARNING OUTCOMES
After reading this chapter student shall be able to:
Understanding Environment, Social and Governance (ESG) pillars of
sustainability
Learn the Sustainable Development Goals which have been accepted by
all the United Nation Members
Creating an awareness of the Global trends of Sustainability
Understanding the evolution of ESG in India
Gaining knowledge of ICAI’s role in Sustainability
Learning about Integrated Reporting and how it can help our profession.
Gain the knowledge of Role of Auditor in Sustainability forum and
certifying the BRSR.
Analyze the Business Responsibility and Sustainable Reporting
requirements.
© The Institute of Chartered Accountants of India
18.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
Evolution of ESG in
India
Initiatives taken by
ICAI
ESG BRSR
9 principles of
BRSR
Overview
Assurance in BRSR
Global trends in
sustainability
Sustainable
Development Goals
Integrated
Reporting
CA Ajoy was keen to understand about sustainability reporting by corporates in light of
mandatory regulatory requirements. One of his corporate clients was required to do such
reporting and assurance report was also needed. In this context, he wanted to familiarize
himself with terms like Sustainable development and Sustainable Development Goals (SDGs)
thoroughly.
Sustainable development simply means development that meets the needs of the present
without compromising the ability of future generations to meet their own needs. SDGs are a
universal call for action to end poverty, protect the planet and improve the lives and
prospects for everyone- everywhere.
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.3
& GOVERNANCE ASSURANCE
Our country has always been in forefront of welfare of humanity. Our ancient texts say: “Keep
pure! For the earth is our mother! And we are her children!” How can a country with such a
universal vision can be left behind in this noble endeavour? And corporates also contribute
to the SDGs. It is due to the fact that world is in need of solutions that the private sector can
deliver representing a large market for innovation.
It is in line with this spirit that Sustainability reporting frameworks have evolved over time
and companies worldwide have adopted these frameworks for measuring, monitoring and
disclosing performance in areas related to environmental, social and governance (ESG).
Many countries have stipulated some form of ESG disclosures.
ESG reporting stands on three pillars viz. environmental, social and governance. Certain
listed companies have to disclose their sustainability performance in accordance with key
performance indicators and 9 principles. Doesn’t it sound interesting? These principles
range from conducting business in ethical manner to promoting human rights.
As part of ESG reporting, it is mandatory for certain listed companies to prepare and disclose
sustainability reports in shape of Business responsibility and sustainability reports (BRSR).
Like in case of meeting requirements of the principle that business is conducted with integrity
and in ethical manner, disclosures on anti-bribery policy like internal control mechanisms
and mechanisms to deal with bribery/corruption complaints are to be made. Such disclosures
are now mandatory for certain listed companies considering each of the 9 principles.
Isn’t such a reporting framework a giant leap forward?
1. INTRODUCTION
Sustainability is a word that has gained its momentum in the past few years, but we don’t often
understand the extent of the meaning in totality. It encompasses how natural systems work, continue
to be diverse, and yield everything required for the environment to remain in balance now and in the
future.
Sustainability is a concept related to the development of products, goods and services that involves
meeting our present needs without compromising the ability of future generations to fulfil their own
needs.
Sustainability as a concept recognises that the environment is an exhaustible resource. Therefore,
it is important to use the environment and its resources rationally and protect it for the good of the
Earth, our environment, humanity, and all living things.
© The Institute of Chartered Accountants of India
18.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The concept of sustainable development is named after the Brundtland report, which reports
sustainable consumption in developed countries.
Sustainable Development defined in this report is as follows:
“Sustainable development is development that strives to meet the needs of developing countries
seeking to achieve a more sustainable world. Sustainable development addresses the needs of the
present moment without compromising current and future generations to meet their own sustainable
lifestyles.”
Sustainable development can be applied to corporate policy in the business world as it encompasses
following three pillars of sustainability:
A. Environment (E)
B. Social (S)
C. Governance (G)
These three pillars constitute the term ESG. Let us understand each element of ESG in depth.
A. Environment (E):
Environmental stands for corporate climate policies, energy use, waste, pollutions,
natural resource conservation, and treatment of animals. It includes the natural
resources that every entity absorbs for its functioning like that of coal, electricity, water and
so on. Processing this energy into products / services which will leave behind certain wastes
like that of carbon emissions, water discharges, e-wastes and so on. Thus, one is dependent
on the environment for carrying out its operations.
B. Social (S):
It addresses the relationships the entity has and the reputation it fosters with people and
institutions in the communities where you do business and the value chain involved. It further
includes labour relations, diversity, and inclusions. Every company operates within a broader
and diverse society.
C. Governance (G):
It is the internal system of practices, controls, and procedures entity adopts in order to govern
itself, make effective investment decisions, comply with the law, and meet the needs of all
stakeholders. Every entity, which is itself a legal creation, requires governance.
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.5
& GOVERNANCE ASSURANCE
The above pillars include the following elements as under:
ENVIRONMENT SOCIAL GOVERNANCE
•Climate Change: •Human Capital: •Corporate Governance:
•Carbon Emissions •Labour Management •Broad Diversity
•Product Carbon •Health & Safety •Executive Pay
FootPrints •Human Capital •Ownership
•Financing Enviornmental Development •Accounting
Impact •Supply Chain Labour •Corporate Behaviour
•Climate Change Standards •Business Ethics
Vulnerability •Product Liability: •Anti - Competitve
•Natural Resources: •Product Safety & Quality Practices
•Water Stress •Chemical Safety •Corruption & Instability
•Bio-diversity & land use •Financial Product Safety •Financial system and
•Raw Material sourcing •Privacy and Data stability
•Pollution & Waste: Security •Tax Transparency
•Toxic emission and •Responsible Investment
waste •Stakeholders Opposition:
•Packing Material and •Controversial Sourcing
waste •Social Opportunity:
•E- Waste •Access to
•Enviornment Communication
Opportunity: •Access to Finance
•Clean Tech •Access to Health Care
•Green Building •Opportunities in
•Renewable Energy Nutrition & Health
Environmental, Social and Governance (ESG) reporting is all about disclosure of information,
data, metrics that explain the added value in these three areas. ESG reporting can be both
quantitative and qualitative in nature.
Qualitative reports tend to describe a company’s strategy or policy around the relevant topics,
while a quantitative approach includes metrics, and key performance indicators (KPIs) linked
to each area in order to measure progress against goals and report on achievements.
Naturally, a mixed approach that makes use of both qualitative and quantitative information
tends to add the maximum value to the quality of disclosures.
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18.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. SUSTAINABLE DEVELOPMENT GOALS
In 2015, Sustainable Development was adopted by all United Nations Members states to provide a
blueprint, which mentioned the Sustainable Development Goals (SDGs).
There were 17 SDGs which are considered as an urgent call for action by all countries, whether
developed or developing countries. They recognized that by ending poverty and other deprivations
must go hand in hand with strategies that improve health and education, reduce inequality, and spur
economic growth – all while tackling climate change and working to preserve our oceans and forests.
Today, the Division for Sustainable Development Goals (DSDG) in the United Nations Department
of Economic and Social Affairs (UNDESA) provides substantive support and capacity building for
the SDGs and their related thematic issues including water, energy, climate, oceans, urbanization,
transport, science and technology, the Global Sustainable Development Report (GSDR),
partnerships and Small Island Developing States. SDG plays a key role in the evaluation of UN
systemwide implementation of the 2030 Agenda and on advocacy and outreach activities relating to
the SDGs. In order to make the 2030 Agenda a reality, broad ownership of the SDGs must translate
into a strong commitment by all stakeholders to implement the global goals. DSDG aims to help
facilitate this engagement.
Following are the 17 SDGs:
No Poverty Reduced Inequalitites
Zero Hunger Sustainable Cities & Communitites
Good Health & Well Being Responsible Consumption &
Production
Quality Education
Climate Action
Gender Equality
Life Below Water
Clean Water & Sanitization
Life on Land
Affordable & Clean Energy
Decent Work & Economic Growth Peace, Justice & Strong Institutions
Industry Innovation & Infrastructure Partnership for the Goals
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3. GLOBAL TRENDS IN SUSTAINABLE REPORTING
The mandatory reporting requirements are mostly associated with the public sector or government-
run companies, large corporations, multi-national business conglomerates, and listed companies in
the stock exchanges. Furthermore, sector-specific, and thematic reporting provisions are also
becoming more common.
The most widely used framework in the world is the Global Reporting Initiative (GRI) Sustainability
Reporting Standards having 93% of the world’s largest 250 corporations report on their sustainability
performance through GRI. It is used in over 100 countries to report sustainability. This independent
international organization is based in Amsterdam, the Netherlands, and has operational hubs in
Brazil, China, Colombia, India, South Africa, and the United States. The GRI Sustainability Reporting
Standards are developed with true multi-stakeholder contributions and rooted in the public interest.
1. Global Reporting Initiative (GRI) – helps the organizations to report on economic,
environmental, and social impacts. The general disclosures which are required to be reported
under this standard are Economic, Environment and Social. This report is addressed to all
the stakeholders of the entity.
2. Carbon Disclosure Project (CDP) – captures the environmental performance data which is
related to GHG emissions, water, forests, and supply chain. Major details required to be
reported are climate change, Forest, and Water security. This report is addressed to all the
investors, buyers, and other stakeholders of the entity.
3. International Integrated Reporting Framework (IIRC) – has established guiding principles
and content elements in order to allow the companies to produce integrated reports. This
report consists of Organisational overview, Governance structure, Business model, risks and
opportunities, strategy, performance, outlook etc.
In September 2020, these framework & standard setting institutions came together to show a
commitment to working towards a comprehensive corporate reporting system.
The intent of the collaboration was:
- Joint market guidance on how the frameworks & standards can be applied in a
complementary and additive way.
- Joint vision of how these elements could complement financial generally accepted accounting
principles (Financial GAAP) and serve as a natural starting point for progress towards a more
coherent, comprehensive corporate reporting system.
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18.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
- Joint commitment to drive towards this goal, through an ongoing programme of deeper
collaboration between the 5 institutions and stated willingness to engage closely with other
interested stakeholders.
In November 2021, the IFRS Foundation Trustees published a revised Constitution and a Feedback
Statement that responds to the feedback from Exposure Draft Proposed Targeted Amendments to
the IFRS Foundation Constitution to Accommodate an International Sustainability Standards Board
to Set IFRS Sustainability Standards.
International investors with global investment portfolios are increasingly calling for high quality,
transparent, reliable, and comparable reporting by companies on climate and other environmental,
social and governance (ESG) matters.
On 3 November 2021, the IFRS Foundation Trustees announced the creation of a new standard-
setting board—the International Sustainability Standards Board (ISSB)—to help meet this
demand.
The intention is for the ISSB to deliver a comprehensive global baseline of sustainability-related
disclosure standards that provide investors and other capital market participants with information
about companies’ sustainability-related risks and opportunities to help them make informed
decisions.
Task Force on Climate-Related Financial Disclosures (TCFD) - It was created in 2015 by the
Financial Stability Board (FSB) with the goal of helping companies create consistent climate-related
disclosures. Unlike GRI, which works on a wide range of organizations, TCFD is targeted at
companies that predominantly handle financial-related interests, such as banks and insurance firms.
The Climate Disclosure Standards Board (CDSB) was an international group of business and
committed to making climate-rated disclosures in the mainstream global corporate reporting.
The CDSB framework was formed to help organizations to disclose climate related risks and
opportunities. The CDSB framework has also set out an approach on for reporting environmental
information.
Further, the ISSB has taken the technical guidance for developing IFRS Sustainability Disclosure
Standards.
The Value Reporting Foundation (VRF) is a non-profit organization which was a result of the merger
between SASB Foundation and the International Integrated Reporting Council (IIRC). The
International Accounting Standards Board (IASB) and the ISSB has agreed to work together in order
to build an Integrated Reporting Framework.
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& GOVERNANCE ASSURANCE
The International Sustainability Standards Board (ISSB) in March 2022 launched a consultation on
its first two proposed standards—one on climate-related disclosures and one on general
sustainability-related disclosures. The proposed standards, when finalised, would form a
comprehensive global baseline of sustainability-related disclosures designed to meet the information
needs of investors in assessing enterprise value.
IFRS S1 : The proposed requirements in the Exposure Draft IFRS S2 Climate-related Disclosures
(Climate Exposure Draft) build upon the recommendations of the Task Force on Climate-Related
Financial Disclosures (TCFD) and incorporate industry-based disclosure requirements derived from
the Sustainability Accounting Standards Board (SASB) Standards.
TEST YOUR UNDERSTANDING 1
You have recently joined a listed company after qualifying CA final exams through campus
placement programme conducted by CMI&B at ICAI. Although the company you have joined in
is not amongst top 1000 listed companies in the country, it wants to include “Sustainability
reporting” in accordance with Global Reporting Initiative framework (GRI) in its annual report on
voluntary basis. “Sustainability reporting” seems to be new buzzword in corporate circles and
you are assigned responsibility for collating all the information required for such reporting.
In above context, dwell upon what is your understanding of “Sustainability reporting”? Can you
list some of its expected benefits?
4. INTEGRATED REPORTING
There are 6 Cs of Integrated Reporting – also known as 6 capitals:
(i) Financial Capital:
- Pool of funds that is available to the organization for use in the production of goods or
provision of services.
- Obtained through financing, such as debt, equity, or grants, or generated through
operations or investments.
(ii) Manufactured Capital:
- Seen as human-created, production-oriented equipment and tools.
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18.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
- Available to the organization for use in the production of goods or the provision of
services, including buildings, equipment, infrastructure (such as roads, ports, bridges
& waste, and water treatment plants).
(iii) Natural Capital:
- Is an input to the production of goods or the provision of services.
- An organization’s activities also impact, positively or negatively, on natural capital.
- Includes water, land, minerals and forests, biodiversity, and ecosystem health.
(iv) Human Capital:
People’s skills and experience, their capacity, and motivations to innovate, including their:
- Alignment with and support of the organization’s governance framework & ethical
values such as its recognition of human rights.
- Ability to understand and implement an organization’s strategy.
- Loyalties and motivations for improving processes, goods, and services, including their
ability to lead and to collaborate.
(v) Social Capital:
- Institutions and relationships established within and between each community, group
of stakeholders and other networks to enhance individual and collective well-being.
- Includes:
o Common values and behaviour.
o key relationships, the trust and loyalty that an organization has developed and
strives to build and protect with customers, suppliers, and business partners.
o an organization’s social license to operate.
(vi) Intellectual Capital:
Key element in an organization’s future earning potential, with a tight link and contingency between
investment in R&D, innovation, human resources, and external relationships, which can determine
the organization’s competitive advantage.
Asia Pacific region continues to dominate in presenting sustainability data in annual reports.
Approximately with 60% of Companies reporting in 2022. Integrated reporting is strong in the Middle
East.
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& GOVERNANCE ASSURANCE
TEST YOUR UNDERSTANDING 2
Trustworthy Industries Limited (a listed company) has already been preparing and disclosing its
sustainability report based upon internationally accepted reporting framework of “Integrated
Reporting” on a voluntary basis even some years before BRSR reporting became mandatory.
Even after BRSR reporting became mandatory, it is cross-referencing disclosures made under
such reporting to disclosures sought under BRSR. The key thrust of “Integrated Reporting” is
how company creates value over short, medium and long term.
Following further information is provided in respect of the above company: -
[i] It has increased the number of customers using digital customer mobile app of the company
from 2 lac users to 4 lac users. There is 100% increase in digital collection. It has benefitted
customers of the company and resulted in use of digital methods for business operations of the
company.
[ii] It has increased the number of beneficiaries under its flagship CSR programmes from
previous 10000 to 75000. It has provided value for communities and provided sustainable
livelihood to them.
Discussing above information, identify which of the capitals of “Integrated Reporting” are being
referred to at [i] and [ii] respectively?
5. GLOBAL SCENARIO IN VARIOUS COUNTRIES
5.1 United States
In March 2022, the US Securities and Exchange Commission (SEC) proposed climate-risk disclosure
requirements, which would expand the annual reporting requirements of publicly traded companies.
In their SEC filings, companies would be required to discuss financially material, climate-related
risks guided by the TCFD recommendations. Reporting would include:
• The company’s climate risk management processes
• How the risks identified would impact financial performance
• How these risks are managed and mitigated
• Any scenario analysis, transition plans, and publicly announced climate goals
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18.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
5.2 United Kingdom
In 2019, the UK passed a law targeting net zero greenhouse gas (GHG) emissions by 2050.
A key regulation for UK ESG disclosures is the Companies Act of 2006, which includes requirements
for annual reporting. These rules apply to large companies that are either listed, exceed £500 million
in annual turnover, or have more than 500 employees. Non-financial information has always been
required in annual reports, but in 2022, the Act was expanded to include sustainability matters. The
new requirements align with the recommendations from the Task Force on Climate-Related Financial
Disclosure (TCFD). As such, companies are required to discuss the strategy, processes, and due
diligence regarding matters of:
- The environment (including the company’s impact on the environment)
- The company’s employees
- Social matters
- Respect for human rights
- Anti-corruption and anti-bribery
Specifically for the environment, climate-related disclosures must include:
- Climate change-related risks and opportunities
- How these risks and opportunities are managed through targets and KPIs
- How climate change is addressed in corporate governance
- How climate risk impacts strategy
Additionally, large UK companies are required to report on their UK energy use and carbon
emissions within their annual reports through the Streamlined Energy and Carbon Reporting.
Further, in 2023 ESG reporting in the UK will be further formalized through the Sustainability
Disclosure Requirements (SDRs). The SDRs will provide a framework for corporates to manage
sustainability-related risks, opportunities, and impacts, as well as set relevant metrics and targets.
Following table showcases the evolution of sustainable development reporting in the recent past:
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March 2021 April 2021
Sustainable Finance Disclosures Regulation European commission adopts the CSRD
(SFDR) go into effect for asset managers proposal, which will require large companies
and financial advisors operating in EU to report on social and environmental
impacts starting in 2024
October 2021 November 2021
GRI standards updated IFRS Foundation announces the formation
of its global reporting standardization
initiative through the ISSB
UK Financial conduct authority releases
sustainability requirements disclosure paper
December 2021 February 2022
The European commission published the The EU adopts a proposal for a directive on
first delegated act on sustainable activities Corporate Sustainability Due Diligence with
for the first two environmental objectives of Rules for companies to respect human
the EU territory rights and the environment in their global
value chains
March 2022 April 2022
US SEC annouces climate change European Financial Reporting Advisory
disclosure proposal Board issues exposure draft of the
ISSB exposure draft for public commentary European Sustainbility Reporting Standard
(ESRS) for public commentary
June 2022
China's voluntary guidance for Enterprise
ESG disclosures takes effect
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18.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
6. EVOLUTION OF ESG IN INDIA
In India, the Ministry of Corporate Affairs (MCA) took the initiative to guide the corporates towards
responsible conduct and a sustainable future by issuing Corporate Social Responsibility Voluntary
Guidelines in December 2009.
The “Voluntary Guidelines on Corporate Social Responsibility”, announced by the MCA in 2009, was
one of the earliest initiatives taken by the Government of India. Its ultimate goal was to integrate
sustainability into business practices and into decision making process.
The MCA further issued additional guidelines, known as the “National Voluntary Guidelines on
Social, Environmental, and Economic Responsibilities of Business, 2011” (NVGs), emphasising the
importance of corporate entities’ environmental, social, and economic responsibilities, as well as the
need to integrate them into business practices and investment decision making processes.
2009 – ‘Corporate Social Responsibility Voluntary Guidelines 2009’
MCA issued CSR voluntary guidelines for the businesses to add value to the operations and
contribute towards the long-term sustainability of the business. The most important element of these
was to encourage the corporates to focus on Ethical functioning, Rights and welfare of workers,
Human Rights, Environmental development and taking social development activities.
2011 – ‘National Voluntary Guidelines on Social, Environmental and Economic
Responsibilities of Business’
In July 2011 ‘National Voluntary Guidelines on Social, Environmental and Economic Responsibilities
of Business’ came which contained comprehensive principles to be adopted by companies as part
of their business practice.
2012 – SEBI Mandates top 100 listed companies to file Business Responsibility Report
Top 100 listed companies by market capitalization were required to file Business Responsibility
Report (BRR). This report was in line with the ESG principles.
2015 – BRR became part of SEBI (Listing Obligations and Disclosure Requirements)
Regulations, 2015
SEBI vide Circular no. CIR/CFD/CMD/10/2015 dated November 04, 2015, had prescribed the format
for the Business Responsibility Report (BRR) in respect of reporting on ESG (Environment, Social
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& GOVERNANCE ASSURANCE
and Governance) parameters by listed entities in line with clause (f) of sub regulation (2) of regulation
34 of SEBI(LODR) Regulations 2015. Top 500 listed companies by market capitalization were
required to file Business Responsibility Report (BRR).
2017 – SEBI recommended Integrated Reporting for top 500 listed companies
On 6 February 2017, SEBI issued a circular advising top 500 listed companies which are required
to prepare BRR to adopt IR on a voluntary basis from the financial year 2017-18.
2019 - National Guidelines on Responsible Business Conduct (NGRBC) 2018
MCA revised the National Voluntary Guidelines on Social, Environmental and Economic
Responsibilities of Business, 2011 (NVGs) and formulated the National Guidelines on Responsible
Business Conduct (NGRBC).
2019 – BRR became mandatory for top 1,000 listed companies
As per SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations,
2019, with effect from December 26, 2019, the annual report of the top 1,000 listed entities based
on market capitalization shall contain a business responsibility report as per clause (f) of sub
regulation (2) of regulation 34 of Listing Regulations.
2021 - New reporting requirements on ESG parameters called the Business Responsibility
and Sustainability Report (BRSR).
Under notification no. SEBI/LAD-NRO/GN/2021/22 dated May 05, 2021, SEBI introduced new
reporting requirements on ESG parameters called the Business Responsibility and Sustainability
Report (BRSR).
The BRSR seeks disclosures from listed entities on their performance against the nine principles of
the ‘National Guidelines on Responsible Business Conduct’ (NGBRCs) and reporting under each
principle is divided into essential and leadership indicators.
The essential indicators are required to be reported on a mandatory basis while the reporting of
leadership indicators is on a voluntary basis. Listed entities should endeavour to report the
leadership indictors also.
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The BRSR is intended towards having quantitative and standardized disclosures on ESG parameters
to enable comparability across companies, sectors, and time.
7. INITIATIVES BY ICAI
In Feb 2020, ICAI constituted Sustainability Reporting Standards Board (SRSB). Mission of the
SRSB is to take appropriate measures to increase awareness and implement measures towards
responsible business conduct, developing audit guidance for Integrated Reporting
ICAI, encouraged by SEBI, introduced India’s first award to celebrate the business practice of
Integrated Reporting, internationally acknowledged as the emerging best practice in corporate
reporting
ICAI has also started a Certificate Course on Sustainable Development Goals (SDGs), Business
Responsibility Reports (BRR), Integrated Reporting (IR) & also proposed an ICAI Executive
Development Program on Business Responsibility Reporting (BRR)
In last 2 years, ICAI has issued following publications:
- Standard on Assurance Engagements (SAE 3410) – Assurance Engagements on
Greenhouse Gas Statements
- Background Material on BRSR (revised 2021)
- Sustainable Development Goals – Accountants creating sustainable World – Parts 1 covering
SDGs 1 to 5
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& GOVERNANCE ASSURANCE
- Sustainable Development Goals – Accountants creating sustainable World – Parts 1 covering
SDGs 6 to 11
- Sustainable Development Goals – Accountants creating sustainable World – Parts 1 covering
SDG 12 to 17
- FAQs on Sustainability Reporting – Heart of Good Governance
- Sustainability Reporting Maturity Model (SRMM) – Version 1.0
7.1 BUSINESS RESPONSIBILITY AND SUSTAINABILITY REPORT
(BRSR)
Reporting under BRSR is mandatory from financial year 2022-23. However, disclosure was voluntary
in financial year 2021-22.
The reporting questionnaire is divided into three sections:
(i) Section A – General Disclosures
This section contains the details of the listed companies, its products, services, operations,
employee related details, its holding, subsidiary, associate companies etc.
(ii) Section B – Management Process and disclosures
It contains questions related to policy and management processes, governance, leadership, and
oversight.
(iii) Section C – Principle-wise performance disclosures
Companies are required to report upon Key performance indicators (KPIs) in alignment with the nine
principles of the NGRBC. The section classifies KPIs into two categories that companies are required
to report upon:
- Essential indicators (Mandatory disclosures)
This would include data on training programs conducted, environmental data on energy, emissions,
water, waste management etc.
- Leadership indicators (Optional disclosures)
It would include life cycle assessments, details of conflict management policy, additional data, on
biodiversity, energy consumptions, supply chain managements etc.
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18.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
BRSR
Section A Section B Section C
Essential Indicators Leadership Indicators
7.1.1 Nine Principles of BRSR
The nine principles in BRSR are categorized into the ESG components of Environment, Social and
Governance with two of the nine in Environment, three in social and four in Governance. Even though
they are separate, they are interlinked to each other in some way. For example, the environmental
protection is closely linked to the stakeholder engagement and inclusive growth.
Principle 1 – Ethics, Transparency and Accountability:
The first principle emphasizes that the business decisions in an organisation should be open to
disclosure and accessible to the relevant interested parties.
The essence of the core elements associated with the first principle are:
a) The entities’ governing structure should develop policies, procedures, and practices for their
offices, factories, and work areas, ensuring that ethics is not compromised.
b) The information relating to the policies, procedures, and practices along with the performance
should be made available to the stakeholders.
c) In case of adverse effects, more care has to be taken for transparent disclosures.
d) The entities in the value chain should be encouraged to adopt these principles by the
governance structure.
e) The entities should proactively respond to the outside entities that violate the nine principles
of the BRSRs. This includes their suppliers, distributors, sub-contractors, or regulatory
officers that may engage with the business concern.
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SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.19
& GOVERNANCE ASSURANCE
Policies and
procedures
Fight
Legal corruption,
compliance anti
Ethics,
competition
Transparency
and
Accountability
Non-
Disclosure of cooperative
risks to with
stakeholders violating
entities
Principle 2 – Safe and Sustainable Goods and Services:
The entities should make sure that their goods, services, and the operations result in better life for
the consumers and end-users.
The essence of the core elements associated with the second principle is:
a) When a product is designed by the entity, the production methods and technologies have to
be devised in such a way so as to minimize the resource usage to make it sustainable.
b) The entities are also responsible to educate and make aware their consumers and clients
about their rights.
c) The entities should take measures that reduce the over exploitation of the nature’s resources
by consuming sustainably and encourage methods for reduce, reuse and recycling of the
resources.
Principle 3 – Promote well-being of all employees including those in the value chain:
The third principle relates to all the initiatives an entity has to take for the benefit of its employees
from the point of view of their dignity, health, well-being.
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The essence of the core elements associated with the principle is:
a) The entity should ensure compliance with all regulatory requirements as far as employees
are concerned.
b) The entities are to respect the dignity of employee as a human being and should not restrict
their freedom of associations, unions, and other participatory mechanism for collective
bargaining of their rights and redressal of issues they face at the workplace.
c) The entities should prevent all kinds of child labour, bonded labour, and any other forms of
involuntary labour.
d) The entities should have a system in which the work-life balance of the employees is not
compromised.
e) The businesses have to ensure timely payment of the worker’s wages and compensation.
f) The payment of the wages has to be as per the living wages, that can take care of the basic
needs and provide economic security to the employees.
g) The entities are responsible to create a workplace and work environment that is safe,
hygienic, and comfortable for people to work for long durations.
h) The skill development, career development and training of the workforce is another
responsibility of the entities employing them.
i) The creation of a workplace which is free of harassment and violence is also a responsibility
of the entity.
Principle 4 - Respect for stakeholders’ interests and responsiveness:
The concept of interested party or stakeholders to a business has been a point of discussion in all
the regulatory and voluntary systems that relate to the management system of any organisation, be
it related to the quality, environment or the occupational health and safety of the workers.
The essence of the core elements associated with the principle is:
a) The entities have to be transparent and communicate with the stakeholders about the impacts
of their operations and business decisions on the people and the nature. The policies,
decisions, and the impact of the operations of the organisation to the stakeholders have to
be disclosed transparently with no ambiguity on the extent of the issues.
b) The entities have to systematically determine the context of their operation and identify their
interested parties.
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& GOVERNANCE ASSURANCE
c) The entities should fairly share the benefits to the stakeholders or give an opportunity to them
to benefit from the operations in an equitable manner.
Principle 5 - Respect and promote human rights:
The concept of human rights is a vast topic that covers a wide variety of violence and belligerent
abusive issues faced by people. It refers to the human rights issues that happen directly or indirectly
due to the operation of the business.
The essence of the core elements associated with the principle are:
a) The entities should have a clear understanding of the human rights and various ways by
which human rights can be violated from the perspective of the Constitution of India, national
laws and policies and the content of International Bill of Human Rights.
b) The entities when developing their management systems, should integrate the human rights
element into their policies, procedures, and practices.
c) Businesses should recognize and respect the human rights of all relevant stakeholders and
groups within and beyond the workplace, including that of communities, consumers, and
vulnerable and marginalized groups.
Principle 6 – Protection and restoration of Environment:
The sixth principle looks at the environmental responsibility as a basic requirement for the economic
prosperity and sustainability.
The core elements associated with the principle are:
a) The entities should have policies, procedures, and practices in place to assess and rectify
impacts to the environment. This should cover the whole life cycle of the product.
b) The entities have to make use of natural and manmade resources in an optimum manner to
ensure their sustainability by taking feedback from the stakeholders.
c) The entities have to measure their performance relating to the prevention of pollution,
destruction of forests, waste generation, energy use, land use, etc.
d) The entities have to contribute towards climate change resilience in line with India’s
commitment to various international mechanisms such as, Paris Agreement and National
Action Plans for Climate Change.
e) The entities should explore the comparison of its activities with industry best practices to
reduce, reuse and recycle/ recover materials, resources.
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18.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
f) The companies have to look out for avenues by which they can improve their performance
towards various environmental responsibilities.
Principle 7 – Influence on Public and Regulatory Policy:
The seventh principle of influencing the policy formulation positively recognizes that the businesses
operate within the framework of statutory and legislative policies of the governing authority.
The principle further highlights that -
a) The core elements of BRSR are to have met holistically when the organisation go ahead with
their contributions to policy formulation and policy advocacy.
b) The collective associations such as, the trade groups and industry chambers have to be
utilized when moving ahead with the policy advocacy and formulation.
c) The role in policy advocacy by the organisation should be in such a way that it encourages
fair competition and prevents human rights abuses.
Principle 8 – Promote Inclusive Growth and equitable development:
This can work only with close participation and collaboration amongst the entities, authorities, the
civil associations contributing to one another for a better livelihood, and assistance to the
marginalized communities.
The core elements of the eighth principle are:
a) The entities should have systems in place to identify and address impacts of their activities
on the social, cultural, and economic aspects of the people. This includes business created
issues like, land acquisition and use and construction activities for new facilities.
b) The entities should review, measure, and track the adverse impacts of their activities on the
society and environment and make action plans to mitigate them adequately.
c) The entities should make efforts to bring up creative products, technologies, and business
concerns that help the marginalized communities to have well-being and a better quality of
life.
d) Entities when designing their CSR activities should review the local and regional development
priorities to help the marginalized groups and communities.
e) The entities should take care to ensure that business induced displacement or relocation of
communities does not happen, and in unavoidable cases, should make sure to have mutually
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agreed, participative, and informed negotiations to provide fair compensation to the affected
people.
f) All forms of intellectual property and traditional knowledge should get the deserved respect
from the organisation, and efforts should be made to ensure that benefits derived from their
knowledge are shared equitably.
Principle 9 – Provide value to the consumers in a responsible manner:
The primary purpose of any business is to create or provide useful products and services to the
customer in exchange of reasonable profits.
The core elements associated with the principle are:
a) Entities should put in their efforts to reduce the negative impacts of their products and
services on consumers, natural environment, and society at large.
b) When conceptualizing, designing, and marketing their products, the organisation should not
in any manner prevent the freedom of choice and fair competition.
c) The entities should transparently and accurately disclose all kinds of adverse impacts to the
user, planet, society, on the biodiversity from their products.
d) When handling customer data, the right to privacy of the customer needs to be maintained.
e) Entities should inform the customers on the safe and responsible ways of usage, reuse,
recycling, and disposal of their products, and ways to eliminate over-consumption.
f) When advertising about their products, the organisations should ensure that misleading and
confusing information is not exposed to the customers about their products or its usage.
g) Business enterprises should make available transparent and accessible grievance redressal
and feedback management system for their customers to raise their voices or to seek
clarifications.
h) Entities, when in the business of providing essential goods and services (e.g., Utilities),
should enable universal access, including to those whose services have been discontinued
for any reason, in a non-discriminatory and responsible manner.
© The Institute of Chartered Accountants of India
18.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
7.1.2 Allignment of BRSR Principles with SDGs
Principles/ P1 P2 P3 P4 P5 P6 P7 P8 P9
SDGs
SDG 1
SDG 2
SDG 3
SDG 4
SDG 5
SDG 6
SDG 7
SDG 8
SDG 9
SDG 10
SDG 11
SDG 12
SDG 13
SDG 14
SDG 15
SDG 16
SDG 17
7.1.3 Assurance in BRSR
SEBI has currently started with the top 1,000 listed companies. But very soon, remaining listed
companies would also need to comply with the provisions of BRSR.
Further, BRSR is expected to be used as a single means for disclosing sustainability related
information in India. This would be the main document which the stakeholders, investors would
review and do industry analysis.
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.25
& GOVERNANCE ASSURANCE
Hence, assurance in this reporting becomes more critical. ESG audit would be a process that would
help the companies to evaluate the environmental and social risks for the Company’s products,
services, operations etc. Conducting an ESG audit also helps businesses look at their supply-chain
risks, risk management capabilities and transparency with shareholders.
ICAI has recently issued Standard on Sustainability Assurance Engagements (SSAE) 3000
Assurance Engagements on Sustainability Information
This Standard deals with assurance engagements on an entity’s sustainability information. This is
an umbrella standard applicable to all assurance engagements on Sustainability information.
The intended users of this Standard include:
Assurance providers providing assurance on sustainability information.
Entities seeking to engage a professional auditor.
Regulators, investors, and other users of Sustainability Reporting data.
This Standard applies for assurance engagements which pertain to providing reasonable or limited
assurance on sustainability information.
The effective date of application of SSAE 3000 is as follows:
Voluntary basis for assurance reports covering periods ending on 31st March 2023.
Mandatory basis for assurance reports covering periods ending on or after 31st March 2024.
ICAI has also issued SSAE 3410, Assurance Engagements on Greenhouse Gas Statements which
deal with assurance engagements on an entity's sustainability information including assurance of
BRSR.
7.1.4 Methodology to provide assurance on BRSR:
Preparation of
Submission Assessment /
of findings Verification report
Review of including final
the of the on-
Issuance of site results of
Assessment responses Assessment/
On-site and assessment
Report and Recommendation
Assessment / and
Preliminary Assessment clarifications
Verification of document
Review of Statement on the
ESG Report review
ESG report, findings
parameters
© The Institute of Chartered Accountants of India
18.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
7.1.5 Social Audit Standards
The Sustainability Reporting Standards Board (SRSB) of the ICAI has recently issued Social Audit
Standards (SAS 100 to 1600). These Standards aim to provide the Social Auditor with the necessary
guidance in relation to independent impact assessment engagement of Social Enterprises engaged
in various areas and the audit steps and procedures that should be applied while conducting the
social impact assessment. The Standard sets out the minimum requirements to be followed while
conducting impact assessment. Laws or regulations may establish additional requirements which
should be followed, as applicable. Following SASs are issued:
SAS Particulars
100 Eradicating hunger, poverty, malnutrition and inequality
200 Promoting health care including mental healthcare, sanitation and making
available safe drinking water
300 Promoting Education, Employability, and Livelihoods
400 Promoting Gender Equality, Empowerment of Women and LGBTQIA+
communities
500 Ensuring environmental sustainability, addressing climate change including
mitigation and adaptation, forest and wildlife conservation
600 Protection of national heritage, art and culture
700 Training to promote rural sports, nationally recognised sports, Paralympic sports
and Olympic sports
800 Supporting incubators of social enterprises
900 Supporting other platforms that strengthen the non-profit ecosystem in fundraising
and capacity building
1000 Promoting Livelihoods for rural and urban poor including enhancing income of
Small and Marginal Farmers and workers in the non-farm sector
1100 Slum area development, affordable housing and other interventions to build
sustainable and resilient cities
1200 Disaster Management, including Relief, Rehabilitation and Reconstruction
Activities
1300 Promotion of financial inclusion
1400 Facilitating Access to Land and Property Assets for disadvantaged Communities
1500 Bridging the digital divide in internet and mobile phone access, addressing issues
of misinformation and data protection
1600 Promoting welfare of migrants and displaced persons
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SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.27
& GOVERNANCE ASSURANCE
8. ROLE OF AUDITOR - CONSIDERATION OF CLIMATE
RELATED RISKS IN AN AUDIT OF FINANCIAL
STATEMENTS
The role of the auditor is to obtain reasonable assurance about whether the financial statements as
a whole are free from material misstatement, whether due to fraud or error, to enable auditor to
report whether the financial statements are prepared and presented fairly, in all material respects,
in accordance with the applicable financial reporting framework.
In developing the understanding of an entity, the auditor should include the consideration of climate-
related risks and how these risks may be relevant to the audits. The climate-related risks could be
more relevant in certain sectors or industries, e.g., banks and insurance, energy, transportation,
materials and buildings, agriculture, food, and forestry products.
Many investors and stakeholders are seeking information from auditor’s reports about how climate-
related risks were addressed in the audit. With this increased user focus on climate change, auditor
need to be aware of, and may face, increasing pressure for transparency about climate matters in
our auditor’s reports. However, the auditor’s reports must follow the requirements of applicable
auditing standards.
The auditor’s report is a key mechanism of communication to users about the audit that was
performed. In addition to the audit opinion, it provides information about auditor’s responsibilities
and, when required, an understanding of the matters of most significance in our audit and how they
were addressed.
In some circumstances, it may warrant inclusion of an Emphasis of matter paragraph to draw
attention to disclosures that are of fundamental importance to users’ understanding of the financial
statements. The auditor should also determine whether the entity has appropriately disclosed
relevant climate-related information in the financial statements in accordance with the applicable
financial reporting framework e.g., Indian Accounting Standards or Accounting Standards, when
relevant before considering climate-related matters in the auditor’s report.
The auditor should also read the other information for consistency with information disclosed in the
financial statements and information that may be publicly communicated to stakeholders outside the
financial statements, such as management report narratives in the annual report, press releases, or
investor updates. This is a requirement under ISA 720 and SA 720, The Auditor’s Responsibilities
Relating to Other Information.
© The Institute of Chartered Accountants of India
18.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Case Study
The agrochemical sector is about a $35 billion industry in India. The Indian agrochemicals market
is segmented by product type (fertilizers, pesticides, adjuvants, and plant growth regulators) and
application (crop-based and non-crop-based). India is one of the most prominent exporters of
agrochemicals in the world and is being keenly looked at as an ideal hub for export-oriented
production of agrochemicals. There has been a recent surge in the production of agrochemicals
to overcome problems such as lack of right nutritious elements required for proper growth of
crops, etc. While there is low awareness about the use and impact of agrochemicals, there is also
a push from the industries to use more agrochemicals, linking it to better yield. The continuous
and increased use of agrochemicals seems to have an adverse effect on humans, animals, and
nature in whole.
The toxicity levels of the agrochemicals are harmful, not only to the workers in the manufacturing
process but also to farmers, the soil, and the end consumers. The Central Insecticide Board (CIB)
of India has categorized agrochemical toxicity levels based on a labeling system—using red,
yellow, blue, and green labels—where red is the most toxic and green is the least. Most of the
red-labeled products are banned abroad but are being sold in India due to the lack of a strong
regulatory environment.
In India, it is estimated that almost 25% of the total amount of agrochemicals sold are counterfeit
products. The quality and the efficacy of these counterfeit products differ from the original
products, which can lead to reputational damages for the companies. Agrochemical companies
need to add barcodes or other identifying technologies to their product packaging, to allow end-
use consumers to check for authenticity. Also, since India is a multilingual country, the companies
will have to publish the usage instructions in multiple languages.
Company A and B are both listed companies and part of top 1000 listed companies. They are
engaged in the production of agrochemicals. Company A has been looking for opportunities to
comply with the recently launched and evolving guidelines for ESG in India while Company B on
the other hand is just focused to increase revenue and profits. In December 2022, Company A
made a decision to eliminate red-labeled products from its portfolio and to increase its research
and development (R&D) spending to safeguard itself from the market shift due to the new
regulatory norms; in 2022, it also discontinued yellow-labeled products. Company A is also
planning to incur a small expenditure to improve their backend systems and provide for all its
products a unique labeling system that is user friendly and interactive. At the other end of the
spectrum, 14% of Company B’s top-selling products are derived from red- and yellow labeled
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.29
& GOVERNANCE ASSURANCE
products.
Initially, Company A’s phasing out of its toxic products negatively affected its revenues by 8%.
But as the country’s regulatory landscape evolves toward more stringent norms, Company A will
be cushioned for regulatory changes and thus, would not face potential future downsides.
Company B has recently witnessed a 9% year on year growth in revenue from the last financial
year and is planning to increase the production of its bestselling product, an insecticide DDT,
categorized as red labelled by the Central Insecticide Board. Company B has recently been
approached by the regulatory authority for an investigation for its products which include
performing additional tests and studies to testify that its products have no adverse effects.
1. What would be the reporting requirements for each of the two companies?
2. Which Company has absorbed the impacts of possible future regulatory changes? What
are the steps taken by that Company for complying with the regulatory standards?
3. What would be the consideration by the auditors of Company A and B in the audit of
financial statements?
9. CONCLUSION
The overarching importance of sustainability reporting continues to gain momentum globally with
demands from various stakeholders and substantial research and developments toward a uniform
set of sustainability standards. The uniformity is not achieved yet due to lack of a common language
for sustainability reporting. As reporting of sustainability information becomes the trend being
observed globally, the demand for independent assurance of sustainability information is anticipated
to grow as entities around the globe look to enhance the integrity of their sustainability reporting.
Hence, it is imperative that auditors and assurance providers understand the current landscape and
continue to monitor ongoing developments. The demand for assurance on “sustainability branded”
reporting continues to grow and therefore there is an urgent need for globally accepted sustainability/
ESG assurance standards that can be used by all assurance professionals.
Integrated Case Scenario
“Quick Push Finance Limited” is one of the top listed 1000 companies by market capitalization. As
per a SEBI circular, Business Responsibility and Sustainability Report (BRSR) based on ESG
parameters is mandatory from financial year 2022-23 for top listed 1000 companies. The company
is an NBFC and is engaged mainly in providing finance for commercial vehicles.
© The Institute of Chartered Accountants of India
18.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The report is to be prepared in three sections- Section A, B and C. Whereas Section A and B relate
to general disclosures and management & process disclosures respectively, Section C of the report
relates to principle wise performance disclosures. Under this section C, information is sought on
each of the 9 principles of “National Guidelines on Responsible Business Conduct” (NGBRCs). This
information is categorized on two indicators i.e., “Essential indicators” and “Leadership indicators”.
The said company has an anti-corruption/anti-bribery policy which is available on its website.
Besides, the company has regularly conducted awareness programmes for its dealers highlighting
relevant governance practices of the company.
The company is sensitive to environmental concerns. It has established mechanisms to recycle
hazardous e-waste in accordance with applicable laws. Further, disposal of paper waste is also
made responsibly. It is also a member of 5 prominent industry chambers/trade associations including
FICCI, CII and ASSOCHAM. Besides, regular inputs to government are provided by the company
through various forums for improvement in administrative processes relating to automobile and
financial sectors.
One of the NGBRC principles states that businesses should promote inclusive growth and equitable
development. The scope of this principle is wide and quite encompassing. Many activities of
company could fall under promotion of inclusive growth and equitable development.
The CFO of company is clueless as to preparation of BRSR. Help him out by answering the following
questions.
Based upon above, answer the following questions: -
1. As regards anti-corruption/anti-bribery policy and organization of awareness programmes for
dealers conducted during the year, which of the following is most likely to be true?
(a) Having an anti-corruption/anti-bribery policy and organization of awareness programmes for
dealers are in nature of essential indicators.
(b) Having an anti-corruption/anti-bribery policy and organization of awareness programmes for
dealers are in nature of leadership indicators.
(c) Having an anti-corruption/anti-bribery policy is in nature of essential indicators. Organization of
awareness programmes for dealers is in nature of leadership indicators.
(d) Having an anti-corruption/anti-bribery policy is in nature of leadership indicators. Organization
of awareness programmes for dealers is in nature of essential indicators.
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.31
& GOVERNANCE ASSURANCE
2. As regards established mechanisms for recycle of hazardous e-waste and disposal of
paper waste by company, which of the NGBRC principle(s) are involved?
(a) Principle 5 only
(b) Principle 9 only
(c) Principles 6 and 9
(d) Principles 2 and 6
3. Considering description of membership of various industry chambers/ trade
associations and providing of inputs to government for improvement in administrative
processes, which of the NGBRC principle is referred to?
(a) Principle 8
(b) Principle 4
(c) Principle 3
(d) Principle 7
4. Which of the following activities relates to the principle that businesses should promote
inclusive growth and equitable development?
(a) CSR projects undertaken by the company in designated aspirational districts of country
(b) Carrying out real time digital Net Promoter score (NPS) with all public customers to gauge
customer reactions and satisfaction
(c) Getting conducted “energy audits” in the company
(d) Conducting programmes to assist employees in finding employment after retirement
5. Which of the following statements is true in respect of essential indicators and
leadership indicators as far as their reporting in BRSR is concerned?
(a) Both types of indicators are mandatorily required to be disclosed.
(b) Essential indicators require mandatory disclosure whereas leadership indicators require
voluntary disclosure.
(c) Essential indicators require voluntary disclosure whereas leadership indicators require
mandatory disclosure.
(d) All indicators based information whether relating to essential indicators or leadership indicators
is voluntary.
© The Institute of Chartered Accountants of India
18.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Key Takeaways
Sustainable development is development that strives to meet the needs of developing
countries seeking to achieve a more sustainable world. Sustainable development addresses
the needs of the present moment without compromising current and future generations to
meet their own sustainable lifestyles.
Environment, social and governance form three pillars of ESG. Environmental, social and
governance (ESG) reporting is all about disclosure of information, data, metrics that explain
and added value in these three areas. ESG reporting can be both quantitative and qualitative
in nature.
Sustainable Development Goals (SDGs) are set of 17 goals in line with the 2030 Agenda for
Sustainable Development” adopted by UN.
International investors with global investment portfolios are increasingly calling for high
quality, transparent, reliable, and comparable reporting by companies on climate and other
environmental, social and governance (ESG) matters.
The Integrated Reporting Framework is used to connect financial statements and
sustainability-related financial disclosures. It has been established to develop high-quality,
understandable, enforceable and globally accepted accounting and sustainability disclosure
standards.
The Integrated reporting framework identifies 6 capitals- financial capital, manufactured
capital, natural capital, human capital, social capital and intellectual capital.
ESG disclosure and reporting is mandatory for top 1000 listed companies in form of Business
responsibility and sustainability reports. (BRSR).
As reporting of sustainability information becomes the trend being observed globally, the
demand for independent assurance of sustainability information is anticipated to grow as
entities around the globe look to enhance the integrity of their sustainability reporting.
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.33
& GOVERNANCE ASSURANCE
TEST YOUR KNOWLEDGE
Theoretical Questions
1. What type of companies are required to mandatorily furnish the Business Responsibility and
Sustainability Report (BRSR) as per the SEBI circular with effect from FY 2022-23?
2. What are the nine principles of BRSR? How are the nine principles of BRSR linked with the
17 UN Sustainable Development Goals?
3. What are the global trends in sustainable reporting?
4. What are the 6 C’s of Integrated reporting?
5. What is the methodology of providing assurance in BRSR?
6. What is the auditor’s role on ESG aspects in an audit of financial statements of the Company?
Answers to Test your Understanding
1. Sustainability reporting is an organization’s practice of reporting publicly on its economic,
environmental, and/or social impacts, and hence its contributions – positive or negative –
towards the goal of sustainable development
Sustainability reporting refers to the information that companies provide about their
performance to the outside world on a regular basis in a structured way. It is the
comprehensive mechanism of measuring and disclosing sustainability data with performance
indicators and management disclosures.
Expected Benefits: It can help stakeholders to understand organizations performance vis a
vis sustainability and impacts. The reporting process emphasizes the link between financial
and non-financial performance.
Such reporting can help entities to focus on long-term value creation, by addressing
environmental, social and governance (ESG) issues. Since investors are increasingly
recognising that environmental and social issues provide both risks and opportunities in
respect of their investments and are seeking disclosures on environmental and social
performance of businesses, they can use ESG performance of companies to make
investment decisions.
© The Institute of Chartered Accountants of India
18.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Investing in social and environmental issues will not only improve own business continuity of
companies but also put them in a better position with their B2B (Business to Business)
customers as well as enable them to acquire new ones.
2. The information at [i] states that company has increased the number of customers using
digital mobile app. Besides, it has led to 100% increase in digital collection. Therefore, it
involves use of technology for deriving business benefits. It has invested in innovation
deriving business benefits from digitization. The capital referred to at [i] is “Intellectual
Capital”.
Increase in number of beneficiaries under flagship CSR programmes providing value for
communities and sustainable livelihood is an example of relationships established within and
between each community, group of stakeholders and other networks to enhance individual
and collective well-being. The capital referred to at [ii] is “Social and Relationship Capital.”
Answers to Integrated Case Scenario
1. (c)
2. (d)
3. (d)
4. (a)
5. (b)
Answers to Case Study
1. Both Companies A and B are among part of top 1000 listed companies. Hence, these
companies have to mandatorily provide BRSR reporting (Business responsibility and
Sustainability reporting) in accordance with 9 principles of NGBRC as mandated by SEBI.
2. Company A has absorbed impact of regulatory changes. It has decided to eliminate red-
labelled and yellow-labelled products from its portfolio which are toxic in nature. Besides, it
has increased its expenditure on R & D to meet with new regulatory norms. It has also
incurred expenditure for improving its labelling system which would help end users to know
about the nature of the product. All these steps have been taken by Company A for complying
with regulatory standards.
Company A is trying to meet with requirements of Principle 2 by making R & D expenditure.
Further, it has also eliminated red-labelled/yellow-labelled products from its portfolio.
Principle 2 relates to the requirement that businesses should provide goods and services in
© The Institute of Chartered Accountants of India
SUSTAINABLE DEVELOPMENT GOALS & ENVIRONMENT, SOCIAL 18.35
& GOVERNANCE ASSURANCE
a manner that is sustainable and safe. Besides, by adopting a friendly bar-coded packaging
labelling system, company is adhering to requirements of Principle 9 which states that
businesses should engage with and provide value to their consumers in a responsible
manner. Steps taken by a company to inform its consumers about safe and responsible usage
of products fall in its domain.
Since toxic agrochemicals are also harmful to workers engaged in their manufacturing
process, their discontinuation bodes well for workers in the company A in line with Principle
3 which states that businesses should respect and promote the well-being of all employees
including those in their value chains. By discontinuing products which are harmful to soil,
company A is meeting requirements of Principle 6 which states that businesses should
respect and make efforts to protect and restore the environment.
3. Company A is complying with regulatory norms whereas 14% of company B’s revenue are
derived from red and yellow labelled products. In fact, company B is planning to increase
production of its red labelled product i.e., insecticide DDT which has been categorized as
such by Central Insecticide Board. The auditor of Company B would have to keep in mind
requirements of SA 250 in this regard. Non-compliance with laws and regulations may result
in fines, litigation or other consequences for the entity that may have a material effect on the
financial statements. It can result in material misstatements. Central Insecticide Board has
already launched its investigation into products of company. All these factors would be taken
into consideration by auditor of Company B.
Auditors of Company A and Company B need to obtain audit evidence regarding compliance
with laws and regulations and audit procedures have to be designed accordingly. Auditor of
Company A can obtain assurance from regulatory compliance by the company. Fall of
revenue by 8% in one year is not a matter of concern to them as it is a transitory phase.
However, auditors of Company B would also have to take into consideration requirements of
SA 570 as non-compliance with regulatory requirements could result into claims from such
proceedings which the company may not be able to satisfy.
Hints /Answers to Theoretical Questions
1. Refer para 7.1
2. Refer para 7.1.1
3. Refer para 3.
4. Refer para 4.
5. Refer para 7.1.4
6. Refer para 8.
© The Institute of Chartered Accountants of India
CHAPTER 19
7
PROFESSIONAL ETHICS &
LIABILITIES OF AUDITORS
LEARNING OUTCOMES
After reading this chapter student shall be able to:
Understand the Application of the International and Indian Code of Ethics
theoretically/practically.
Learn the Application of Fundamental Principles of Professional Ethics by
Professional Accountants in practice, service or otherwise occupied.
Identifying threats and Safeguards measures while Compliance of
Fundamental Principles of Professional Ethics.
© The Institute of Chartered Accountants of India
19.2 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
CHAPTER OVERVIEW
This chapter encapsulates the relevant professional ethics guidelines, requirements and the
standards of conduct expected from a Chartered Accountant. The Chapter has been divided
into various sections to facilitate systematic and easy learning by the students.
Chartered Accountants
in Practice
Membership of the
Institute Chartered Accountants
in Service and
Overview of the Code otherwise occupied
of Ethics
Professional
Professional Ethics
The Chartered
Accountants Act, 1949: Types of Misconduct:
Other Misconduct
Council Guidelines Disciplinary Procedure
First Schedule
Recommended Self-
Regulatory Measures Schedules to the Act
Second Schedule
CA R is one of the leading practitioners in Varanasi and is a partner in audit firm consisting of 8
partners. The firm is allotted branch audit of a leading public sector bank in the same city having
advances of `450 crore. Advances portfolio of the branch consist of some reputed export firms.
It is noticed during audit that drawing power in stock statements submitted to bankers by these
firms is not arrived at properly. There are no apparent errors as such. The issue he is raising can
be overlooked, if he chooses to do so. Besides, his staff also digs out certain frivolous procedural
irregularities in relation to these accounts. The accounts of all these firms are, otherwise,
operating satisfactorily. He intends to report these accounts as NPAs in memorandum of changes
and is creating headache for AGM every other day. Completion of audit is being delayed on one
pretext or another. Even informal calls by Circle DGM prove to be futile. The amounts involved
are huge and much is at stake for branch management.
Frustrated and harassed AGM of branch advises owners of these firms to meet CA R in his office
and sort out the matter themselves. Out of 7 such firms, 3 owners meet him in his office and
assure to avail services of his firm in immediate future. They also try to assuage his ego. He leaves
out these accounts from reporting. Owners of the remaining firms do not meet him. Peeved by
this, their loan accounts are reported as NPA and adverse comments are made in LFAR.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.3
Is Chartered accountant acting ethically? The answer is resounding NO. He is trying to put his
personal benefit and interest above all things. He is overlooking certain matters falling in his
discretion selectively for obvious reasons. He is not looking at things objectively. A
distinguishing feature of Chartered Accountancy profession is the acceptance of responsibility
to act in public interest. Such a behavioural attitude is not expected from professionals. Ethics is
something which comes from an individual intrinsically. It has to be ingrained in the temperament
of an individual to withstand any selfish motive or temptation. It is a state of mind to act and
perform in accordance with moral principles. Spirit of ethics is to be followed and not only what
is expressly stated or codified.
Consider another case of a practicing Chartered Accountant who comes to know of certain
information by virtue of his association with a client. He is also dealing with another client in same
line of business. Can he use information acquired from first client to advantage or disadvantage
of second client? Again, answer would be in negative. As by doing so, he could breach
confidentiality. It can lead to conflict of interest. A professional accountant is not supposed to
allow a conflict of interest to compromise professional or business judgment.
Professional work of accountants could involve ethical situations on a daily basis consisting of
perceived benefits, pressures or dilemmas. There could be a thin line of difference between
ethical and unethical. It requires judgment in every situation in accordance with spirit of ethics
and its principles.
Exhaustive code of ethics is in place for public accountants. It not only contains fundamental
principles governing professional ethics along with conceptual framework but also deals with
independence requirements for assurance engagements. Besides, there are specific provisions
of Chartered Accountants Act, 1949 dealing with professional misconduct.
1. INTRODUCTION
The Oxford Dictionary states ethics as “the moral principle that governs a person's behavior or how
an activity is conducted”. It is the branch of knowledge that deals with moral principles, whereas
“Professional Ethics” consist of personal, organizational and corporate standards of behaviour
expected for professionals.
Chartered Accountants as professionals are engaged in building trust to vast variety of users,
whether shareholders, government, banks, investors, employees or others, which imposes a public
interest responsibility on their profession. Like other professionals, Chartered Accountants also have
some set of code of ethics. This Code of Ethics establishes ethical requirements for
Professional Accountants.
© The Institute of Chartered Accountants of India
19.4 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
A Chartered Accountant, either in practice or in service, has to
abide by these ethical behaviours. They are expected to follow the
fundamental principles of professional ethics while performing their
jobs. Service users of professionals should be able to feel secure
that there exists a framework of professional ethics which governs
the provision of those services. Any deviation from the ethical
responsibilities brings the disciplinary mechanism into action
against the Chartered Accountants. Fig: Professional Ethics∗
Code of Ethics– Its Necessity: Ethics are as old as human civilization. It is nothing but the laws or
rules of acceptable behaviour. The whole foundation of any profession, particularly CA profession,
is its credibility. The sole purpose of Code of Ethics is to ensure and uphold this credibility. The main
ingredient of our profession is independence. An auditor needs to be independent while carrying out
his audit. The provisions discussed in the same ensure that the independence of members of the
Institute is not affected.
Our Institute’s Motto – ‘Ya Esha Supteshu Jagrati’ is adopted from Kathopanishad and it denotes
‘eternal vigilance’ – awakening when the world is asleep.
A distinguishing feature of the accountancy profession is its acceptance of the responsibility
to act in the public interest. Code of Ethics seeks to protect the interests of the profession as a
whole. It is a shield that enables us to command respect.
2. OVERVIEW OF THE CODE OF ETHICS
The revised Code of Ethics contains the following material:
• Part 1 – Complying with the Code, Fundamental Principles and Conceptual Framework,
which includes the fundamental principles and the conceptual framework and is applicable to
all professional accountants.
• Part 2 – Professional Accountants in Service, which sets out additional material that applies
to professional accountants in service when performing professional activities. Professional
accountants in service include professional accountants employed, engaged or contracted in
an executive or non-executive capacity in, for example:
o Commerce, industry or service.
o The public sector.
o Education.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.5
o The not-for-profit sector.
o Regulatory or professional bodies.
Part 2 is also applicable to individuals who are professional accountants in public practice when
performing professional activities pursuant to their relationship with the firm as an employee.
• Part 3 – Professional Accountants in Public Practice, which sets out additional material that
applies to professional accountants in public practice when providing professional services.
o Independence Standards, which sets out additional material that applies to
professional accountants in public practice when providing assurance services, as
follows:
o Part 4A – Independence for Audit and Review Engagements, which applies when
performing audit or review engagements.
o Part 4B – Independence for Assurance Engagements Other than Audit and
Review Engagements, which applies when performing assurance engagements that
are not audit or review engagements.
• Glossary, which contains defined terms (together with additional explanations where
appropriate) and described terms which have a specific meaning in certain parts of the Code.
For example, as noted in the Glossary, in Part 4A, the term “audit engagement” applies
equally to both audit and review engagements. The Glossary also includes lists of
abbreviations that are used in the Code and other standards to which the Code refers.
Overview of the Code of Ethics
Part 1 Independence
Part 2 Part 3 Glossary
Standards
Complying Professional
with the Code, Part 4A Part 4B
Professional Accountants
Fundamental in Public
Principles and Accountants
in Service Practice
Conceptual
Framework Independence
for Assurance
Independence Engagements
for Audit and Other than Audit
Review and Review
Engagements Engagements
© The Institute of Chartered Accountants of India
19.6 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The Code contains sections which address specific topics. Some sections contain
subsections dealing with specific aspects of those topics.
Each section of the Code is structured, where appropriate, as follows:
• Introduction – sets out the subject matter addressed within the section, and introduces the
requirements and application material in the context of the conceptual framework.
Introductory material contains information, including an explanation of terms used, which is
important to the understanding and application of each Part and its sections.
• Requirements – establish general and specific obligations with respect to the subject matter
addressed.
• Application material – provides context, explanations, suggestions for actions or matters to
consider, illustrations and other guidance to assist in complying with the requirements.
A professional accountant shall comply with the Code. There might be circumstances where laws or
regulations preclude an accountant from complying with certain parts of the Code. In such
circumstances, those laws and regulations prevail, and the accountant shall comply with all other
parts of the Code.
2.1 Fundamental Principles
In order to achieve the objectives of the Accountancy profession, professional accountants have to
observe a number of prerequisites or fundamental principles. The fundamental principles as
discussed in Code of Ethics of ICAI, to be complied, are given below:
Integrity
Objectivity
Professional
Competence and
Due Care
Confidentiality
Professional
Behaviour
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.7
(a) Integrity – Subsection 111
1. A professional accountant shall comply with the principle of integrity, which requires an
accountant to be straightforward and honest in all professional and business
relationships. Integrity implies fair dealing and truthfulness.
2. A professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the accountant believes that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information provided negligently; or
(c) Omits or obscures required information where such omission or obscurity would be
misleading.
However, a professional accountant will not be considered to be in breach of matters
mentioned above in paragraph 2 if the professional accountant provides a modified report in
respect of such above mentioned matter.
3. When a professional accountant becomes aware of having been associated with information
described in paragraph 2, the accountant shall take steps to be disassociated from that
information.
(b) Objectivity- Subsection 112
A professional accountant shall
A professional accountant shall not
comply with the principle of
undertake a professional activity if a
objectivity, which requires an
circumstance or relationship unduly
accountant not to compromise
influences the accountant’s
professional or business judgment
professional judgment regarding that
because of bias, conflict of interest or
activity.
undue influence of others.
(c) Professional Competence and Due Care – Subsection 113
1. A professional accountant shall comply with the principle of professional competence
and due care, which requires an accountant to:
(a) Attain and maintain professional knowledge and skill at the level required to ensure
that a client or employing organization receives competent professional service, based
on current technical and professional standards and relevant legislation; and
(b) act diligently in accordance with applicable technical and professional standards.
© The Institute of Chartered Accountants of India
19.8 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2. Serving clients and employing organizations with professional competence requires the
exercise of sound judgment in applying professional knowledge and skill when
undertaking professional activities.
3. Maintaining professional competence requires a continuing awareness and an
understanding of relevant technical, professional and business developments.
4. Continuing professional development enables a professional accountant to develop and
maintain the capabilities to perform competently within the professional environment.
5. Diligence encompasses the responsibility to act in accordance with the requirements of
an assignment, carefully, thoroughly and on a timely basis.
6. In complying with the principle of professional competence and due care, a professional
accountant shall take reasonable steps to ensure that those working in a professional
capacity under the accountant’s authority have appropriate training and supervision.
Where appropriate, a professional accountant shall make clients, the employing organization, or
other users of the accountant’s professional services or activities, aware of the limitations inherent
in the services or activities.
(d) Confidentiality- Subsection 114
1. A professional accountant shall comply with the principle of confidentiality, which requires an
accountant to respect the confidentiality of information acquired as a result of professional
and employment relationships. An accountant shall:
Be alert to the possibility of inadvertent disclosure, including in a social environment, and
particularly to a close business associate or an immediate or a close family member;
Maintain confidentiality of information within the firm or employing organization;
Maintain confidentiality of information disclosed by a prospective client or employing
organization;
Not disclose confidential information acquired as a result of professional and employment
relationships outside the firm or employing organization without proper and specific
authority, unless there is a legal or professional duty or right to disclose;
Not use confidential information acquired as a result of professional and employment
relationships for the personal advantage of the accountant or for the advantage of a third party;
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.9
Not use or disclose any confidential information, either acquired or received as a result
of a professional or employment relationship, after that relationship has ended; and
Take reasonable steps to ensure that personnel under the accountant’s control, and
individuals from whom advice and assistance are obtained, respect the accountant’s duty
of confidentiality.
2. Confidentiality serves the public interest because it facilitates the free flow of information from
the professional accountant’s client or employing organization to the accountant in the
knowledge that the information will not be disclosed to a third party. Nevertheless, the
following are circumstances where professional accountants are or might be required to
disclose confidential information or when such disclosure might be appropriate:
(a) Disclosure is required by law,
Production of documents or other provision of evidence in the course
of legal proceedings.
Disclosure to the appropriate public authorities of infringements of
the law that come to light
(b) Disclosure is permitted by law and is authorized by the client or the employing
organisation;
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the requirements of Peer Review or Quality Review of the
Institute;
(ii) To respond to an inquiry or investigation by a professional or regulatory body;
(iii) To protect the professional interests of a professional accountant in legal
proceedings; or
(iv) To comply with technical and professional standards, including ethics
requirements.
3. In deciding whether to disclose confidential information, professional accountants
should consider the following points:
(a) Whether the interests of any party, including third parties whose interests might
be affected, could be harmed if the client or employing organization consents to
the disclosure of information by the professional accountant;
© The Institute of Chartered Accountants of India
19.10 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(b) Whether all the relevant information is known and substantiated, to the extent it is
practicable; and
(c) The proposed type of communication, and to whom it is addressed;
(d) Whether the parties to whom the communication is addressed are appropriate
recipients.
4. A professional accountant shall continue to comply with the principle of confidentiality even
after the end of the relationship between the accountant and a client or employing
organization. When changing employment or acquiring a new client, the accountant is entitled
to use prior experience but shall not use or disclose any confidential information acquired or
received as a result of a professional or employment relationship.
(e) Professional Behaviour- Subsection 115
1. A professional accountant shall comply with the principle of professional behaviour, which
requires an accountant to comply with relevant laws and regulations and avoid any conduct
that accountant knows or should know might discredit the profession.
Conduct that might discredit the profession includes conduct that a reasonable and informed
third party would be likely to conclude adversely affects the good reputation of the profession.
A professional accountant shall not knowingly engage in any employment, occupation or
activity that impairs or might impair the integrity, objectivity or good reputation of the
profession, and as a result would be incompatible with the fundamental principles.
2. When promoting himself and his work, a professional accountant shall not bring the
profession into disrepute. A professional Accountant is required to conduct his affairs in a
manner that he remains outside the boundaries of professional and other misconduct. A
professional accountant shall be honest and truthful and should not make:
(a) Exaggerated claims for the services they are able to offer, the qualifications they
possess, or experience they have gained; or
(b) Disparaging references or unsubstantiated comparisons to the work of others.
(c) Any direct or indirect measures to advertise any professional/other facts which are in
violation of Advertisement Guidelines issued by the Council of the Institute from time
to time.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.11
The professional accountant should ensure that the contents of an advertisement are true to
the best of his knowledge and belief, and are in conformity with the Advertisement Guidelines,
and be aware that the Institute does not own any responsibility, whatsoever, for such contents
or claims by him. However, if a professional accountant is in doubt about whether a form of
proposed advertising is appropriate, the accountant is encouraged to consult with the Ethical
Standards Board of ICAI.
A professional accountant shall comply with each of the fundamental principles.
The fundamental principles of ethics establish the standard of behaviour expected of a
professional accountant.
The conceptual framework establishes the approach which an accountant is required to
apply to assist in complying with those fundamental principles.
A professional accountant might face a situation in which complying with one fundamental
principle conflicts with complying with one or more other fundamental principles. In such
a situation, the accountant might consider consulting, with:
• Others • Those
within the firm • Legal
charged with • The Institute counsel.
or employing governance.
organization.
However, such consultation does not relieve the accountant from the responsibility to
exercise professional judgment to resolve the conflict or, if necessary, and unless
prohibited by law or regulation, disassociate from the matter creating the conflict.
The professional accountant is encouraged to document the substance of the issue, the
details of any discussions, the decisions made and the rationale for those decisions.
2.2 Threats, Evaluation of Threats and Safeguards
The conceptual framework specifies an approach for a professional accountant to:
(i) Identify threats to compliance with the fundamental principles;
(ii) Evaluate the threats identified; and
(iii) Address the threats by eliminating or reducing them to an acceptable level.
© The Institute of Chartered Accountants of India
19.12 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
A. Threats
Threats to compliance with the fundamental principles fall into one or more of the following
categories:
the threat that a financial or other interest will inappropriately
influence a professional accountant’s judgment or behaviour;
Self-interest
threat –
the threat that a professional accountant will not appropriately evaluate the
results of a previous judgment made; or an activity performed by the
accountant, or by another individual within the accountant’s firm or employing
Self-review organization, on which the accountant will rely when forming a judgment as
threat – part of performing a current activity;
Threats the threat that a professional accountant will promote a client’s or
Advocacy
employing organization’s position to the point that the accountant’s
threat –
objectivity is compromised;
Familiarity the threat that due to a long or close relationship with a client, or
threat – employing organization, a professional accountant will be too
sympathetic to their interests or too accepting of their work; and
Intimidation
threat –
the threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to
exercise undue influence over the accountant.
A. The following are examples of facts and circumstances within each of those categories
of threats that might create threats for a professional accountant when undertaking a
professional service:
Self-interest Threats:
• A professional accountant having a direct financial interest in a client.
• A professional accountant quoting a low fee to obtain a new engagement and the fee is
so low that it might be difficult to perform the professional service in accordance with
applicable technical and professional standards for that price.
• A professional accountant having a close business relationship with a client.
• A professional accountant having access to confidential information that might be used
for personal gain.
• A professional accountant discovering a significant error when evaluating the results of a
previous professional service performed by a member of the accountant’s firm.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.13
Self-review Threats
• A professional accountant issuing an assurance report on the effectiveness of
the operation of financial systems after implementing the systems.
• A professional accountant having prepared the original data used to generate records
that are the subject matter of the assurance engagement.
Advocacy Threats
• A professional accountant promoting the interests of, or shares in, a client.
• A professional accountant acting as an advocate on behalf of a client in litigation or
disputes with third parties.
• A professional accountant lobbying in favor of legislation on behalf of a client.
Familiarity Threats
• A professional accountant having a close or immediate family member who is a
director or officer of the client.
• A director or officer of the client, or an employee in a position to exert significant influence
over the subject matter of the engagement, having recently served as the engagement
partner.
An audit team member having a long association with the audit client.
Intimidation Threats
• A professional accountant being threatened with dismissal from a client
engagement or the firm because of a disagreement about a professional matter.
• A professional accountant feeling pressured to agree with the judgment of a client
because the client has more expertise on the matter in question.
• A professional accountant being informed that a planned promotion will not occur unless
the accountant agrees with an inappropriate accounting treatment.
• A professional accountant having accepted a significant gift from a client and being
threatened that acceptance of this gift will be made public.”.
© The Institute of Chartered Accountants of India
19.14 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
B. The following are examples of facts and circumstances within each of those categories
that might create threats for a professional accountant when undertaking a professional
activity:
Self-interest Threats
• A professional accountant holding a financial interest in, or receiving a loan or
guarantee from, the employing organization.
• A professional accountant participating in incentive compensation arrangements
offered by the employing organization.
• A professional accountant having access to corporate assets for personal use.
• A professional accountant being offered a gift or special treatment from a supplier of
the employing organization.
Self-review Threats
• A professional accountant determining the appropriate accounting treatment for
a business combination after performing the feasibility study supporting the purchase
decision.
Advocacy Threats
• A professional accountant having the opportunity to manipulate information in a
prospectus in order to obtain favorable financing.
Familiarity Threats
• A professional accountant being responsible for the financial reporting of the
employing organization when an immediate or close family member employed by the
organization makes decisions that affect the financial reporting of the organization.
• A professional accountant having a long association with individuals influencing
business decisions.
Intimidation Threats
• A professional accountant or immediate or close family member facing the
threat of dismissal or replacement over a disagreement about:
o The application of an accounting principle.
o The way in which financial information is to be reported.
• An individual attempting to influence the decision-making process of the professional
accountant, for example with regard to the awarding of contracts or the application of an
accounting principle.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.15
Specific circumstances give rise to unique threats to compliance with one or more of the fundamental
principles. Such unique threats cannot be categorized. In either professional or business
relationships, a professional accountant in public practice should always be on the alert for such
circumstances and threats.
B. Evaluation of Threats:
The conditions, policies and procedures described above might impact the evaluation of whether a
threat to compliance with the fundamental principles is at an acceptable level.
(i) Acceptable level: An acceptable level is a level at which a professional accountant using the
reasonable and informed third party test would likely conclude that the accountant complies
with the fundamental principles.
(ii) Reasonable and Informed Third Party: The reasonable and informed third party test is a
consideration by the professional accountant about whether the same conclusions would
likely be reached by another party. Such consideration is made from the perspective of a
reasonable and informed third party, who weighs all the relevant facts and circumstances that
the accountant knows, or could reasonably be expected to know, at the time the conclusions
are made. The reasonable and informed third party does not need to be an accountant but
would possess the relevant knowledge and experience to understand and evaluate the
appropriateness of the accountant’s conclusions in an impartial manner.
C. Addressing Threats
If the professional accountant determines that the identified threats to compliance with the
fundamental principles are not at an acceptable level, the accountant shall address the threats by
eliminating them or reducing them to an acceptable level. The accountant shall do so by:
(i) Eliminating the circumstances, including interests or relationships, that are creating the
threats;
(ii) Applying safeguards, where available and capable of being applied, to reduce the threats to
an acceptable level; or
(iii) Declining or ending the specific professional activity.
Actions to Eliminate Threats: Depending on the facts and circumstances, a threat might be
addressed by eliminating the circumstance creating the threat. However, there are some situations
in which threats can only be addressed by declining or ending the specific professional activity. This
is because the circumstances that created the threats cannot be eliminated and safeguards are not
capable of being applied to reduce the threat to an acceptable level.
© The Institute of Chartered Accountants of India
19.16 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
D. Safeguards:
Safeguards are actions individually or in combination that the accountant takes that effectively
reduce threats to an acceptable level. Safeguards vary depending on the facts and circumstances.
Examples of actions that in certain circumstances might be safeguards to address threats
include:
• Assigning additional time and qualified personnel to required tasks when an
engagement has been accepted might address a self-interest threat.
•Having an appropriate reviewer, who was not a member of the team, review the
work performed or advise as necessary might address a self-review threat.
• Using different partners and engagement teams with separate reporting lines for the
provision of non-assurance services to an assurance client might address self-review, advocacy
or familiarity threats.
• Involving another firm to perform or re-perform part of the engagement might address
self-interest, self-review, advocacy, familiarity or intimidation threats.
• Separating teams when dealing with matters of a confidential nature might address a
self-interest threat.
2.3 Non-Compliance with Laws and Regulations (NOCLAR)
In the course of providing a professional service to a client or carrying out professional activities for
an employer, a Professional accountant may come across an instance of non-compliance with laws
and regulations (NOCLAR) or suspected NOCLAR committed or about to be committed by the client
or the employer, or by those charged with governance, management or employees of the client or
employer.
Non-compliance with laws and regulations (“non-compliance”) comprises of acts of omission or
commission, intentional or unintentional, which are contrary to the prevailing laws or regulations
committed by:
a client/professional accountant’s employing organisation;
those charged with governance of a client or employing organisation;
management of a client/ employing organisation; or
other individuals working for or under the direction of a client/ employing organisation.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.17
However, NOCLAR under Revised Code of Ethics does not address the personal misconduct
unrelated to the business activities of the client/ employing organisation and non-compliance by
parties other than listed out in the definition of NOCLAR.
As per IESBA, following examples would be covered in NOCLAR:-
Money laundering, Banking and other
Fraud, corruption and Securities markets
terrorist financing and financial products and
bribery and trading
proceeds of crime services
Tax and pension
Environmental Public health and
Data protection liabilities and
protection safety
payments
The objective of NOCLAR is that - turning a blind eye to potential NOCLAR is not an appropriate
response from professional accountants, while placing renewed emphasis on the roles of
management and those charged with governance in addressing the matter. Further, it increases
awareness and understanding among Professional accountant of their legal and regulatory
responsibilities when they face NOCLAR.
Some important facts about NOCLAR are given below:
During Course of Providing a Service: NOCLAR will be applicable if a professional accountant
encounters, or is made aware of, non-compliance or suspected non-compliance in the course of
providing a professional service to a client. He is not required to investigate, nor responsible for
ensuring compete compliance.
Expertise of Laws not Required: A professional accountant is expected to apply knowledge and
expertise, and exercise professional judgment. However, he is not expected to have a level of
knowledge of laws and regulations greater than that which is required to undertake the engagement.
Whether an act constitutes non-compliance is ultimately a matter to be determined by a court or
other appropriate adjudicative body.
Certain Matters Expressly out of Purview: Matters that are clearly inconsequential, or relating to
personal misconduct pertaining to business activities of the client not covered.
Disclosure, which is Contrary to Law not Required: As per IESBA Code, disclosure of the matter
to an appropriate authority would be precluded if doing so would be contrary to law or regulation.
© The Institute of Chartered Accountants of India
19.18 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
2.3.1 Applicability of NOCLAR in India:
1. Responding to Non-Compliance with Laws and Regulations (NOCLAR) applicable to
Professional Accountants in service (Section 260): Applicable to Senior Professional
Accountants in service, being employees of listed entities.
Senior professional accountants in service (“senior professional accountants”) are
directors, officers or senior employees able to exert significant influence over, and make
decisions regarding, the acquisition, deployment and control of the employing organization’s
human, financial, technological, physical and intangible resources.
It is further explained that the senior professional accountants refer to key managerial
personnel.
2. Responding to Non-Compliance with Laws and Regulations (NOCLAR) applicable to
Professional Accountants in public practice (Section 360) : Applicable to Audit
engagements of entities the shares of which are listed on recognized stock exchange(s) in
India and have net worth of 250 crores of rupees or more.
“For the purpose of Section-360 “Audit” or “Audit engagement” shall mean a reasonable
assurance engagement in which a professional accountant in public practice expresses an
opinion whether financial statements give a true and fair view in accordance with an
applicable financial reporting framework”.
2.3.2 NOCLAR vs. SA 250
1. SA 250 is applicable only on Audit, and not on other Assurance engagements. However,
NOCLAR is applicable on professional accountants in service, and in practice.
2. SA 250 talks of auditor’s responsibilities for laws having direct effect on the determination of
material amounts and disclosures in the financial statements (such as tax and labour laws);
and other laws and regulations that do not have a direct effect on the determination of the
amounts and disclosures in the financial statements, but compliance with which may be
fundamental to the operating aspects of the business. NOCLAR, while being alike to SA 250
till this point, is further ahead of it in that it takes into account non-compliance that causes
substantial harm resulting in serious consequences in financial or non-financial terms.
3. SA 250 does not define stakeholders. NOCLAR is related to affect of non-compliance on
investors, creditors, employees as also the general public.
4. As per NOCLAR, in exceptional circumstances, the professional accountant might become
aware of an imminent breach of a law or regulation that would cause substantial harm to
investors, creditors, employees or the general public. Having first considered whether it would
be appropriate to discuss the matter with management or those charged with governance of
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.19
the company, the accountant shall exercise professional judgment and determine whether to
disclose the matter immediately to an appropriate authority in order to prevent or mitigate the
consequences of such imminent breach. If disclosure is made, that disclosure is permitted.
This provision is not existent in SA 250.
2.3.2 Applicability of NOCLAR in India:
Responding to
NOCLAR
In case of In case of Steps to be taken
Employment Audit Engagement for responding
Obtaining an
Responsibility of understanding of the
Senior Professional matter
Accountant in Responsibilities of
Service Professional
Accountant
Addressing the
matter
Responsibilities of
Professional
Accountant other
than Senior
Professional
Accountant Seeking Advice
Determining whether
further action is
needed
Determining whether to
disclose the matter to an
Appropriate Authority
Imminent Breach
Documentation
© The Institute of Chartered Accountants of India
19.20 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
It may also be noted that in a situation where disclosure ought to be made by the Auditor, the
“Appropriate authority” for the purpose of disclosure will depend on the nature of the matter. For
example, the appropriate authority would be SEBI in the case of fraudulent financial reporting.
Appropriate alignment has been made in the Code with regard to requirements of Confidentiality, as
required under Chartered Accountants Act, 1949.
2.3.3 Provisions of Confidentiality under Chartered Accountants Act, 1949
For Members in practice – Clause (1) of Part -I of Second schedule to The Chartered
Accountants Act, 1949 : A chartered accountant in practice shall be deemed to be guilty of
professional misconduct, if he discloses information acquired in the course of his professional
engagement to any person other than his client so engaging him, without the consent of his client or
otherwise than as required by any law for the time being in force;
For Members in service - Clause (2) of Part-II to the Second Schedule of the Chartered
Accountants Act, 1949 : A member of the Institute, whether in practice or not, shall be deemed to
be guilty of professional misconduct, if he being an employee of any company, firm or person,
discloses confidential information acquired in the course of his employment except as and when
required by any law for the time being in force or except as permitted by the employer;
Documentation Requirements in NOCLAR :
Revised Code over and above require the professional accountant to follow the additional documents
requirements as under:
• How management / those charged with governance have responded to the matter.
• The course of action the accountant considered, the judgments made and the decisions that
were taken, having regard to the reasonable and informed third party test.
• How the accountant is satisfied that the responsibility of public interest has been fulfilled.
This documentation is in addition to complying with the documentation requirements under
applicable auditing standards. SAs, for example, require a professional accountant performing an
audit of financial statements to:
• Prepare documentation sufficient to enable an understanding of significant matters arising
during the audit, the conclusions reached, and significant professional judgments made in
reaching those conclusions;
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.21
• Document discussions of significant matters with management, those charged with
governance, and others, including the nature of the significant matters discussed and when
and with whom the discussions took place; and
• Document identified or suspected non-compliance, and the results of discussion with
management and, where applicable, those charged with governance and other parties
outside the entity.
3. MEMBERSHIP OF THE INSTITUTE
On acceptance of application by the Council, the applicant's name shall be entered in the Register
and a certificate of membership in the appropriate Form shall be issued to the applicant.
Particulars of the Register: Section 19 of the Chartered Accountants Act, 1949 provides the
particulars to be included in the Register about every member of the Institute, namely-
Full name, date of birth, domicile, residential and professional address;
Date of entry of name in the Register; Qualifications;
Whether the member holds a COP; and Any other prescribed particulars.
3.1 Disabilities for the Purpose of Membership
Section 8 of the Chartered Accountants Act, 1949 enumerates the circumstances under which a
person is debarred from having his name entered in or borne on the Register of Members, as follows:
(i) If he has not attained the age of 21 years at the time of his application for the entry of his
name in the Register of members; or
(ii) If he is of unsound mind and stands so adjudged by a competent court; or
(iii) If he is an undischarged insolvent; or
(iv) If he, being a discharged insolvent, or has not obtained from the court a certificate stating
that his insolvency was caused by misfortune without any misconduct on his part; or
(v) If he has been convicted by a competent Court whether within or without India, of an offence
involving moral turpitude and punishable with imprisonment or of an offence, not of a technical
nature, committed by him in his professional capacity unless in respect of the offence
committed he has either been granted a pardon or, on an application made by him in this
behalf, the Central Government has, by an order in writing, removed the disability; or
© The Institute of Chartered Accountants of India
19.22 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(vi) If he has been removed from membership of the Institute on being found on inquiry to have
been guilty of professional or other misconduct;
It may be noted that a person who has been removed from membership for a specified period, shall
not be entitled to have his name entered in the Register until the expiry of such period.
In addition, failure on the part of a person to disclose the fact that he suffers from any one of the
disabilities aforementioned would constitute professional misconduct. The name of the person, who
is found to have been subject at any time to any of the disabilities aforementioned, can be removed
from the Register of Members by the Council.
3.2 Types of Members of the Institute
Section 5 of the Chartered Accountants Act, 1949 provides the division of members of the Institute.
The members shall be divided into two classes designated as Associates and Fellows.
Associate Member: Any person, whose name
has been entered in the Register of members,
Classes of Members
of the Institute shall be deemed to have become an Associate
of the Institute and shall also be entitled to use
the letters A.C.A. after his name to indicate that
he is an Associate Member of the Institute.
Associates Fellows Fellow Member: The name of following types
of members shall be entered into the Register
of members as a Fellow of the Institute, on
payment of such fees along with the application made and granted in the prescribed manner-
(i) An associate member who has been in continuous practice in India for at least 5 years,
(ii) A member who has been an associate for a continuous period of not less than 5 years and
who possesses such qualifications as may be prescribed by the Council with a view to
ensuring that he has experience equivalent to the experience normally acquired as a result
of continuous practice for a period of 5 years as a Chartered Accountant.
The abovementioned members shall be entitled to use the letters F.C.A. after his name to indicate
that he is a Fellow Member of the Institute.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.23
3.3 Removal of Name from the Register
As per section 20 of the Act, the Council may remove, from the Register, the name of any member
of the Institute in the following cases-
(i) who is dead; or
(ii) from whom a request has been received to that effect; or
(iii) who has not paid any prescribed fee required to be paid by him; or
(iv) who is found to have been subject at the time when his name was entered in the Register of
members, or who at any time thereafter has become subject, to any of the disabilities
mentioned in Section 8, or who for any other reason has ceased to be entitled to have his
name borne on the Register.
The Council shall remove the name of any member from the Register in respect of whom an order
has been passed under this Act removing him from membership of the Institute.
If the name of any member has been removed from the Register for non-payment of prescribed
fee as required to be paid by him, then, on receipt of an application, his name may be entered
again in the Register of members on payment of the arrears of annual fee and entrance fee along
with such additional fee, as may be determined by the Council.
3.4 Restoration of Membership
In addition to the provisions of the section 20 of the Chartered Accountants Act, 1949 (as discussed
in above Para), Regulation 19 of the Chartered Accountants Regulations, 1988, states that the name
of the member may be restored by the Council in the Register on an application, in the appropriate
Form, received in this behalf whose name has been removed from the Register for non-payment of
prescribed fee as required to be paid by him, if he is otherwise eligible to such membership, on his
paying the arrears of annual membership fee, entrance fee and additional fee determined by the
Council under the Act.
However, the effective date in case of restoration of cancelled membership, in different situations,
shall be in the following manner:
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19.24 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Application for restoration and requisite • Restoration shall be with effect from the
fees are made within the same year of date on which it was removed from the
removal Register.
Removal of name under the orders of the
Board of Discipline or the Disciplinary • Restoration shall be in accordance with
Committee or the Appellate Authority or the such orders.
High Court
• Restoration shall be with effect from the
In other cases date on which the application and fee are
received.
3.5 Penalty for Falsely Claiming to be a Member etc.
Section 24 of the Chartered Accountants Act, 1949 provides that any person who-
(i) not being a member of the Institute;
(a) represents that he is a member of the Institute; or
(b) uses the designation Chartered Accountant;
(ii) being a member of the Institute, but not having a certificate of practice, represents that he is
in practice or practices as a Chartered Accountant,
shall be punishable on first conviction with fine which may extend to ` 1000, and on any subsequent
conviction with imprisonment which may extend to 6 months or with fine which may extend to
` 5,000, or with both.
The provision may be understood with a case, where, the Court of Additional Chief Judicial
Magistrate had by its judgement found the accused guilty under Section 24(i)(a) & (b) of the
Chartered Accountants Act, 1949 and Section 465 of the Indian Penal Code. The Court imposed a
fine on the accused and in the event of his failure to pay the fine, sentenced to rigorous imprisonment
for three months. (Case of Prem Batra decided on 18.7.1989)
4. CHARTERED ACCOUNTANTS IN PRACTICE
A practicing Chartered Accountant is a person who is a member of the Institute and is holding
Certificate of Practice; and includes such members of the Institute who are deemed to be in Practice
in accordance with the provisions of the Chartered Accountants Act, 1949.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.25
4.1 Significance of the Certificate of Practice
Section 6 of the Chartered Accountants Act, 1949 provides that: -
(1) No member of the Institute shall be entitled to practise whether in India or elsewhere unless
he has obtained from the Council a certificate of practice:
It may be noted that this provision is not applicable to any person who, immediately before
the commencement of this Act, has been in practice as a registered accountant or a holder
of a restricted certificate until one month has elapsed from the date of the first meeting of the
Council.
(2) Every such member shall pay such annual fee for his certificate as may be determined, by
notification, by the Council [..], and such fee shall be payable on or before the 1st day of April
each year
(3) The certificate of practice obtained under sub-section (1) may be cancelled by the Council
under such circumstances as may be prescribed.
A member who is not in practice is precluded from accepting engagement to render services of any
of the types normally prescribed for a Chartered Accountant, even though for doing so, he does not
require special qualifications.
The Council of the institute is of view that-
(i) Once the person concerned becomes a member of the Institute, he is bound by the provisions
of the Chartered Accountants Act and its Regulations. If and when he appears before the
Income-tax Tribunal as an Income-tax representative after having become a member of the
Institute, he could so appear only in his capacity as a Chartered Accountant and a member
of the Institute. Having, as it were, brought himself within the jurisdiction of the Chartered
Accountants Act and its Regulations, he could not set them at naught by contending that even
though he continues to be a member of the Institute and has been punished by suspension
from practice as a member, he would be entitled, in substance, to practice in some other
capacity.
(ii) A member of the Institute can have no other capacity in which he can take up such practice,
separable from his capacity to practice as a member of the Institute.”
Therefore, in nutshell, a Chartered Accountant whose name has been removed from the
membership for professional and/or other misconduct, during such period of removal, will
not appear before the various tax authorities or other bodies before whom he could have
appeared in his capacity as a member of this Institute.
© The Institute of Chartered Accountants of India
19.26 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Illustration 1
A Chartered Accountant in practice has been suspended from practice for a period of
6 months and he had surrendered his Certificate of Practice for the said period. During the said
period of suspension, though the member did not undertake any audit assignments, he undertook
representation assignments for income tax whereby he would appear before the tax authorities in
his capacity as a Chartered Accountant.
Solution
Undertaking Tax Representation Work: A chartered accountant not holding certificate of
practice cannot take up any other work because it would be violation of the relevant provisions of
the Chartered Accountants Act, 1949.
In case a member is suspended and is not holding Certificate of Practice, he cannot in any other
capacity take up any practice separable from his capacity to practice as a member of the Institute.
This is because once a person becomes a member of the Institute; he is bound by the provisions
of the Chartered Accountants Act, 1949 and its Regulations.
If he appears before the income tax authorities, he is only doing so in his capacity as a chartered
accountant and a member of the Institute. Having bound himself by the said Act and its
Regulations made there under, he cannot then set the Regulations at naught by contending that
even though he continues to be a member and has been punished by suspension, he would be
entitled to practice in some other capacity.
Conclusion: Thus, in the instant case, a chartered accountant would not be allowed to represent
before the income tax authorities for the period he remains suspended. Accordingly, in the present
case he is guilty of professional misconduct.
4.2 Cancellation and Restoration of Certificate of Practice
Regulation 10 provides that a Certificate of Practice (COP) shall be liable for cancellation, if:
(i) the name of the holder of the certificate is removed from the Register; or
(ii) the Council is satisfied, after giving an opportunity of being heard to the person
concerned, that such certificate was issued on the basis of incorrect, misleading or false
information, or by mistake or inadvertence; or
(iii) a member has ceased to practise; or
(iv) a member has not paid annual fee for certificate of practice till 30 th day of September of
the relevant year.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.27
Where a COP is cancelled, the holder shall surrender the same to the Secretary.
Further, Regulation 11 on restoration of COP states that, on an application made in the approved
Form and on payment of such fee, the Council may restore the COP with effect from the date on
which it was cancelled, to a member whose certificate has been cancelled due to non-payment of
the annual fee for the COP and whose application, complete in all respects, together with the fee, is
received by the Secretary before the expiry of the relevant year.
4.3 Members - deemed to be in Practice
Every member of the Institute is entitled to designate himself as a Chartered Accountant. There are
two classes of members, those who are in practice and those who are otherwise occupied. In Section
2(2) of the Act, the term deemed “to be in practice” has been defined as follows:
“A member of the Institute shall be deemed “to be in practice” when individually or in partnership
with Chartered Accountants in practice, or in partnership with members of such other recognised
professions as may be prescribed, he, in consideration of remuneration received or to be received.
(i) engages himself in the practice of accountancy; or
(ii) offers to perform or performs service involving the auditing or verification of financial
transactions, books, accounts or records, or the preparation, verification or certification
of financial accounting and related statements or holds himself out to the public as an
accountant; or
(iii) renders professional services or assistance in or about matters of principle or detail
relating to accounting procedure or the recording, presentation or certification of financial
facts or data; or
(iv) renders such other services as, in the opinion of the Council, are or may be rendered by
a Chartered Accountant in practice;
and the words “to be in practice” with their grammatical variations and cognate expressions shall be
construed accordingly.
Explanation – An associate or a fellow of the Institute who is a salaried employee of a Chartered
Accountant in practice or a firm of such Chartered Accountants or firm consisting of one or more
chartered accountants and members of any other professional body having prescribed qualifications
shall, notwithstanding such employment, be deemed to be in practice for the limited purpose of the
training of Articled Assistants”.
Pursuant to Section 2(2)(iv) above, the Council has passed a resolution permitting a Chartered
Accountant in practice to render entire range of “Management Consultancy and other Services”.
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19.28 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The expression “Management Consultancy and other Services” shall not include the function of
statutory or periodical audit, tax (both direct taxes and indirect taxes) representation or advice
concerning tax matters or acting as liquidator, trustee, executor, administrator, arbitrator or receiver,
but shall include the following-
(i) Financial management planning and financial policy determination.*
(ii) Capital structure planning and advice regarding raising finance.*
(iii) Working capital management.*
(iv) Preparing project reports and feasibility studies.*
(v) Preparing cash budget, cash flow statements, profitability statements, statements of
sources and application of funds etc.
(vi) Budgeting including capital budgets and revenue budgets.
(vii) Inventory management, material handling and storage.
(viii) Market research and demand studies.
(ix) Price-fixation and other management decision making.
(x) Management accounting systems, cost control and value analysis.
(xi) Control methods and management information and reporting.
(xii) Personnel recruitment and selection.
(xiii) Setting up executive incentive plans, wage incentive plans etc.
(xiv) Management and operational audits.
(xv) Valuation of shares and business and advice regarding amalgamation, merger and
acquisition. Acting as Registered Valuer under the Companies Act, 2013 read with The
Companies (Registered Valuers and Valuation) Rules, 2017. (incorporated pursuant to
decision of Council at its 388th Meeting)
(xvi) Business Policy, corporate planning, organisation development, growth and diversification.
(xvii) Organisation structure and behaviour, development of human resources including design
and conduct of training programmes, work study, job-description, job evaluation and
evaluation of workloads.
(xviii) Systems analysis and design, and computer related services including selection of
hardware and development of software in all areas of services which can otherwise be
* Consideration of “tax implications” while rendering the services at (i), (ii), (iii) and (iv) above will be
considered as part of “Management Consultancy and other services”.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.29
rendered by a Chartered Accountant in practice and also to carry out any other professional
services relating to EDP.
(xix) Acting as advisor or consultant to an issue, including such matters as:
(a) Drafting of prospectus and memorandum containing salient futures of prospectus. Drafting
and filing of listing agreement and completing formalities with Stock Exchanges, Registrar
of Companies and SEBI.
(b) Preparation of publicity budget, advice regarding arrangements for selection of (i) ad-
media, (ii) centres for holding conferences of brokers, investors, etc., (iii) bankers to issue,
(iv) collection centres, (v) brokers to issue, (vi) underwriters and the underwriting
arrangement, distribution of publicity and issue material including application form,
prospectus and brochure and deciding on the quantum of issue material (In doing so, the
relevant provisions of the Code of Ethics must be kept in mind).
(c) Advice regarding selection of various agencies connected with issue, namely Registrars to
Issue, printers and advertising agencies.
(d) Advice on the post issue activities, e.g., follow up steps which include listing of instruments and
dispatch of certificates and refunds, with the various agencies connected with the work.
Explanation - For removal of doubts, it is hereby clarified that the activities of broking,
underwriting and portfolio management are not permitted.
(xx) Investment counselling in respect of securities [as defined in the Securities Contracts
(Regulation) Act, 1956 and other financial instruments.] (In doing so, the relevant
provisions of the Code of Ethics must be kept in mind).
(xxi) Acting as registrar to an issue and for transfer of shares/other securities. (In doing so, the
relevant provisions of the Code of Ethics must be kept in mind).
(xxii) Quality Audit.
(xxiii) Environment Audit.
(xxiv) Energy Audit.
(xxv) Acting as Recovery Consultant in the Banking Sector.
(xxvi) Insurance Financial Advisory Services under the Insurance Regulatory & Development
Authority Act, 1999, including Insurance Brokerage.
(xxvii) Acting as Insolvency Professional in terms of Insolvency and Bankruptcy Code, 2016
(incorporated pursuant to decision of Council at its 362 nd Meeting).
(xxviii) Administrative Services. (incorporated pursuant to decision of Council at its 388th Meeting)
Administrative services involve assisting clients with their routine or mechanical tasks
within the normal course of operations. Such services require little to no professional
judgment and are clerical in nature.
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19.30 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Examples of administrative services include:
• Word processing services.
• Preparing administrative or statutory forms for client approval.
• Submitting such forms as instructed by the client.
• Monitoring statutory filing dates, and advising an audit client of those dates.
For example, the functions of a GST practitioner as specified under Rule 83(8) of Central Goods
and Services Tax Rules, 2017:-
(a) furnish the details of outward and inward supplies;
(b) furnish monthly, quarterly, annual or final return;
(c) make deposit for credit into the electronic cash ledger;
(d) file a claim for refund;
(e) file an application for amendment or cancellation of registration;
(f) furnish information for generation of e-way bill;
(g) furnish details of challan in form GST ITC-04;
(h) file an application for amendment or cancellation of enrolment under rule 58; and
(i) file an intimation to pay tax under the composition scheme or withdraw from the said
scheme.
Pursuant to Section 2(2)(iv) of the Chartered Accountants Act, 1949, read with Regulation 191 of
Chartered Accountants Regulations, 1988 a member shall be deemed to be in practice if he, in his
professional capacity and neither in his personal capacity nor in his capacity as an employee, acts
as a liquidator, trustee, executor, administrator, arbitrator, receiver, adviser or representative for
costing, financial or taxation matters or takes up an appointment made by the Central Government
or a State Government or a court of law or any other legal authority or acts as a Secretary unless
his employment is on a salary-cum-full-time basis.
It is necessary to note that a person is deemed to be in practice not only when he is actually engaged
in the practice of accountancy but also when he offers to render accounting services whether or not
he in fact does so. In other words, the act of setting up of an establishment offering to perform
accounting services would tantamount to being in practice even though no client has been served.
It may also be noted that a member of the Institute is deemed to be in practice during the period he
renders ‘service with armed forces’.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.31
The above provisions need to be correlated with the provisions of section 144 of the Companies Act,
2013 which prohibits an auditor of the company from rendering certain services directly or indirectly
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.
Design and
Accounting and book implementation of any
Internal audit;
keeping services; financial information
system;
Investment advisory Investment banking
Actuarial services;
services; services;
Rendering of Any other kind of
Management services;
outsourced financial services as may be
and
services; prescribed.
Certain services not to be rendered by the Auditor as per section 144 of the Companies
Act 2013.
Illustration 2
Mr. A, a practicing Chartered Accountant agreed to select and recruit personnel, conduct training
programmes for and on behalf of a client where he is not providing any assurance service. Is
this a professional misconduct?
© The Institute of Chartered Accountants of India
19.32 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Solution
Providing Management Consultancy and Other Services: Under Section 2(2)(iv) of the
Chartered Accountants Act, 1949, a member of the Institute shall be deemed “to be in practice”
when individually or in partnership with Chartered Accountants in practice, he, in consideration
of remuneration received or to be received renders such other services as, in the opinion of the
Council, are or may be rendered by a Chartered Accountant in practice. Pursuant to Section
2(2)(iv) above, the Council has passed a resolution permitting a Chartered Accountant in practice
to render entire range of “Management Consultancy and other Services”.
The definition of the expression “Management Consultancy and other Services” includes
Personnel recruitment and selection. Personnel Recruitment and selection includes,
development of human resources including designing and conduct of training programmes, work
study, job description, job evaluation and evaluations of workloads.
Conclusion: Therefore, Mr. A is not guilty of professional misconduct.
4.4 Companies not to Engage in Accountancy
Section 25 of the Chartered Accountants Act, 1949 provides that:
(1) No company, whether incorporated in India or elsewhere, shall practise as chartered
accountants.
Here, the term “company” shall include any limited liability partnership which has company
as its partner for the purpose of this section.
(2) If any company contravenes this provision then, without prejudice to any other proceedings
which may be taken against the company, every director, manager, secretary and any other
officer thereof who is knowingly a party to such contravention shall be punishable with fine
which may extend on first conviction to ` 1,000 and on any subsequent conviction to ` 5,000.
In addition, as per section 141(2) of the Companies Act, 2013, where a firm (including a limited
liability partnership) is appointed as an auditor of a company, then, only the partners who are
chartered accountants shall be authorised to act and sign on behalf of the firm.
Thought the LLPs are allowed to be appointed as an auditor in accordance with the Companies Act,
2013, however, it cannot be engaged into practice, if it has company as its partner, as per the
Chartered Accountants Act, 1949.
Therefore, it can be inferred that the LLP not having any company as its partner, can be engaged
into practicing and thus take audit assignments.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.33
4.5 Member in Practice Prohibited from using a Designation other than
Chartered Accountant
(i) Members of the Institute are now permitted to use the word 'CA' as prefix before their name
irrespective of the fact that they are in practice or not.
(ii) Under Section 7 of the Chartered Accountants Act, 1949 a member in practice cannot use any
designation other than that of a Chartered Accountant, nor he can use any other description,
whether in addition thereto or in substitution therefor, but a member who is not in practice and
does not use the designation of a Chartered Accountant may use any other description.
Nevertheless a member in practice may use any other letters or description indicating shall be
deemed to prohibit any such person from adding any other description or letters to his name, if
entitled thereto, to membership of such other Institute of accountancy, whether in India or
elsewhere, as may be recognised in this behalf by the Council, or any other qualification that he
may possess, or to prohibit a firm, all the partners of which are members of the Institute and in
practice, from being known by its firm name as Chartered Accountants.
Merchant Banker / Advisor to an issue: The members may apply for and obtain registration as
category IV Merchant Banker under the SEBI’s rules and regulations and act as Advisor or
Consultant to an issue. In client Companies’ offer documents and advertisements regarding capital
issue, name and address of the Chartered Accountant or firm of Chartered Accountants acting as
Advisor or Consultant to the Issue could be indicated under the caption “Advisor/Consultant to the
Issue”. However, the name and address of such Chartered Accountant/firm of Chartered
Accountants should not appear prominently.
Directors of Companies, Members of political parties, position in clubs, etc.: The members of
the Institute who are also Directors in Companies, members of Political parties or Chartered
Accountants Cells in the political parties, holding different positions in clubs or other organisations
are not permitted to mention these positions as these would be violative of the provisions of Section
7 of the Act.
Members who are also Cost Accountants: Though a member cannot designate himself as a
Cost Accountant, he can use the letters A.C.M.A (Associate) or F.C.M.A (Fellow) after his name,
when he is a member of that Institute.
Permission to mention qualifications of certain Institutions: The members are permitted to
mention membership of a foreign Institute of Accountancy, which has been recognized by the
Council through a Memorandum of Understanding (MoU) / Mutual Recognition Agreement (MRA)
with the said Institute.
© The Institute of Chartered Accountants of India
19.34 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Other Qualifications of the member
With regard to the other qualifications of a member, which he is permitted to mention, the following
observations of the Supreme Court in Institute of Chartered Financial Analyst of India (ICFAI) vs
Council of the Institute of Chartered Accountants of India (ICAI) dated 16th May, 2007 are relevant:
“The expression 'any other qualification that he may possess', therefore, must be read as
qualification other than conferred upon the member by other Institutes of Accountancy. Such
qualification of accountancy may be conferred even by other Institutes. But as noticed hereinbefore,
an exemption had been granted by reason of a resolution of the Institute in relation to the Institute
of Cost and Works Accountants. Furthermore, a degree conferred by any university also is subject
to an exemption from the rigour of the provisions of Section 7 of the Act. There cannot, therefore,
be any doubt whatsoever that 'the other qualification' would mean a qualification other than granted
by an Institute of Accountancy, subject of course to recognition thereof by the Institute.”
3. For example, though a member cannot designate himself as a Cost Accountant, he
can use the letters A.C.M.A.(Associate) or F.C.M.A. (fellow) after his name, when he is a
member of that Institute.
It is improper for a Chartered Accountant to state on his professional documents that he is an
Income-tax Consultant, Cost Accountant, Company Secretary, Cost Consultant or a Management
Consultant.
Member are allowed to appear before the various authorities including Company Law Board, Income
Tax Appellate Tribunal, Sales Tax Tribunal where the law has permitted the same, so far as the
designation “Corporate Lawyer” is concerned, the Council was of the view that as per the existing
provisions of law, a Chartered Accountant in practice is not entitled to use the designation “Corporate
Lawyer”.
Further, the members are not permitted to use the initials ‘CPA’ (standing for Certified Public
Accountant) on their visiting cards.
Members of the Institute in practice who are otherwise eligible may also practice as Company
Secretaries and/or Cost Accountants. Such members shall, however, not use designation/s of the
aforesaid Institute/s simultaneously with the designation “Chartered Accountant”.
4.6 Maintenance of Branch Offices
In terms of Section 27 of the Act, if a Chartered Accountant in practice or a Firm of Chartered
Accountants has more than one office in India, each one of such offices should be in the separate
charge of a member of the Institute. Failure on the part of a member or a firm to have a member in
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.35
charge of its branch and a separate member in case of each of the branches, where there is more
than one, would constitute professional misconduct.
However, exemption has been given to members practicing in hill areas subject to certain
conditions. The conditions are:
(1) Such members/firm be allowed to open temporary offices in a city in the plains for a limited
period not exceeding 3 months in a year.
(2) The regular office need not be closed during this period and all correspondence can
continue to be made at the regular office.
(3) The name board of the firm in the temporary office should not be displayed at times other
than the period such office is permitted to function as above.
(4) The temporary office should not be mentioned in the letterheads, visiting cards or any other
documents as a place of business of the member/firm.
(5) Before commencement of every winter it shall be obligatory on the member/firm to inform
the Institute that he/it is opening the temporary office from a particular date and after the
office is closed at the expiry of the period of permission, an intimation to that effect should
also be sent to the office of the Institute by registered post.
Above conditions apply to any additional office situated at a place beyond 50 kms from the municipal
limits in which any office is situated.
It is necessary to mention that the Chartered Accountant in-charge of the branch of another firm
should be associated with him or with the firm either as a partner or as a paid assistant. If he is a
paid assistant, he must be in whole time employment with him.
The requirement of Section 27 in regard to a member being in charge of an office of a Chartered
Accountant in practice or a firm of such Chartered Accountants shall be satisfied only if the member
is actively associated with such office. Such association shall be deemed to exist if the member
resides in the place where the office is situated for a period of not less than 182 days in a year or if
he attends the said office for a period of not less than 182 days in a year or in such other
circumstances as, in the opinion of the Executive Committee, establish such active association.
However, a member can be in-charge of two offices if they are located in one and the same
Accommodation. In this context some of the Council’s decisions are as follows:
(1) With regard to the use of the name-board, there will be no bar to the putting up of a name-
board in the place of residence of a member with the designation of Chartered Accountant,
provided it is a name-plate or a name-board of an individual member and not of the firm.
© The Institute of Chartered Accountants of India
19.36 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Illustration 3
Mr. X & Mr. Y, partners of a Chartered Accountant Firm, one in-charge of Head Office
and another in-charge of Branch at a distance of 80 km. from the municipal limits, puts
up a name-board of the firm in both premises and also in their respective residences.
Putting Name Board of the Firm at Residence: The council of the Institute has decided
that with regard to the use of the name-board, there will be no bar to the putting up of a
name-board in the place of residence of a member with the designation of chartered
accountant, provided, it is a name-plate or board of an individual member and not of the
firm.
In the given case, partners of XY & Co., put up a name board of the firm in both offices
but not in their respective residences.
Conclusion: Thus, the chartered accountants are guilty of misconduct. Distance given in
the question is not relevant for deciding.
(2) The exemption may be granted to a member or a firm of Chartered Accountants in practice
to have a second office without such second office being under the separate charge of a
member of the Institute, provided-
(a) the second office is located in the same premises, in which the first office is located
or,
(b) the second office is located in the same city, in which the first office is located or,
City X
1st Office
2nd Office
(c) the second office is located within a distance of 50 km. from the municipal limits of a
city, in which the first office is located.
City X Municipal Limit City Y
1stOffice 2nd Office
(Head Office) (Branch Office)
15 km 35 km 10 km
Effective distance from 1st Office = 35 km + 10 km = 45 km
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.37
A member having two offices of the type referred to above shall have to declare, which of the
two offices is his main office, which would constitute his professional address.
Illustration 4
Mr. K, Chartered Accountant practicing as a sole proprietor has an office in the suburbs
of Chennai. Due to increase in the income tax assessment work, he opens another office
near the income tax office, which is within the city and at a distance of 30 km. from his
office in the suburb. For running the new office, he has employed a retired Income Tax
Commissioner who is not a Chartered Accountant.
Solution
Maintenance of Branch Office in the Same City: As per section 27 of the Chartered
Accountants Act, 1949 if a chartered accountant in practice has more than one office in
India, each one of these offices should be in the separate charge of a member of the
Institute. However, a member can be in charge of two offices if the second office is located
in the same premises or in the same city, in which the first office is located; or the second
office is located within a distance of 50 km. from the municipal limits of a city, in which
the first office is located.
In the given case, Mr. K, Chartered Accountant in practice as a sole proprietor at Chennai
has an office in suburbs of Chennai, and due to increase in the work he opened another
branch within the city near the income tax office. He also employed a retired income tax
commissioner to run the new office and the second office is situated within a distance of
30 kilometers from his office in the suburb.
Conclusion: In view of above provisions, there will be no misconduct if Mr. K will be in-
charge of both the offices. However, he is bound to declare which of the two offices is the
main office.
4.7 KYC Norms for CA in Practice
The financial services industry globally is required to obtain information of their clients and comply
with Know Your Client Norms (KYC norms). Keeping in mind the highest standards of Chartered
Accountancy profession in India, the Council of ICAI issued such norms to be observed by the
members of the profession who are in practice.
© The Institute of Chartered Accountants of India
19.38 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In light of this background, the Council of ICAI approved the following KYC Norms which are
mandatory in nature and shall apply in all assignments pertaining to attestation functions.
The KYC Norms approved by the Council of ICAI are given below:
1. Where Client is an Individual/ Proprietor
A. General Information
Name of the Individual
PAN No. or Aadhar Card No. of the Individual
Business Description
Copy of last Audited Financial Statement
B. Engagement Information
Type of Engagement
2. Where Client is a Corporate Entity
A. General Information
Name and Address of the Entity
Business Description
Name of the Parent Company in case of Subsidiary
Copy of last Audited Financial Statement
B. Engagement Information
Type of Engagement
C. Regulatory Information
Company PAN No.
Company Identification No.
Directors’ Names & Addresses
Directors’ Identification No.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.39
3. Where Client is a Non-Corporate Entity
A. General Information
Name and Address of the Entity
Copy of PAN No.
Business Description
Partner’s Names & Addresses (with their PAN/Aadhar Card/DIN No.)
Copy of last Audited Financial Statement
B. Engagement Information
Type of Engagement
5. CHARTERED ACCOUNTANTS IN SERVICE
In accordance with the definitions provided under the Code of Ethics, a Professional Accountant in
Service or Chartered Accountant in Service means a professional accountant employed or engaged
in an executive or non-executive capacity in areas such as commerce, industry, service, the public
sector, education, the not-for-profit sector, regulatory bodies or professional bodies, or a
professional accountant contracted by such entities.
6 DISCIPLINARY PROCEDURE
Sections 21, 21A, 21B, 21C, 22-A and 22-G of the Chartered Accountants Act read with The
Chartered Accountants (Procedure of Investigations of Professional and Other Misconduct of Cases)
Rules, 2007 have laid down the following procedure in regard to the investigation of misconduct of
members which has been summarized as under:-
© The Institute of Chartered Accountants of India
19.40 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Flow Chart of Discipline Procedure Mechanism
Receipt of (i) Complaint along with prescribed fee, or (ii) Information,
against member of ICAI of alleged misconduct
Disciplinary Directorate
Prima Facie Opinion
Guilty Not Guilty
Submit all information &
Falling in Falling in complaints to
First Schedule Second Schedule or Both Board of Discipline
Place the matter Place the matter
before Board of Discipline before Accepted Rejected
Disciplinary Committee
Accepted Rejected
Accepted Rejected Advice the Director
Conduct Close the (Discipline) to further
enquiry matter investigate
Conduct Close the
enquiry matter
Found guilty May proceed with the
Found guilty matter, if it’s allied to
the First Schedule
Yes No
Yes No
It can,
(i) reprimand the member It can, Refer the matter to the
(ii) remove name of the (i) reprimand the member Disciplinary
member upto a period of 3 (ii) remove name of the Committee, if it’s allied
months member permanently or for to the Second
(iii) impose fine upto any duration, it thinks fit Schedule or Both
` 1,00,000 (iii) impose fine upto
` 5,00,000
Any member or Director (Discipline) aggrieved by order of Board or
Disciplinary Committee can prefer an appeal within 90 days
Appellate Authority
ItIt can,
can,
(i) Confirm,
(i) Confirm, modify
modify or
or set
set aside
aside the
the order.
order.
(ii) Impose,
(ii) Impose, Set
Set aside,
aside, Reduce
Reduce or
or enhance
enhance penalty.
penalty.
(iii) remit
(iii) remit the
thecase
casetotothe
theBoard
BoardofofDiscipline
Disciplineor or Disciplinary
Disciplinary Committee for
Committee
reconsideration.
for reconsideration.
(iv) Pass
(iv) Pass such
such order
order as
as the
the Authority
Authority thinks
thinks fit.
fit.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.41
7 TYPES OF MISCONDUCT: PROFESSIONAL OR OTHER
MISCONDUCT
For the purposes of this Act, the expression “professional or other misconduct” shall be deemed to
include any act or omission, on the part of any member of the Institute either in his individual capacity
or as partner or owner of a firm, as mentioned in any of the Schedules, but nothing in this section
shall be construed to limit or abridge in any way the power conferred or duty cast on the Director
(Discipline) under sub-section (1) of section 21 to inquire into the conduct of such member or firm,
under any other circumstances.’
A member is liable to disciplinary action under Section 21 of the Chartered Accountants Act, if he is
found guilty of any Professional or Other Misconduct.
7.1 Professional Misconduct
Professional misconduct has been defined in part I, II and III of the First Schedule; and part I and II
of the Second Schedule. A member who is engaged in the profession of accountancy whether in
practice or in service should conduct/restrict his actions in accordance with the provisions contained
in the respective parts of the schedules. If the member is found guilty of any of the acts or omissions
stated in any of the respective parts of the Schedule, he/she shall be deemed to be guilty of
professional misconduct.
7.2 Other Misconduct
Other misconduct has been defined in part IV of the First Schedule and part III of the Second
Schedule. These provisions empower the Council to inquire into any misconduct of a member even
it does not arise out of his professional work. This is considered necessary because a chartered
accountant is expected to maintain the highest standards of integrity even in his personal affairs and
any deviation from these standards, even in his non-professional work, would expose him to
disciplinary action.
4. For example, a member who is found to have forged the will of a relative, would
be liable to disciplinary action even though the forgery may not have been done in the
course of his professional duty.
Other misconduct would also relate to conviction by a competent court for an offence involving moral
turpitude punishable with transportation or imprisonment to an offence not of a technical nature
committed by the member in his professional capacity. [See section 8(v) of the Act].
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19.42 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
8. SCHEDULES TO THE ACT
Acts or omissions which comprise professional misconduct within the meaning of Section 22 of the
Chartered Accountants Act are defined in two Schedules viz. the First Schedule and the Second
Schedule. The First Schedule is divided into four parts, Part I of the First Schedule deals with the
misconduct of a member in practice which would have the effect generally of compromising his
position as an independent person. Part II deals with misconduct of members in services. Part III
deals with the misconduct of members generally and Part IV deals with other misconduct in relation
to members of the institute generally.
The Second Schedule is divided into three parts. Part I deals with misconduct in relation to a member
in practice, Part II deals with misconduct of members generally and Part III deals with other
misconduct in relation to members of the Institute generally.
Part I: Professional misconduct in relation to No. of Clauses:
Chartered Accountants in practice 12
Part II: Professional misconduct in relation to No. of Clauses: 2
Members of the Institute in service
First Schedule
Part III: Professional misconduct in relation to
Members of the Institute generally No. of Clauses: 3
Types of Schedules
Part IV: Other misconduct in relation to Members of
the Institute generally No. of Clauses: 2
Part I: Professional misconduct in relation to
Chartered Accountants in practice No. of Clauses: 10
Part II: Professional misconduct in relation to
Second Schedule Members of the Institute generally No. of Clauses: 4
Part III: Other misconduct in
relation to Members of the
Institute generally No. of Clause: 1
The implications of the different clauses in the schedules are discussed below:
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.43
8.1 The First Schedule
Where the Director (Discipline) is of the opinion that member is guilty of any professional or other
misconduct mentioned in the First Schedule; he shall place the matter before the Board of Discipline.
PART I - Professional Misconduct in relation to Chartered Accountants in Practice
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he:
Clause (1): allows any person to practice in his name as a chartered accountant unless such
person is also a chartered accountant in practice and is in partnership with or employed by
him.
Who can be allowed to
practice in a CA’s name?
Chartered Accountant in
Non- Chartered Accountant
practice
Not allowed Partner Employee Others
Allowed Allowed Not Allowed
The above clause is intended to safeguard the public against unqualified accountant practicing under
the cover of qualified accountants. It ensures that the work of the accountant will be carried out by
a Chartered Accountant who may be his partner or his employee and would work under his control
and supervision.
Illustration 5
Mr. C, Chartered Accountant, in practice allowed his brother-in-law Mr. P who is not a Chartered
Accountant, to practice in the name of CA. C. He also allowed CA T who is employee in his firm
to practice in the name. Whether Mr. C is correct in allowing his brother-in-law Mr. P and CA T
employee of his firm to practice in his name.
Solution
Allowing to Practice in a Chartered Accountant’s name: As per Clause (1) of Part I to the First
Schedule to Chartered Accountants’ Act, 1949, a Chartered Accountant in practice is deemed to
be guilty of professional misconduct if he allows any person to practice in his name as a chartered
© The Institute of Chartered Accountants of India
19.44 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
accountant unless such person is also a chartered accountant in practice and is in partnership
with or employed by him.
In the given situation Mr. C, Chartered Accountant who is in practice allowed a non-Chartered
Accountant his brother-in-law Mr. P to practice in the name of CA. C is not correct in view of
Clause 1 of Part I to the First Schedule. However, he can allow CA T who is employee in his firm
to practice in his name.
Conclusion: Thus, CA. C will be held guilty of professional misconduct for allowing Mr. P who is
not a Chartered Accountant to practice in his name as a chartered accountant as per Clause (1)
of Part I to the First Schedule.
Clause (2): pays or allows or agrees to pay or allow, directly or indirectly, any share,
commission or brokerage in the fees or profits of his professional business, to any person
other than a member of the Institute or a partner or a retired partner or the legal representative
of a deceased partner, or a member of any other professional body or with such other persons
having such qualification as may be prescribed, for the purpose of rendering such
professional services from time to time in or outside India.
Explanation - In this item, “partner” includes a person residing outside India with whom a chartered
accountant in practice has entered into partnership which is not in contravention of item (4) of this
Part.
It is in order for a member to share his fees or profits with another member of the Institute and/or a
firm of Chartered Accountants. A practicing Member of the Institute can share fees or profits arising
out of his professional business with such members of other professional bodies or with such other
persons having such qualifications as may be prescribed from time to time by the Council.
The Council has prescribed [Regulation 53A (1) of the Chartered Accountants Regulations,
1988] the professional bodies, which are as under: -
(a) The Institute of Company Secretaries of India established under the Company
Secretaries Act, 1980.
(b) The Institute of Cost & Works Accountants of India established under the Cost & Works
Accountants Act, 1959.
(c) Bar Council of India established under the Advocates Act, 1961.
(d) The Indian Institute of Architects established under the Architects Act, 1972.
(e) The Institute of Actuaries of India established under the Actuaries Act, 2006.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.45
Further, the Council has also prescribed [Regulation 53A (3) of the Chartered Accountants
Regulations, 1988] the persons qualified in India, which are as under:
(i) Company Secretary within the meaning of the Company Secretaries Act, 1980;
(ii) Cost Accountant within the meaning of the Cost and Works Accountants Act, 1959;
(iii) Actuary within the meaning of the Actuaries Act, 2006;
(iv) Bachelor in Engineering from a University established by law or an Institution recognised
by law;
(v) Bachelor in Technology from a University established by law or an institution recognised
by law;
(vi) Bachelor in Architecture from a University established by law or an institution recognised
by law;
(vii) Bachelor in Law from a University established by law or an institution recognised by law;
(viii) Master in Business Administration from Universities established by law or technical
institutions recognised by All India Council for Technical Education.
The Institute came across certain Circulars/Orders issued by the Registrars of various State Co-
operative Societies wherein it has been mentioned that certain amount of audit fee is payable to the
concerned State Government and the auditor has to deposit a percentage of his audit fee in the
state Treasury by a prescribed challan within a prescribed time of the receipt of Audit fee. The
Council considered the issue and while noting that the Government is asking auditors to deposit
such percentage of their audit fee for recovering the administrative and other expenses incurred in
the process, the Council decided that as such there is no bar in the Code of Ethics to accept such
assignment wherein a percentage of professional fee is deducted by the Government to meet the
administrative and other expenditure.
Considering the case where a Chartered Accountant gave 50% of the audit fees received by him
to the complainant, who was not a Chartered Accountant, under the nomenclature of office
allowance and such an arrangement continued for a number of years, it was held by the Council
that in substance the Chartered Accountant had shared his profits and, therefore, was guilty of
professional misconduct under the clause. It is not the nomenclature to a transaction that is
material but it is the substance of the transaction, which has to be looked into.
© The Institute of Chartered Accountants of India
19.46 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Treatment of Goodwill –
Share of Profit / Sale
of Goodwill
Partnership Proprietorship
Firm Firm
There are two or No sharing of fees between Goodwill of a proprietary
more partners Legal Representative of firm of chartered accountant
and one of them single member firm and can be sold/transferred to
dies purchaser of Goodwill of the another eligible member of
firm on the death of the Sole the Institute, after the death
Proprietor of the firm of the proprietor concerned.
Legal Payments may be made in * The Council permitted the
Representative instalments, provided the sale/transfer of goodwill for
(say, widow) of agreement of the sale of such cases in the following
the deceased goodwill contains such manner:
partner can provision
continue to
receive a share
of the firm,
only if the
partnership Death of proprietor
Death of proprietor concerned occurred Death of proprietor
agreement concerned occurred on concerned had occurred
contains such on or after 30.8.1998
or after 30.8.1998 and there existed a on or before 29th
provision August, 1998
dispute as to the legal
heir of the deceased
Provided such sale is proprietor
completed in all aspects
within a year of the death
of such proprietor Provided the Provided such
concerned. information as to the sale/transfer is
existence of the dispute completed/effected and
The name of the concerned is received by the the Institute's
firm would be kept in Institute within a year of permission to practice
abeyance (i.e. not removed the death of the in the deceased's
on receipt of information proprietor concerned. proprietary firm name is
about the death of the sought for by 28th
proprietor as is being done The name of concerned
firm shall be kept in August, 1999 and the
at present) only upto a firm name concerned is
period of 1 year from the abeyance till 1 year
from the date of still available with the
death of proprietor Institute
concerned as aforesaid settlement of dispute
* In case of a partnership firm when all the partners die at the same time, the above Council decision
would also be applicable.
Illustration 6
Mr. Qureshi, Chartered Accountant, in practice died in a road accident. His widow proposes to
sell the practice of her husband to Mr. Pardeshi, Chartered Accountant, for ` 5 lakhs. The price
also includes right to use the firm name - Qureshi and Associates. Can widow of Qureshi sell
the practice and can Mr. Pardeshi continue to practice in that name as a proprietor?
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.47
Solution
Sale of Goodwill: With reference to Clause (2) of Part I to the First Schedule to Chartered
Accountants’ Act, 1949, the Council of the Institute of Chartered Accountants of India
considered whether the goodwill of a proprietary concern of chartered accountant can be sold
to another member who is otherwise eligible, after the death of the proprietor.
It lays down that the sale is permitted subject to certain conditions discussed in the above
flowchart. It further resolved that the legal heir of the deceased member has to obtain the
permission of the Council within a year of the death of the proprietor concerned.
Conclusion: Thus, in a given case, the widow of Mr. Qureshi, who has proposed to sell the
practice for ` 5 lakhs is in effect proposing the sale of goodwill. Thus, the act of Mrs. Qureshi is
permissible and Mr. Pardeshi can continue to practice in that name as a proprietor.
Clause (3): accepts or agrees to accept any part of the profits of the professional work of a
person who is not a member of the Institute.
Provided that nothing herein contained shall be construed as prohibiting a member ‘from
entering into profit sharing or other similar arrangements, including receiving any share
commission or brokerage in the fees, with a member of such professional body or other
person having qualifications, as is referred to in item (2) of this part.
Just as a member cannot share his fees with a non-member, he is also not permitted to receive and
share the fees of others except for sharing with Member of such professional body or other person
having such qualification as may be prescribed (Regulation 53A of the Chartered Accountants
Regulations, 1988) by the Council for the purpose of Clause (2), (3) and (5) of Part I of First
Schedule. Such a restriction is necessary so that a Chartered Accountant who is often required to
engage or to recommend for engagement by his clients, the services of the members of other
professions, cannot share the fees received by other persons who are otherwise not permitted by
the Council in terms of provision of this clause.
Referral fees amongst members: It is not prohibited for a member in practice to charge Referral
Fees, being the fees obtained by a member in practice from another member in practice in relation to
referring a client to him.
Clause (4): enters into partnership, in or outside India, with any person other than Chartered
Accountant in practice or such other person who is a member of any other professional body
having such qualifications as may be prescribed, including a resident who but for his
residence abroad would be entitled to be registered as a member under clause (v) of sub-
© The Institute of Chartered Accountants of India
19.48 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
section (1) of section 4 or whose qualifications are recognized by the Central Government or
the Council for the purpose of permitting such partnerships.
The Council has prescribed Regulation 53A (3) (as discussed under clause (2) of this part)
and Regulation 53B of the Chartered Accountants Regulations, 1988 for the persons qualified
and the professional bodies.
The Regulation 53B prescribes the membership of following professional bodies for entering into
partnership:
(a) Company Secretary, member, The Institute of Company Secretaries of India, established
under the Company Secretaries Act, 1980;
(b) Cost Accountant, member, The Institute of Cost and Works Accountants of India established
under the Cost and Works Accountants Act, 1959;
(c) Advocate, member, Bar Council of India established under the Advocates Act, 1961;
(d) Engineer, member, The Institution of Engineers, or Engineering from a University established
by law or an institution recognized by law.
(e) Architect, member, The Indian Institute of Architects established under the Architects Act,
1972;
(f) Actuary, member, The Institute of Actuaries of India, established under the Actuaries Act,
2006.
A Chartered Accountant in practice is not permitted to enter into partnership with any person
other than a Chartered Accountant in practice or such other persons as may be prescribed by
the Council from time to time. The members may however take note of the fact that they cannot
form Multi-Disciplinary partnerships till such time that Regulators of such other professionals
also permit partnership with chartered accountants, and guidelines in this regard are issued by
the Council.
Clause (5) Secures either through the services of a person who is not an employee of such
Chartered Accountant or who is not his partner or by means which are not open to a Chartered
Accountant, any professional business.
Provided that nothing herein contained shall be construed as prohibiting any agreement
permitted in terms of item (2), (3) and (4) of this part.
“A man must stand erect, and not to be kept erect by others”, is a dictum by Marcus Aurelius which
though applicable for a man in every walk of life is more so in the case of a professional life. A
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.49
Chartered Accountant must seek work not through any agency, but by the respect, that he is able to
command for his professional talent and skill and by the confidence he is able to inspire by his
reputation. All forms of canvassing on that account are regarded unethical and are prohibited. The
decision of the Council under this clause is given below:
A Chartered Accountant wrote various letters to officers of different Army Canteens giving details
about him and his experience, his partner & office and the norms for charging audit fees. He was
held guilty for violation of Clauses (5) & (6). (Jethanand Sharda vs. Deepak Mehta – Council’s
decision dated 1st to 4th July, 1998 – Page 61 of Volume VIII(2) of Disciplinary Cases).
It may further be noted that the acts of partners and employees of the Firm towards securing
professional work are subject to the provisions of Clauses (6) and (7) of Part-I of First
Schedule of Chartered Accountants Act, 1949.
Clause (6) Solicits clients or professional work either directly or indirectly by circular,
advertisement, personal communication or interview or by any other means.
Provided that nothing herein contained shall be construed as preventing or prohibiting -
(i) Any Chartered Accountant from applying or requesting for or inviting or securing
professional work from another chartered accountant in practice; or
(ii) A member from responding to tenders or enquiries issued by various users of
professional services or organizations from time to time and securing professional
work as a consequence.
However, as per the guideline issued by the Council of the Institute of Chartered Accountants
of India, a member of the Institute in practice shall not respond to any tender issued by an
organization or user of professional services in areas of services which are exclusively
reserved for chartered accountants, such as audit and attestation services. However, such
restriction shall not be applicable where minimum fee of the assignment is prescribed in the
tender document itself or where the areas are open to other professionals along with the
Chartered Accountants.
Further, keeping in view the broad purview of Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, an advertisement of Coaching /teaching activities by a
member in practice may amount to indirect solicitation, as well as solicitation by any other
means, and may therefore be violative of the provisions of Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949.
© The Institute of Chartered Accountants of India
19.50 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
In view of the above, such members are advised to abstain from advertising their association with
Coaching / teaching activities through hoardings, posters, banners and by any other means, failing
which they may be liable for disciplinary action, as per the provisions of Chartered Accountants Act,
1949 and Rules/Regulations framed thereunder. However, it may be noted that subject to the above
prohibition, such members may put, outside their Coaching/teaching premises, sign board
mentioning the name of Coaching/teaching Institute, contact details and subjects taught therein only.
As regards the size and type of sign board, the Council Guidelines as applicable to Firms of
Chartered Accountants would apply.
It is an elaboration of the principle propounded in the preceding clause enjoining that for securing
professional work the help of others should not be sought. This clause further enjoins on a member
not to solicit professional work by means of advertisement, circular, personal communication or
interview or by any other means. The members should not adopt any indirect methods to adventure
their professional practice with a view to gain publicity and thereby solicit clients or professional
work. Such a restraint must be practiced so that members may maintain their independence of
judgment and may be able to command the respect of their prospective clients.
The professional work cannot be secured either by advertisement or by circulars or by solicitation.
It can only be obtained by a member gradually building confidence in his ability and integrity. The
service tendered by an accountant is of a personal and intimate nature and its value can be
appraised only by personal contact and experience. A public advertisement is likely to lead to an
impression that the professional person is over anxious to win confidence, which however will have
the opposite effect. The satisfaction of clients would be the best advertisement, which would lead to
other clients. Unabashed advertisement would affect the public esteem in which the profession is
held and would act to the disadvantage of its members. An advertisement is not a key to success in
the profession. It is the quality service, which attracts and retains the clients.
Some forms of soliciting work which the Council has prohibited are discussed below:
(a) Advertisement and note in the press – Members should not advertise for soliciting work or
advertise in a manner which could be interpreted as soliciting or offering to undertake
professional work. They are also not permitted to use the less open method of circulating
letters to a small field of possible clients. Personal canvassing or canvassing for clients of
previous employer through the help of the employees are also not permitted. The exceptions
to the above rule are:
(i) A member may request another Chartered Accountant in practice for professional
work.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.51
(ii) a member may advertise changes in partnerships or dissolution of a firm, or of any
change in address of practice and telephone numbers. Such announcements should
be limited to a bare statement of facts and consideration given to the appropriateness
of the area of distribution of the newspaper or magazine and number of insertions.
(iii) a member is also permitted to issue a classified advertisement in the journal/
newsletter of the Institute intended to give information for sharing professional work
on assignment basis or for seeking partnership or salaried employment of an
accountancy nature, provided it only contains the accountant’s name, address or
telephone number, fax number, e-mail address and address(es) of social Networking
sites of members. However, mere factual position of experience and area of
specialization, relevant to seek response to the advertisement, are permissible.
(b) Application for empanelment for allotment of audit and other professional work – The
Government departments, government companies/Corporations, courts, co-operative
societies and banks and other similar institutions prepare panels of chartered accountants for
allotment of audit and other professional work. Where the existence of such a panel is within
the knowledge of a member, he is free to write to the concerned organization with a request
to place his name on the panel. However, it would not be proper for the Chartered
Accountant to make roving enquiries by applying to any such organization for having
his name included in any such panel. It is permissible to quote fees on enquiries being
received from such bodies, which maintain such panel.
(c) Responding to Tenders, Advertisements and Circulars: It is not prohibited to the members
to respond to tenders and requests made by users of professional work. This is however
subject to conditions that may be issued by the Council from time to time.
The Council has issued Guidelines No. 1-CA(7)/03/2016 dated 7th April 2016 (see Appendix
‘J’) which stipulate that a member of the Institute in practice shall not respond to any tender
issued by an organization or user of professional services in areas of services which are
exclusively reserved for Chartered Accountants, such as audit and attestation services.
However, such restriction shall not be applicable where minimum fee of the assignment is
prescribed in the tender document itself or where the areas are open to other professionals
along with the Chartered Accountants. The “minimum fee” for this purpose should be such
that it commensurates with size, value, volume, manpower requirement and nature of work.
EMD/Security Deposit: The Council is of the view that while interference with the practices
prevailing for requirement of EMD/Deposit is not required. However, on having received
© The Institute of Chartered Accountants of India
19.52 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
complaint/ instance of exorbitant EMD/Deposit, the Ethical Standards Board may look into
the matter on case to case basis.
A cost sheet be maintained by members of the Institute responding to tenders, incorporating
details of the costs being incurred therein having regard to number of persons involved, hours
to be spent, etc, so that the same may be called for by the Institute for perusal.
(d) Publication of Books, Articles or Presentation: It is not permissible for a member to
mention in a book or an article published by him, or a presentation made by him, any
professional attainment(s), whether of the member or the firm of chartered accountants, with
which he is associated. However, he may indicate in a book, article or presentation the
designation “Chartered Accountant” as well as the name of the firm.
(e) Issue of Greeting Cards or Invitations: The Council does not approve of the issue of
greeting cards or personal invitations by members indicating their professional designation,
status and qualifications etc. However, the Council is of the view that the designation
“Chartered Accountant” as well as the name of the firm may be used in greeting cards,
invitations for marriages and religious ceremonies and any invitations for opening or
inauguration of office of the members, change in office premises and change in telephone
numbers, provided that such greeting cards or invitations etc. are sent only to clients, relatives
and friends of the members concerned.
(f) Advertisement for Silver, Golden, Platinum or Centenary celebrations: It is not permitted
to advertise the events organised by a Firm of Chartered Accountants. However, considering
the need of interpersonal socialization/relationship of the members through such get together
occasions, the advertisement for Silver, Golden, Diamond, Platinum or Centenary
celebrations of the Chartered Accountants Firms may be published in newspaper or
newsletter.
(g) Sponsoring Activities
(a) A member in practice or a Firm of Chartered Accountants is not permitted to sponsor
an event. However, such member or Firm may sponsor an event conducted by a
Programme Organizing Unit (PoU) of the ICAI, provided such event has the prior
approval of Continuing Professional Education (CPE) Directorate of the ICAI.
(b) Members sponsoring activities relating to Corporate Social Responsibility may mention
their individual name with the prefix “CA”. However, the mention of Firm name or CA
Logo is not permitted.
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(h) Advertisement of Teaching/Coaching activities by members: The members engaged in
teaching /coaching activities, while advertising such teaching /coaching activities, shall
comply with the Regulation 190A of the Chartered Accountants Regulations, 1988(discussed
in the Chapter in Clause 11).
Keeping in view the broad purview of Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, an advertisement of Coaching /teaching activities by a
member in practice may amount to indirect solicitation, as well as solicitation by any other
means, and may therefore be violative of the provisions of Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949.
In view of the above, such members are advised to abstain from advertising their association
with Coaching /teaching activities through hoardings, posters, banners and by any other
means, failing which they may be liable for disciplinary action, as per the provisions of
Chartered Accountants Act, 1949 and Rules/Regulations framed thereunder.
Subject to the above prohibition, such members may put, outside their Coaching/ teaching
premises, sign board mentioning the name of Coaching/teaching Institute, contact details and
subjects taught therein only. As regards the size and type of sign board, the Council
Guidelines as applicable to Firms of Chartered Accountants would apply.
(i) Sharing Firm Profile with prospective Client: It is not permitted to share Firm profile with
a prospective Client unless it is in response to a proposed client’s specific query, and
otherwise not prohibited to be used by the client.
(j) Television or Movie Credits: While sharing name of the member or Firm of Chartered
Accountants for inclusion in Television or Movie Credits, it must be taken care of that
exhibition of name is not made differently as compared to other entries in the credits.
(k) Soliciting professional work by making roving enquiries: It is not permissible for a
member to address letters, emails or circulars specifically to persons who are likely to require
services of a Chartered Accountant since it would tantamount to advertisement.
(l) Seeking work from Professional Colleagues: The issue of an advertisement or a circular
by a Chartered Accountant, seeking work from professional colleagues on any basis
whatsoever except as provided above would be in violation of this clause.
(m) Scope of representation which an auditor is entitled to make under Section 225(3) of
the Companies Act, 1956 (Section 140(4) of the Companies Act, 2013): The right to make
representation does not mean that an auditor has any prescriptive right or a lien to an audit.
The wording of his representation should be such that, apart from the opportunity not being
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19.54 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
abused to secure needless publicity, it does not tantamount directly or indirectly to canvassing
or soliciting for his continuance as an auditor. The letter should merely set out in a dignified
manner how he has been acting independently and conscientiously through the term of office
and may, in addition, indicate if he so chooses, his willingness to continue as auditor if
reappointed by the shareholders.
(n) Acceptance of original professional work by a member emanating from the client
introduced to him by another member: The Council has decided that a member should not
accept the original professional work emanating from a client introduced to him by another
member. If any professional work of such client comes to him directly, it should be his duty
to ask the client that he should come through the other member dealing generally with his
original work.
(o) Giving Public Interviews: While giving any interview or otherwise furnishing details about
themselves or their firms in public interviews or to the press or at any forum, the members
should ensure that, it should not result in publicity. Due care should be taken to ensure that
such interviews or details about the members or their firms are not given in a manner
highlighting their professional attainments. Any detail which is given must, in addition to
meeting the above requirements, be given only as a response to a specific question, and of
factual nature only.
(p) Members and/or firms who publish advertisements under Box numbers: Members/Firms
are prohibited from inserting advertisements for soliciting clients or professional work under
box numbers in the newspapers. This practice is in violation of this clause.
(q) Educational Videos: While the videos of educational nature may be uploaded on the internet
by members, no reference should be made to the Chartered Accountants Firm wherein the
member is a partner/ proprietor. Further, it should not contain any contact details or website
address.
Illustration 7
Mr. S, a Chartered Accountant published a book and gave his personal details as the author. These
details also mentioned his professional experience.
Soliciting Professional Work: Clause (6) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 refers to professional misconduct of a member in practice if he solicits client
or professional work either directly or indirectly, by circular, advertisement, personal
communication or interview or by any other means. Therefore, members should not adopt any
indirect methods to advertise their professional practice with a view to gain publicity and thereby
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solicit clients or professional work. Such a restraint must be practiced so that members may
maintain their independence of judgement and may be able to command the respect of their
prospective clients. While elaborating forms of soliciting work, the Council has specified that a
member is not permitted to indicate in a book or an article, published by him, his association with
any firm of chartered accountants. In this case, Mr. S, a Chartered Accountant published the book
and mentioned his professional experience in detail in the same.
Conclusion: Mr. S being a chartered accountant in practice has committed the professional
misconduct by mentioning his professional experience.
Illustration 8
M/s XYZ, a firm of Chartered Accountants created a website “www.xyzindia.com”. The website
besides containing details of the firm and bio-data of the partners also contains the passport size
photographs of all the partners of the firm.
Hosting Details on Website: As per detailed guidelines of the ICAI laid down in
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949, a chartered
accountant of the firm can create its own website using any format subject to guidelines. However,
the website should be so designed that it does not solicit clients or professional work and should
not amount to direct or indirect advertisement. The guidelines of the ICAI to allow a firm to put up
the details of the firm, bio-data of partners and display of a passport size photograph.
Conclusion: In the case of M/s XYZ, all the guidelines seem to have been complied and there
appears to be no violation of the Chartered Accountants Act, 1949 and its Regulations.
Illustration 9
M/s LMN, a firm of Chartered Accountants responded to a tender from a State Government for
computerization of land revenue records. For this purpose, the firm also paid ` 50,000 as earnest
deposit as part of the terms of the tender.
Responding to Tenders: Clause (6) of Part I of the First Schedule to the Chartered Accountants
Act, 1949 lays down guidelines for responding to tenders, etc. As per the guidelines if a matter
relates to any services other than audit, members can respond to any tender. Further, in respect
of a non-exclusive area, members are permitted to pay reasonable amount towards earnest
money/security deposits. However, on having received complaint/ instance of exorbitant
EMD/Deposit, the Ethical Standards Board may look into the matter on case to case basis.
Conclusion: In the instance case, since computerization of land revenue records does not fall
within exclusive areas for chartered accountants, M/s LMN can respond to tender as well as deposit
` 50,000 as earnest deposit and shall not have committed any professional misconduct.
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19.56 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Illustration 10
Mr. Honest, a Chartered Accountant in practice, wrote two letters to M/s XY Chartered Accountants
a firm of CAs; requesting them to allot him some professional work. As he did not have a significant
practice or clients he also wrote a letter to M/s ABC, a firm of Chartered Accountants for securing
professional work. Mr. Clever, another CA, informed ICAI regarding Mr. Honest's approach to
secure the professional work. Is Mr. Honest wrong in soliciting professional work?
Securing Professional Work: Clause (6) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 states that a Chartered Accountant in practice shall be deemed to be guilty
of misconduct if he solicits clients or professional work either directly or indirectly by a circular,
advertisement, personal communication or interview or by any other means. Provided that nothing
herein contained shall be construed as preventing or prohibiting any Chartered Accountant from
applying or requesting for or inviting or securing professional work from another chartered
accountant in practice.
Such a restraint has been put so that the members maintain their independence of judgment and
may be able to command respect from their prospective clients.
Conclusion: In the given case, Mr. Honest wrote letters only to other Chartered Accountants, M/s
XY and M/s ABC requesting them to allot some professional work to him, which is not prohibited
under Clause (6) as explained above. Thus, Mr. Honest has not committed any professional
misconduct by soliciting professional work.
Clause (7) Advertises his professional attainments or services, or uses any designation or
expressions other than the Chartered Accountant on professional documents, visiting cards,
letter heads or sign boards unless it be a degree of a University established by law in India
or recognized by the Central Government or a title indicating membership of the Institute of
Chartered Accountants or of any other institution that has been recognized by the Central
Government or may be recognized by the Council.
Provided that a member in practice may advertise through a write up, setting out the service
provided by him or his firm and particulars of his firm subject to such guidelines as may be
issued by the Council.
This clause prohibits advertising of professional attainments or services of a member. However, the
services can be advertised in a restricted way through a write up subject to the Guidelines of the
Council issued from time to time. Refer chapter 3 of the book. It also restrains a member from using
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.57
any designation or expression other than that of a Chartered Accountant in documents through which
the professional attainments of the member would come to the notice of the public.
Other Designations: It is improper for a Chartered Accountant in practice to state on his
professional documents that he is an Income-tax Consultant, Cost Accountant, Company Secretary,
Cost Consultant or a Management Consultant.
While noting that it had already allowed its members to appear before the various authorities
including Company Law Board, Income Tax Appellate Tribunal, Sales Tax Tribunal where the law
has permitted the same, so far as the designation “Corporate Lawyer” is concerned, the Council was
of the view that as per the existing provisions of law, a Chartered Accountant in practice is not
entitled to use the designation “Corporate Lawyer”.
A member must not use the designation such as ‘Member of Parliament’, ‘Municipal Councilor’ nor
any other functionary in addition to that of Chartered Accountant.
A member empanelled as Insolvency Professional or Registered Valuer can mention “Insolvency
Professional” or “Registered Valuer” respectively on his visiting card and letter head.
Permission to mention qualifications of certain Institutions: The members are permitted to
mention a title on their visiting cards to indicate membership of a foreign Institute of Accountancy,
which has been recognised by the Council e.g. South African Institute of Chartered Accountants
(SAICA), Institute of Certified Public Accountants (CPA Ireland) and Institute of Chartered
Accountants in England and Wales (ICAEW).
Date of setting-up practice: The date of setting up the practice by a member or the date of
establishment of the firm on the letter heads and other professional documents etc. should not be
mentioned.
Practice as Advocate: Members of the Institute in practice who are otherwise eligible may practise
as advocates subject to the permission of the Bar Council but in such case, they should not use
designation ‘Chartered Accountant’ in respect of the matters involving the practice as an advocate.
In respect of other matters they should use the designation ‘Chartered Accountant’ but they should
not use the designation ‘Chartered Accountant’ and ‘Advocate’ simultaneously.
Practice as Company Secretary/Cost Management Accountant: Members of the Institute in
practice who are otherwise eligible may also practice as Company Secretaries and/or Cost
Management Accountants. Such members shall, however, not use designation/s of the aforesaid
Institute/s simultaneously with the designation “Chartered Accountant”.
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19.58 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
It is clarified that in the event of the permission being granted to a member in practice to also hold
COP of sister Institute(s)/Bar Council, such a member be treated as a member in full-time practice.
Mention of Firm name except on Professional Documents: It is not proper for a Firm of Chartered
Accountants to use the designation ‘Chartered Accountant’ except on professional documents,
visiting cards, letter heads or sign boards and under the circumstances clarified under Clause (6).
However, an individual member may use the prefix “CA” with his name.
Notice in the Press relating to the Success in an Examination: Notice in the press relating to
the success in an examination of an individual candidate, should not contain any element of
undesirable publicity either in relation to the articled/audit assistant or an employee or the member
or the firm with whom he was served.
It is usual for local papers to publish details of the examination success of local candidates. Some
biographical information is often included. The rule aforementioned is not intended to discourage
the printing of news of local interest but is intended to indicate the need for restraint. The candidate’s
name and address, school and local background, examination passed with details of any prize or
place gained, the name of the principal, firm and town in which the principal practices may be
published.
Reports and Certificates: The reports and certificates issued by a Chartered Accountant bring him
to the notice of the public in a greater or lesser degree. It is therefore incumbent upon him to ensure
that the extent and manner of publication of certificates are limited to what is necessary to enable
the report or certificate to serve its proper purpose. The members may however note that they should
use letterhead of their Firm for issuing reports and certificates.
Appearance of Chartered Accountants on Electronic Media (including Internet): Members may
appear on television, films and Internet and agree to broadcast in the Radio or give lectures at
forums and may give their names and describe themselves as Chartered Accountants. Special
qualifications or specialised knowledge directly relevant to the subject matter of the programme may
also be given. Firm name may also be mentioned, however, any exaggerated claim or any kind of
comparison is not permissible. What he may say or write must not be promotional of him or his firm
but must be an objective professional view of the topic under consideration.
Publicity is permitted for appointments to positions of local or national importance or for the views
of members on matters of similar importance. Mention of the membership of the Institute is desirable
in such cases. What should be aimed at is to achieve suitable publicity for the Institute and its
members generally. Members giving talks or lectures or attending conference may describe
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.59
themselves as Chartered Accountants only when they are acting in their capacity as Chartered
Accountants. However, reference to the professional firm of the member should not be given.
Organising Training Courses, Seminars etc. for his staff: A Chartered Accountant in practice
holding training courses, seminars etc. for his staff may also invite the staff of other Chartered
Accountants and clients to attend the same. However, undue prominence should not be given to the
name of the Chartered Accountant in any booklet or document issued in connection therewith.
Writing Articles or Letters to the Press: Members writing articles or letters to the Press on subjects
connected with the profession may give their names and use the description Chartered Accountants.
Size of Sign Board: With regard to the size of sign board for his office that a member can put up, it
is a matter in which the members should exercise their own discretion and good taste while keeping
in mind the appropriate visibility and illumination (limited to the sake of visibility). However, use of
glow signs or lights on large-sized boards as is used by traders or shop-keepers is not permissible.
A member can have a name board at the place of his residence with the designation of a Chartered
Accountant, provided it is a name plate or name board of an individual member and not of the firm.
Public Announcements with details of Directors: The Council’s attention has been drawn to the
fact that more and more Companies are appointing Chartered Accountants as Directors on their
Boards. The prospectus or public announcements issued by these Companies often publish
descriptions about the Chartered Accountant’s expertise, specialisation and knowledge in any
particular field or add appellations or adjectives to their names. Attention of the members in this
context is invited to the provisions of Clause (6) and (7) of Part I of the First Schedule to the
Chartered Accountants Act.
In order that the inclusion of the name of a member of the Institute in the prospectus or public
announcements or other public communications issued by the Companies in which the member is a
director does not contravene the above noted provisions, it is necessary that the members should
take necessary steps to ensure that such prospectus or public announcements or public
communications do not advertise his professional attainments and also that such prospectus or
public announcements or public communications do not directly or indirectly amount to solicitation
of clients for professional work by the member. While it may be difficult to lay down a rigid rule in
this respect, the members must use their good judgement, depending upon the facts and
circumstances of each case to ensure that the above noted provisions are complied with both in
letter and spirit.
It is advisable for a member that as soon as he is appointed as a director on the Board of a Company,
he should specifically invite the attention of the management of the Company to the aforesaid
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provisions and should request that before any such prospectus or public announcements or public
communication mentioning the name of the member concerned, is issued, the material pertaining to
the member concerned should, as far as practicable be got approved by him. The use of the
expression ‘Chartered Accountant’ is permissible. However, the member must ensure that
descriptions about his expertise, specialisation and knowledge in any particular field or other
appellations or adjectives are not published with his name. Particulars about directorships held by
the member in other Companies can, however, be given, but the name of the firm of Chartered
Accountants in which the member is a partner, should not be given.
Network Firms and Networking Guidelines: The Council has permitted Network amongst the
Firms registered with the Institute. A member of the Network may advertise to the extent
permitted by the Advertisement Guidelines issued by Institute.
Note:
Students are required to refer Para 9 of this Chapter for Guidelines for Networking
discussed in Chapter XV of Council General Guidelines 2008.
Advertisement Guidelines issued by Institute are being given in details in the Chapter
Use of Logo: For use of logos by Members on letter heads, visiting cards etc. the Council had
decided that the logos unconnected with the first letter of the name of the firm or its partners or
proprietors would not be permitted for use by members in practice/firms of Chartered Accountants
on their letter heads, visiting cards etc. as the same would have amounted to advertisement or
smacking of publicity. Subsequent to above, the Institute came across cases of registration of firm
name in circumvention of the provisions contained in the Regulation 190 of the Chartered
Accountants Regulations, 1988. The members/firms by themselves or through engineered name had
been seeking to obtain firm name approval based on the name of the partner/s selected in the
manner that logo of the firm would be identical to the firm name which would have not otherwise
been permissible as firm name under Regulation 190.
In order to ensure compliance with the Regulations, the Council decided that the use of
logo/monogram of any kind/form/ style/design/colour etc. whatsoever on any display material or
media e.g. paper stationery, documents, visiting cards, magnetic devices, internet, sign board, by
the members in practice and/or the firm of Chartered Accountants, be prohibited. Use/printing of
member/firm name in any other manner tantamounting to logo/monogram was also prohibited.
Common CA Logo: To promote the brand of CA profession and responding to the long felt need to
have a symbol of CA Profession in India, ICAI came up with a unique logo which could be used by
all members, whether in practice or not. Encapsulating the current beliefs, attitudes and values of
the profession, the CA Logo seeks to enhance the identity of the members. The logo consists of the
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.61
letters ‘CA’ with a tick mark (upside down) inside a rounded rectangle with white background. The
letters ‘CA’ have been put in blue, the corporate colour which not only stands out on any background
but also denotes creativity, innovativeness, knowledge, integrity, trust, truth, stability and depth. The
upside down tick mark, typically used by the chartered accountants, has been included to symbolize
the wisdom and value of the professional. The green colour in the tick mark signifies growth,
prosperity, harmony and freshness. Members are encouraged to use this logo. The Council has
decided that use of CA logo in the stamp is permissible, subject to CA logo guidelines.
[Students are advised to refer Chapter XVI on Logo Guidelines under Para no 9 Council
Guidelines.]
Guidelines for elected Members of the Council/ office Bearers of the Regional Council in
the context of use of designation etc. and manner of Printing of Letter-heads and visiting
cards.
The guidelines/directions laid down by the Council as revised by the Council from time to time for
use of designation etc. and manner of printing letter-heads and visiting cards of the President, Vice-
President of the Institute, Members of the Council, Chairmen of various non-standing Committees
of the Institute; Chairmen, other office bearers and Members of the Regional Councils; Chairmen,
other office-bearers and Members of the Managing Committees of the Branches are appearing in
Appendix ‘F’ to Code of Ethics publication.
Illustration 11
A practising Chartered Accountant uses a visiting card in which he designates himself, besides
as Chartered Accountant, as a Tax Consultant.
Tax Consultant: Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part
I of the First Schedule to the said Act prohibits advertising of professional attainments or
services of a member. It also restrains a member from using any designation or expression
other than that of a chartered accountant in documents through which the professional
attainments of the member would come to the notice of the public.
Under the clause, use of any designation or expression other than chartered accountant for a
chartered accountant in practice, on professional documents, visiting cards, etc. amounts to a
misconduct unless it be a degree of a university or a title indicating membership of any other
professional body recognised by the Central Government or the Council.
Conclusion: Thus, it is improper to use designation "Tax Consultant" since neither it is a degree
of a University established by law in India or recognised by the Central Government nor it is a
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19.62 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
recognised professional membership by the Central Government or the Council.
Illustration 12
B, a Chartered Accountant in practice is a partner in 3 firms. While printing his personal letter
heads, B gave the names of all the firms in which he is a partner.
Advertisement of Professional Attainments: Clause (7) of Part I of the First Schedule to the
Chartered Accountants Act, 1949 prohibits advertising of professional attainments or services
of a member. It also restrains a member from using any designation or expression other than
that of a Chartered Accountant in documents through which the professional attainments of the
member would come to the notice of the public. Even a member is not permitted to specify the
date of setting up of practice or establishment of firm on letterheads. However, there is no
prohibition for printing names of all the three firms on the personal letterheads in which a
member holding Certificate of Practice is a partner.
Conclusion: Thus, B is not guilty of any misconduct under the Chartered Accountants Act, 1949.
Illustration 13
The offer document of a listed company in which Mr. D, a practising Chartered Accountant is a
director mentions the name of Mr. D as a director along with his various professional attainments
and spheres of specialisation.
Advertisement of Professional Attainments: The Council of the ICAI has in a communication
to members stated that if a public company, in which a chartered accountant in practice is a
director, issues a prospectus or gives any announcement that gives descriptions about the
Chartered Accountant’s expertise, specialisation and knowledge in any particular field, it shall
constitute a misconduct under Clauses (6) and (7) of Part I of the First Schedule to the Chartered
Accountants Act, 1949. The Council has further stated that in such cases the member concerned
has to take necessary steps to ensure that such prospectus or public announcements or public
communications do not advertise his professional attainments and also that such prospectus or
public announcements or public communications do not directly or indirectly amount to
solicitation of clients for professional work by the members.
Conclusion: Thus, in the instant case, Mr. D would be held to be guilty of professional mis-
conduct and liable for disciplinary action.
Illustration 14
A Chartered Accountant in practice, empanelled as an Insolvency Professional (IP) has
mentioned the same on his visiting cards, letter heads and other communications also. A person
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.63
residing in his neighbourhood, has filed a complaint for professional misconduct against the said
member for such mention of IP.
Using Designation of Insolvency Professional: As per Clause (7) of Part I of First Schedule
to the Chartered Accountants Act, 1949, a CA in practice is deemed to be guilty of professional
misconduct if he (i) advertises his professional attainments or services or (ii) uses any
designation or expressions other than ‘Chartered Accountant” on professional documents,
visiting cards, letter heads or sign boards unless it be a degree of a university established by
law in India or recognized by the Central Government or a title indicating membership of the
ICAI or of any other institution that has been recognized by the Central Government or may be
recognized by the council.
Here, a Chartered Accountant empaneled as IP (Insolvency Professional) can mention
“Insolvency Professional” on his visiting cards, letter heads and other communication, as this is
a title recognised by the Central Government in terms of Clause 7 of Part 1 of First Schedule to
the Chartered Accountants Act, 1949.
Conclusion: Thus, complaint of neighbor is not enforceable/ valid.
Clause (8) accepts a position as auditor previously held by another chartered accountant or
a certified auditor who has been issued certificate under the Restricted Certificate Rules, 1932
without first communicating with him in writing.
It must be pointed out that professional courtesy alone is not the major reason for requiring a member
to communicate with the existing accountant who is a member of the Institute or a certified auditor.
The underlying objective is that the member may have an opportunity to know the reasons for the
change in order to be able to safeguard his own interest, the legitimate interest of the public and the
independence of the existing accountant. It is not intended, in any way, to prevent or obstruct the
change. When making the inquiry from the retiring auditor, the one proposed to be appointed or
already appointed should primarily find out whether there are any professional or other reasons why
he should not accept the appointment.
It is important to remember that every client has an inherent right to choose his accountant also that
he may, subject to compliance, with the statutory requirements in the case of limited companies,
make a change whenever he chooses, whether or not the reasons which had impelled him to do so
are good and valid. The change normally occurs where there has been a change of venue of
business and a local accountant is preferred or where the partner who has been dealing with the
client’s affairs retires or dies; or where temperaments clash or the client has some good reasons to
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feel dissatisfied. In such cases, the retiring auditor should always accept the situation with good
grace.
The existence of a dispute as regards the fees may be root cause of an auditor being changed. This
would not constitute valid professional reasons on account of which an audit should not be accepted
by the member to whom it is offered. However, in the case of an undisputed audit fees for carrying
out the statutory audit under the Companies Act, 2013 or various other statutes having not been
paid, the incoming auditor should not accept the appointment unless such fees are paid. In respect
of other dues, the incoming auditor should in appropriate circumstances use his influence in favour
of his predecessor to have the dispute as regards the fees settled. The professional reasons for not
accepting an audit would be:
(a) Non-compliance of the provisions of Sections 139 and 140 of the Companies Act, 2013 as
mentioned in Clause (9) of the Part - I of First Schedule to The Chartered Accountants Act,
1949; and
(b) Non-payment of undisputed Audit Fees by auditees other than in case of Sick Units for
carrying out the Statutory Audit under the Companies Act, 2013 or various other statutes; and
(c) Issuance of a qualified report.
In the first two cases, an auditor who accepts the audit would be guilty of professional misconduct.
In this connection, attention of members is invited to the Council General Guidelines, 2008 appearing
in Chapter-4. In the said Guidelines, Council has explained that the provision for audit fee in
accounts signed by both the auditee and the auditor along with other expenses, if any, incurred by
the auditor in connection with the audit, shall be considered as “undisputed audit fee” and “sick unit”
shall mean a unit registered for not less than five years, which has at the end of any financial year
accumulated losses equal to or exceeding its entire net worth.
In the last case, however, he may accept the audit if he is satisfied that the attitude of the retiring
auditor was not proper and justified. If, on the other hand, he feels that the retiring auditor had
qualified the report for good and valid reasons, he should refuse to accept the audit. There is no
rule, written or unwritten, which would prevent an auditor from accepting the appointment offered to
him in these circumstances. However, before accepting the audit, he should ascertain the full facts
of the case. For nothing will bring the profession to disrepute so much as the knowledge amongst
the public that if an auditor is found to be “inconvenient” by the client, he could readily be replaced
by another who would not displease the client and this point cannot be too over-emphasised.
Where the Previous Auditor is not available for accepting payment of undisputed audit fees, and it
is not otherwise possible to transfer the payment to him electronically, the Incoming Auditor may
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.65
advise the client to purchase Demand Draft of the amount equivalent to undisputed Audit Fees of
retiring auditor, and may accept the Audit assignment after verifying the same. It will be the duty of
the Incoming auditor to ensure the payment of undisputed Audit Fees of the retiring auditor at the
earliest possibility.
What should be the correct procedure to adopt when a prospective client tells you that he wants to
change his auditor and wants you to take up his work? There being two persons involved, the
Company and the old auditor, the former should be asked whether the retiring auditor had been
informed of the intention to change. If the answer is in the affirmative, then a communication should
be addressed to the retiring auditor. If, however, it is learnt that the old auditor has not been informed,
and the client is not willing to make the first move, it would be necessary to ask him the reason for
the proposed change. If there is no valid reason for a change, it would be healthy practice not to
accept the audit. If he decides to accept the audit he should address a communication to the retiring
auditor.
As stated earlier, the object of the incoming auditor, in communicating with the retiring auditor is to
ascertain from him whether there are any circumstances which warrant him not to accept the
appointment.
5. For example, whether the previous auditor has been changed on account of having
qualified his report or he had expressed a wish not to continue on account of
something inherently wrong with the administration of the business. The retiring
auditor may even give out information regarding the condition of the accounts of the client or the
reason that impelled him to qualify his report. In all these cases it would be essential for the
incoming auditor to carefully consider the facts before deciding whether or not he should accept
the audit, and should he do so, he must also take into account the information while discharging
his duties and responsibilities.
Sometimes, the retiring auditor fails without justifiable cause except a feeling of hurt because of the
change, to respond to the communication of the incoming auditor. So that it may not create a
deadlock, the auditor appointed can act, after waiting for a reasonable time for a reply.
The Council has taken the view that a mere posting of a letter “under certificate of posting” is not
sufficient to establish communication with the retiring auditor unless there is some evidence to show
that the letter has in fact reached the person communicated with. A Chartered Accountant who relies
solely upon a letter posted “under certificate of posting” therefore does so at his own risk.
The view taken by the Council has been confirmed in a decision by the Rajasthan High Court in J.S.
Bhati v.s. The Council of the Institute of Chartered Accountants of India and another. The following
observations of the Court are relevant in this context:
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“Mere obtaining a certificate of posting in my opinion does not fulfil the requirements of Clause (8)
of Schedule I as the presumption under Section 114 of the Evidence Act that the letter in due course
reached the addressee cannot replace that positive degree of proof of the delivery of the letter to
the addressee which the letters of the law in that case required. The expression ‘in ‘communication
with’ when read in the light of the instructions contained in the booklet ‘Code of Conduct’ (now Code
of Ethics) cannot be interpreted in any other manner but to mean that there should be positive
evidence of the fact that the communication addressed to the outgoing auditor by the incoming
auditor reached his hands. Certificate of posting of a letter cannot, in the circumstances, be taken
as a positive proof of its delivery to the addressee”.
Members should therefore communicate with a retiring auditor in such a manner as to retain in their
hands positive evidence of the delivery of the communication to the addressee. In the opinion of
the Council, the following would in the normal course provide such evidence:-
(a) Communication by a letter sent through “Registered Acknowledgement due”, or
(b) By hand against a written acknowledgement, or
(c) Acknowledgement of the communication from retiring auditor’s vide email address registered
with the Institute or his last known official email address, or
(d) Unique Identification Number (UDIN) generated on UDIN portal (subject to separate
guidelines to be issued by the Council in this regard)
Premises found Locked: The communication received back by the Incoming Auditor with “Office
found Locked” written on the Acknowledgement Due shall be deemed as having been delivered to
the retiring auditor.
Firm not found at the given Registered address : If the Communication sent by the Incoming
auditor is received back with remarks “No such office exists at this address”, and the address of
communication is the same as registered with the Institute on the date of dispatch, the letter will be
deemed to be delivered, unless the retiring auditor proves that it was not really served and that he
was not responsible for such non-service.
As a matter of professional courtesy and professional obligation it is necessary for the new auditor
appointed to act jointly with the earlier auditor and to communicate with such earlier auditor.
Special Audit under Income Tax Act, 1961: It would be a healthy practice if a Tax Auditor
appointed for conducting special audit under the Income Tax Act,1961 communicates with the
member who has conducted the Statutory Audit.
The Council has also laid down the detailed guidelines on the subject as under:-
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.67
Communication required for all kinds of audit: The requirement for communicating with the
previous auditor being a Chartered Accountant in practice would apply to all types of Audit viz.,
Statutory Audit, Tax Audit, GST Audit, Internal Audit, Concurrent Audit or any other kind of audit.
Communication in case of Assignments done by other professionals: A Communication is
mandatorily required for all types of Audit/Report where the previous auditor is a Chartered
Accountant. In case of assignments done by other professionals not being Chartered Accountants,
it would also be a healthy practice to communicate.
Lack of time in acceptance of Government Audits: Although the mandatory requirement of
communication with previous auditor being Chartered Accountant applies, in uniform manner, to
audits of both government and Non-Government entities, yet in the case of audit of government
Companies/ banks or their branches, if the appointment is made well in time to enable the obligation
cast under this clause to be fulfilled, such obligation must be complied with before accepting the
audit. However, in case the time schedule given for the assignment is such that there is no time to
wait for the reply from the outgoing auditor, the incoming auditor may give a conditional acceptance
of the appointment and commence the work which needs to be attended to immediately after he has
sent the communication to the previous auditor in accordance with this clause. In his acceptance
letter, he should make clear to the client that his acceptance of appointment is subject to professional
objections, if any, from the previous auditors and that he will decide about his final acceptance after
taking into account the information received from the previous auditor.
Illustration 15
Mr. X, a Chartered Accountant accepted his appointment as tax auditor of a firm under Section
44AB, of the Income-tax Act, and commenced the tax audit within two days of his appointment
since the client was in a hurry to file Return of Income before the due date. After commencing
the audit, Mr. X realised his mistake of accepting this tax audit without sending any
communication to the previous tax auditor. In order to rectify his mistake, before signing the
tax audit report, he sent a registered post to the previous auditor and obtained the postal
acknowledgement. Will Mr. X be held guilty under the Chartered Accountants Act?
Communication with the Previous Auditor: As per Clause (8) of Part I of First Schedule to
the Chartered Accountants Act, 1949, Mr. X will be held guilty since he has accepted the tax
audit, without first communicating with the previous auditor in writing. The object of the
incoming auditor communicating in writing with the retiring auditor is to ascertain whether there
are any circumstances which warrant him not to accept the appointment, for example, whether
the previous auditor has been changed on account of having qualified the report or he had
expressed a wish not to continue on account of something inherently wrong with the
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administration of the business. The retiring auditor may even give out information regarding
the condition of the accounts of the client or the reason that impelled him to qualify his report.
Under all circumstances, it would be essential for the incoming auditor to carefully consider
the facts before deciding whether or not he should accept the audit. As a matter of professional
courtesy and professional obligation it is necessary for the new auditor appointed to
communicate with such earlier auditor.
Conclusion: Therefore, Mr. X will be held guilty of professional misconduct.
Illustration 16
W, a Chartered Accountant had sent letters under certificate of posting to the previous auditor
informing him his appointment as an auditor before the commencement of audit by him.
Communication with the Previous Auditor: Clause (8) of Part I of the First Schedule to the
Chartered Accountants Act, 1949 requires communication by the incoming auditor with the
previous auditor before accepting a position by him. The Council of the Institute has taken the
view that a mere posting of a letter “under certificate of posting” is not sufficient to establish
communication with the retiring auditor unless there is some evidence to show that the letter
has in fact reached the person communicated with. A Chartered Accountant who relies solely
upon a letter posted “under certificate of posting” therefore does so at his own risk. Since the
letters were sent by “W” to the previous auditor informing him of his appointment as an auditor
before the commencement of audit by him under Certificate of Posting is not sufficient to prove
communication with the retiring auditor. In the opinion of the Council, communication by a
letter sent “Registered Acknowledgement Due” or by hand against a written acknowledgement
would in the normal course provide positive evidence.
Conclusion: Hence “W” was guilty of professional misconduct under Clause (8) of Part I of
First Schedule to the Chartered Accountants Act, 1949
Clause (9) accepts an appointment as auditor of a company without first ascertaining from it
whether the requirements of Section 225 of the Companies Act, 1956 (1 of 1956), in respect
of such appointment have been duly complied with;
The Companies Act, 2013 provides for the requirements which an auditor appointed in respect of a
Company should satisfy himself about, before he accepts the appointment. The relevant provisions
are contained in Section 139 and 140 of Companies Act, 2013 Act (erstwhile Section 225 of
Companies Act, 1956) and the Council has notified that the provisions to be complied with under
Clause (9) are those contained in Sections 139 and 140 of the Act. Section 139 contains several
provisions in the matter of appointment of auditors in different circumstances and situations whereas
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Section 140 lays down the procedure which must be followed whenever a Company desires to
change its auditors. In order that the validity of the appointment of an auditor is not challenged or
objected to by shareholders or the retiring auditors at a later date, it has been made obligatory on
the Incoming Auditor to ascertain from the Company that the appropriate procedure in the matter of
appointment has been faithfully followed.
The following guidelines have been issued by the Council for this purpose:-
Clause (9) of Part I of the First Schedule to Chartered Accountants Act, 1949 provides that a
member in practice shall be deemed to be guilty of professional misconduct if he accepts an
appointment as auditor of a Company without first ascertaining from it whether the
requirements of Sections 139 and 140 of the Companies Act, 2013, in respect of such
appointment have been duly complied with. Under this clause it is obligatory on the incoming
auditor to ascertain from the Company that the appropriate procedure in the matter of his
appointment has been duly complied with so that no shareholder or retiring auditor may, at
a later date, challenge the validity of such appointment.
The steps to be taken by an Auditor of a Company who is appointed in the following
circumstances are indicated in the paragraphs below:
(a) When the auditor appointed is the First Auditor of the Company.
(b) When the auditor is appointed in place of an existing auditor who has resigned or has
been removed or has ceased to hold office for any other reason.
(c) When the auditor or auditors appointed by the Company were holding this office jointly
with others and one or more of such joint auditors are not reappointed.
(d) When one or more of the auditors appointed by the Company was/were not holding this
office earlier.
Note : Students are advised to refer Intermediate level Paper 2 Corporate and Other Law for more
details regarding Section 139 and 140, Section 139 of the Companies Act, 2013 laid down the
procedure to be followed by a Company for appointment of an auditor and Section 140 of the
Companies Act, 2013 lays down the procedure for appointment of auditor other than the retiring
auditor and for removal of existing auditor.
The procedure to be followed by the Company is given below:-
• If a member of the Company wants that the retiring auditor should not be reappointed or that
an auditor other than the retiring auditor should be appointed, he has to give a special notice
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19.70 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
u/s 140(4) of Companies Act, 2013 to the Company for a resolution at the Annual General
Meeting for this purpose.
• Such special notice is also required to be given if a member of the Company wants to remove
the auditor before the expiry of his term of office. The special notice should be given before
the date of the General Meeting when the question of appointment or reappointment of the
auditor is to be considered.
• On receipt of the special notice of such a resolution, the Company has to send a copy of the
same to the retiring auditor forthwith, as required u/s 140(4) of Companies Act, 2013.
• The Company is also required to send the special notice to the members of the Company at
least seven days before the Meeting as per the provisions of Section 115 read with Section
20 of the Companies Act, 2013. According to these provisions, a document may be served
on a company or an officer thereof by sending it to the company or the officer at the registered
office of the company by registered post or by speed post or by courier service or by leaving
it at its registered office or by means of such electronic or other mode as may be prescribed.
• After receipt of the above notice, the retiring auditor can submit his representation to the
members of the Company. Such representation, on receipt by the Company, is required to
be sent to its members as required under Section 140(4) of the Companies Act.
• The representation received from the retiring auditor will have to be considered at the General
Meeting of the Company before the resolution proposed by the concerned member is passed.
The resolution proposed by the concerned member can be passed only in accordance with
the provisions of Section 114 of the Companies Act, 2013.
• Under Clause (9) of Part I of the First Schedule to the Chartered Accountants Act, 1949, the
incoming auditor has to ascertain whether the Company has complied with the provisions of
the above sections. The word "ascertain” means “to find out for certain”. This would mean
that the incoming auditor should find out for certain as to whether the Company has complied
with the provisions of Sections 139 and, 140 of the Companies Act, 2013. In this respect, it
would not be sufficient for the incoming auditor to accept a certificate from the management
of the Company that the provisions of the above sections have been complied with. It is
necessary for the incoming auditor to verify the relevant records of the Company and
ascertain as to whether the Company has, in fact, complied with the provisions of the above
sections. If the Company is not willing to allow the incoming auditor to verify the relevant
records in order to enable him to ascertain as to whether the provisions of the above sections
have been complied with, the incoming auditor should not accept the audit assignment.
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It is suggested that the incoming auditor should verify the following records of the Company:-
If the appointment of the auditor is being made for the first time after incorporation of the Company,
the auditor should verify as to whether the Board of Directors have passed the resolution for his
appointment within thirty days of the date of registration of the Company.
If the Board of Directors have not appointed the first auditor but the appointment is being made by
a general meeting of the Company, the auditor should verify as to whether a proper notice convening
the general meeting has been issued by the Company and whether the resolution has been validly
passed at the general meeting of the Company.
If the appointment is being made to fill a casual vacancy, the incoming auditor should verify as to
whether the Board of Directors have powers to fill the casual vacancy and whether the Board of
Directors have passed the resolution filling the casual vacancy.
If the vacancy has arisen due to resignation of the auditor, the incoming auditor should see as to
whether a proper resolution filling the vacancy has been passed at the General Meeting of the
Company.
If the vacancy has arisen as a result of removal of the auditor before the expiry of his term of office,
the incoming auditor should see that special resolution has been passed at the General Meeting of
the Company and that the previous approval of the Central Government has been obtained by the
Company.
Where the auditor other than the retiring auditor is proposed to be appointed, the incoming auditor
should ascertain whether the provisions of Sections 139 and 140 have been complied with. These
provisions equally apply where an auditor who was jointly holding office with another auditor or
auditors and any one or more of such joint auditors has not been reappointed.
For the purpose of ascertaining whether the Company has complied with the provisions of
Section 140 of the Companies Act the incoming auditor should verify the records of the
Company in respect of the following matters:-
a. Whether a member of the Company has given special notice of the resolution as required
under Section 140 (4) of the Companies Act, 2013. The notice shall be sent by members to
the company not earlier than three months but at least fourteen days before the date of the
meeting at which the resolution is to be moved, exclusive of the day on which the notice is
given and the day of the meeting. A true copy of this notice should be obtained by the
incoming auditor.
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19.72 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
b. Whether this special notice has been sent to all the members, of the Company as required
under Section 115 of Companies Act, 2013 at least 7 days before the date of the General
Meeting.
c. Whether this special notice has been sent to the retiring auditor forthwith as required under
Section 140 (4).
d. Whether the representation received from the retiring auditor has been sent to the members
of the Company as required under Section 140 (4) .
e. Whether the representation received from the retiring auditor has been considered at the
general meeting and the resolution proposed by the special notice has been properly passed
at the general meeting.
As regards the mode of sending the notice of the resolution to the members of the Company
as provided in Sections 139 and 140 and section 20 to be followed for service of documents,
which is as under:-
(A) A document may be served on a company or an officer thereof by sending it to the company
or the officer at the registered office of the company by registered post or by speed post or
by courier service or by leaving it at its registered office or by means of such electronic or
other mode as may be prescribed.
(B) As regards the mode of sending the notice of the resolution to the retiring auditor as provided
in Sections 224 & 225 of Companies act, 1956 (equivalent Sections being Section 139 & 140
of Companies 2013), attention is invited to the Department of Company Affairs circular dated
17.10.1981 issued to all Chambers of Commerce, which is reproduced below:-
“I am directed to say that it has been reported by the Institute of Chartered Accountants of
India that difficulties are being experienced by retiring Auditors in the operation of the
provisions of Section 225 of the Companies Act, 1956 whenever any appointment of a new
auditor takes place. Such difficulties arise because of the fact that the copy of the special
notice required to be served u/s 225(2) of the Act on the retiring auditors are not effectively
served and proof of such service is not available. To obviate such difficulties; therefore, it is
advisable that the copy of the special notice u/s 225(2) of the Act should be sent to the retiring
auditors by Registered A/D post.”
(C) Accordingly, it is necessary for the incoming auditor to satisfy himself that the notice provided
for in Sections 139 & 140 of Companies Act, 2013 has been effectively served on the outgoing
auditor (e.g. by seeing that the notice has been duly served through hand delivery or by Regd.
Post with A.D.). Production of a certificate of posting by the Company would not be adequate
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.73
for the purpose of the incoming auditor satisfying himself about compliance with Sections
139/140. Acknowledgement received from the outgoing auditor would be one of the forms in
which such satisfaction can be obtained.
A copy of the relevant minutes of the general meeting where the above resolution is passed duly
verified by the Chairman of the meeting should also be obtained by the incoming auditor for his records.
Sometimes the annual general meeting is adjourned without conducting any business or after
conducting business in respect of some of the items on the agenda. The items in respect of which
the business is conducted may or may not include the item relating to appointment of auditors. Under
Section 139(1) the retiring auditor holds office till the conclusion of every sixth annual general
meeting. Therefore, when the annual general meeting is adjourned in the circumstances stated
above, the retiring auditor will continue to hold the office of auditor till the adjourned meeting is held
and the business listed in the agenda of the meeting is concluded. In case a new auditor is appointed
at the original meeting (which is adjourned) such auditor can assume office only after the conclusion
of such adjourned meeting.
If any annual general meeting is adjourned without appointing an auditor, no special notice for
removal or replacement of the retiring auditor received after the adjournment can be taken note of
and acted upon by the Company, since in terms of Section 115 of the Companies Act, special notice
should be given to the Company at least fourteen clear days before the meeting in which the subject
matter of the notice is to be considered. The meeting contemplated in Section 115 undoubtedly is
the original meeting. 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 mentioned in Section 139.
If the incoming auditor is satisfied that the Company has complied with the provisions of Sections
139 and 140 of the Companies Act, he should first communicate with the outgoing auditor in writing
as provided in Clause (8) of Part I of the First Schedule to the Chartered Accountants Act, 1949
before accepting the audit assignment.
Unjustified removal of auditors: In order to examine various ethical issues and safeguard the
independence of the Auditors, the Council has set up a Ethical Standards Board (ESB). This Board
examines various issues concerning professional ethics governing the members of the Institute
which are either raised by the members or are taken up based on their importance. The
recommendations of the Board are forwarded to the Council for its consideration. This Board is also
charged with the responsibility of looking into the cases of removal and resignation of auditors and
making an appropriate report to the Council.
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19.74 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The following guidelines have been issued for the Board for looking into the cases of
Removal of Auditors:
A. Where an auditor resigns his appointment as an auditor of a Company or does not offer
himself for reappointment as auditor of such Company, he shall send a communication, in writing,
to the Board of Directors of the Company giving reasons therefor, if he considers that there are
professional reasons connected with his resignation or not offering himself for re-appointment
which, in his opinion, should be brought to the notice of the Board of Directors, and shall send a
copy of such communication to the Institute. It shall be obligatory on the incoming auditor, before
accepting appointment, to obtain a copy of such communication from the Board of Directors and
consider the same before accepting the appointment.
B. Where an auditor, though willing for re-appointment has not been reappointed, he shall
file with the Institute a copy of the statement which he may have sent to the management of the
Company for circulation among the shareholders. It shall be obligatory on the incoming auditor
before accepting the appointment, to obtain a copy of such a communication from the Company
and consider it, before accepting the appointment.
C. The Ethical Standards Board, on a review of the communications referred to in paras (A)
and (B), may call for such further information as it may require from the incoming auditor, the
outgoing auditor and the Company and make a report to the Council in cases where it considers
necessary.
D. The above procedure is also followed in the case of removal of auditors by the government
and other statutory authorities.
[Note: Students are advised to refer Appendix ‘G’ For the Mission Statement, Terms of
Reference and Procedure to be followed by the Board for dealing with the cases of Unjustified
Removal of Auditors.]
Illustration 17
CA Raja was appointed as the Auditor of Castle Ltd. for the year 2022-23. Since he declined to
accept the appointment, the Board of Directors appointed CA Rani as the auditor in the place of
CA Raja, which was also accepted by CA Rani.
Appointment of Auditor by Board: Board can appoint the auditor in the case of casual vacancy
under section 139(8) of the Companies Act, 2013. The non-acceptance of appointment by CA.
Raja does not constitute a casual vacancy to be filled by the Board. In this case, it will be deemed
that no auditor was appointed in the AGM.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.75
Further, as per Section 139(10) of the Companies Act, 2013 when at any annual general meeting,
no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of
the company. The appointment of the auditor by the Board is defective in law.
Clause (9) of Part I of First Schedule to the Chartered Accountants Act, 1949 states that a
chartered accountant is deemed to be guilty of professional misconduct if he accepts an
appointment as auditor of a company without first ascertaining from it whether the requirements
of section 225 of the Companies Act, 1956 (now Section 139, 140 and 142 read with Section
141 of the Companies Act, 2013), in respect of such appointment have been fully complied with.
Conclusion: Hence, CA. Rani is guilty of professional misconduct since she accepted the
appointment without verification of statutory requirements.
Illustration 18
Mr. X is a Chartered Accountant accepted the appointment as Statutory Auditor of the Company
ABC Ltd. without communicating with the previous auditor before accepting the audit. He also
failed to ascertain the compliance of requirement of Section 139 and 140 of the Companies Act,
2013 in respect of the appointments have been duly complied with.
Communication by incoming auditor with previous auditor: Clause (8) of Part I of the First
Schedule to the Chartered Accountants Act, 1949 requires communication by the incoming
auditor with the previous auditor before accepting a position by him.
Clause (9) of Part I of the First Schedule to the Chartered Accountants Act, 1949, provides that
a member in practice shall be deemed to be guilty of professional misconduct if he accepts an
appointment as auditor of a company without first ascertaining from it whether the requirements
of Section 225 of the Companies Act, 1956 (now Section 139 and 140 of the Companies Act,
2013), in respect of such appointment have been duly complied with.
Under this clause it is obligatory on the incoming auditor to communicate with previous auditor
and ascertain from the Company that the appropriate procedure in the matter of his appointment
has been duly complied with so that no shareholder or retiring auditor may, at a later date,
challenge the validity of such appointment.
In this case Mr. X accepted the appointment as Statutory Auditor of the Company ABC Ltd.
without communicating with the previous auditor. Further, he accepted the appointment without
first ascertaining whether the requirement of Section 139 and 140 of the Companies Act, 2013
in respect of the appointments have been duly complied with.
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19.76 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Conclusion: Therefore, Mr. X is liable for misconduct under clause 8 and Clause 9 since he
accepted the appointment without communicating with previous auditor as well as for not
verifying the compliance of statutory requirements.
Clause (10) Charges or offers to charge, accepts or offers to accept in respect of any
professional employment fees which are based on a percentage of profits or which are
contingent upon the findings, or results of such employment, except as permitted under any
regulations made under this Act.
What distinguishes a profession from a business is that professional services are not rendered with
the sole purpose of a profit motive. Personal gain is one but not the main or the only objective.
Professional opinion, therefore frowns upon methods where payment is made to depend on the basis
of results. It is obvious that a person who is to receive payment in direct proportion to the benefit
received by his client, may be tempted to exaggerate the advantage of his service or may adopt
means that are not ethical. It will have the effect of undermining his integrity and impairing his
independence. Therefore, members are prohibited from charging or accepting any remuneration
based on a percentage of the profits or on the happening of a particular contingency such as, the
successful outcome of an appeal in revenue proceedings.
Professional services should not be offered or rendered under an arrangement whereby no fee will
be charged unless a specified finding or result is obtained or where the fee is otherwise contingent
upon the findings or results of such services. However, fees should not be regarded as being
contingent if fixed by a court or other public authority.
The Council of the Institute has however framed Regulation 192 which exempts members from the
operation of this clause in certain professional services. The said Regulation 192 is reproduced -
192. Restriction on fees - No Chartered Accountant in practice shall charge or offer to charge,
accept or offer to accept, in respect of any professional work, fees which are based on a percentage
of profits, or which are contingent upon the findings or results of such work, provided that:
(a) “In the case of a receiver or a liquidator, the fees may be based on a percentage of the
realization or disbursement of the assets;
(b) In the case of an auditor of a co-operative society, the fees may be based on a percentage
of the paid up capital or the working capital or the gross or net income or profits;
(c) In the case of a valuer for the purposes of direct taxes and duties, the fees may be based on
a percentage of the value of property valued;
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.77
(d) in the case of certain management consultancy services as may be decided by the resolution
of the Council from time to time, the fees may be based on percentage basis which may be
contingent upon the findings, or results of such work;
(e) in the case of certain fund raising services, the fees may be based on a percentage of the
fund raised;
(f) in the case of debt recovery services, the fees may be based on a percentage of the debt
recovered;
(g) in the case of services related to cost optimisation, the fees may be based on a percentage
of the benefit derived; and
(h) any other service or audit as may be decided by the Council. [Following activities have
been decided by the Council under “h” above :-(i) Acting as Insolvency Professional;(ii) Non-
Assurance Services to Non-Audit Clients]
Illustration 19
Mr. P a practicing chartered accountant acting as liquidator of AB & Co. charged his professional
fees on percentage of the realization of assets.
Restriction on fees based on a Percentage: According to Clause (10) of Part I of First Schedule
to the Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to
be guilty of professional misconduct if he charges or offers to charge, accepts or offers to accept
in respect of any professional employment fees which are based on a percentage of profits or
which are contingent upon the findings, or results of such employment, except as permitted under
any regulations made under this Act.
However, CA Regulation allow the Chartered Accountant in practice to charge the fees in respect
of any professional work which are based on a percentage of profits, or which are contingent
upon the findings or results of such work, in the case of a receiver or a liquidator, and the fees
may be based on a percentage of the realization or disbursement of the assets.
In the given case, Mr. P, a practicing Chartered Accountant, has acted as liquidator of AB & Co.
and charged his professional fees on percentage of the realisation of assets.
Conclusion: Therefore, Mr. P shall not be held guilty of professional misconduct as he is allowed
to charge fees on percentage of the realisation of assets being a liquidator.
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19.78 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Clause (11) Engages in any business or occupation other than the profession of chartered
accountant unless permitted by the Council so to engage.
Provided that nothing contained herein shall disentitle a chartered accountant from being a
director of a company (Not being managing director or a whole time director) unless he or
any of his partners is interested in such company as an auditor.
This is a provision introduced to restrain a member in practice from engaging himself in any business
or occupation other than that of chartered accountant except when permitted by the Council to be
so engaged. The objective is to restrain members from carrying on any other business in conjunction
with the profession of accountancy and combining such work with any business, which is not in
keeping with the dignity of the profession. Another reason for the introduction of such prohibition is
that a chartered accountant, if permitted to enter into all kinds of business, would be able to advertise
for his other business and thereby secure an unfair advantage in his professional practice.
The Council, on a very careful consideration of the matter, has formulated Regulation, 190A and
191 which are reproduced below, specifying the activities with which a member in practice can
associate himself with or without the permission of the Council.
190A. Chartered Accountant in practice not to engage in any other business or
occupation.
“A chartered accountant in practice not to engage in any other business or occupation other than
the profession of accountancy except with the permission granted in accordance with a resolution
of the Council”.
191. Part-time employment a Chartered Accountant in practice may accept.
“Notwithstanding anything contained in Regulation 190A but subject to the control of the Council,
a Chartered Accountant in practice may act as a liquidator, trustee, executor, administrator,
arbitrator, receiver, adviser or representative for costing, financial or taxation matter, or may take
up an appointment that may be made by the Central Government or a State Government or a
court of law or any other legal authority or may act as a Secretary in his professional capacity,
provided his employment is not on a salary-cum-full-time basis”.
Appendix 9 C.A. Regulations, 1988
The General and specific Resolutions passed by the Council under the power vested in it under
Regulation 190A as included in Appendix 9 of C.A. Regulations, 1988 are also reproduced below for
information.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.79
General Resolution
Permission granted generally - Members of the Institute in practice be generally permitted to
engage in the following categories of occupations, for which no specific permission from the Council
would be necessary in individual cases:
(1) Employment under Chartered Accountants in practice or firms of such chartered accountants.
(2) Private tutorship.
(3) Authorship of books and articles.
(4) Holding of Life Insurance Agency License for the limited purpose of getting renewal
commission.
(5) Attending classes and appearing for any examination.
(6) Holding of public elective offices such as M.P., M.L.A. and M.L.C.
(7) Honorary office leadership of charitable-educational or other non-commercial organisations.
(8) Acting as Notary Public, Justice of the Peace, Special Executive Magistrate and the like.
(9) Part-time tutorship under the coaching organisation of the Institute.
(10) Valuation of papers, acting as paper-setter, head-examiner or a moderator, for any
examination.
(11) Editorship of professional journals.
(12) Acting as Surveyor and Loss Assessor under the Insurance Act, 1938 provided they are
otherwise eligible.
(13) Acting as recovery consultant in the banking sector
(14) Owning agricultural land and carrying out agricultural activity (w.e.f. August 9 th, 2008).
Specific Resolution - Members of the Institute in practice may engage in the following categories
of business or occupations, after obtaining the specific and prior approval of the Council in each
case:
(1) Full-time or part-time employment in business concerns provided that the member and/or his
relatives do not hold “substantial interest” in such concerns.
(2) Full-time or part-time employment in non-business concern.
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19.80 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(3) Office of managing director or a whole-time director of a body corporate within the meaning
of the Companies Act, 1956 (now Companies Act, 2013) provided that the member and/or
any of his relatives do not hold substantial interest in such concern.
(4) Interest in family business concerns (including such interest devolving on the members as a
result of inheritance / succession / partition of the family business) or concerns in which
interest has been acquired as a result of relationships and in the management of which no
active part is taken.
(5) Interest in an educational institution.
(6) Part-time or full-time lectureship for courses other than those relating to the Institute’s
examinations conducted under the auspices of the Institute or the Regional councils or their
branches.
(7) Part-time or full-time tutorship under any educational institution other than the coaching
organization of the Institute.
(8) Editorship of journals other than professional journals.
(9) Any other business or occupation for which the Executive Committee considers that
permission may be granted.
However, it is open to the Council to refuse permission in individual cases though covered under
any of the above categories. For the purpose of the above resolution:
(i) the expression “relative”, in relation to a member, means the husband, wife, brother or sister
or any lineal ascendant or descendant of that member;
(ii) a member shall be deemed to have a “substantial interest” in a concern -
(i) in a case where the concern is a Company, if its shares (not being shares entitled to
a fixed rate of dividend whether with or without a further right to participate in profits)
carrying not less than twenty per cent of voting power at any time, during the relevant
years are owned beneficially by such member or by any one or more of the following
persons or partly by such member and partly by one or more of the following persons:
(a) One or more relatives of the member;
(b) Any concerns in which any of the persons referred to above has a substantial
interest;
(ii) in the case of any other concern, if such member is entitled or the other persons
referred to above or such member and one or more of the other persons referred to
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above are entitled in the aggregate, at any time during the relevant years to not less
than twenty percent of the profits of such concern.
Attention of the members is also invited to para 3 of the above Resolution relating to the holding of
office of a managing director or a whole-time director in a company. In such cases, a member can
accept the office of a managing director or a whole- time director only after obtaining, the specific
and prior approval of the Council. Attention of the members is also invited to the provisions of Section
2(26) of the Companies Act, 1956 (now Section 2(54) of the Companies Act, 2013) under which
even where a person is not designated as a managing director or a whole-time director, he can be
deemed to be a managing director or a whole-time director if he is entrusted with the whole or
substantially the whole of the management of the affairs of the company. It may be pointed out that
a member cannot accept and hold the office of a managing director or a whole-time director in a
company if the member and/or his partners and relatives hold substantial interest in such a company.
The Council has considered the question of permitting members in practice to become a Director,
Managing Director, full time/Executive Director etc. and related issues and the following decisions
have been taken.
As regards the question of permitting member in practice to be a Director, Promoter/Promoter-
Director, Subscriber to the Memorandum and Articles of Association of any company including a
board managed company, it was decided that -
(a) Director of a Company
(i) The expression “Director Simplicitor” means an ordinary / simple Director who is not a
Managing Director or Whole time Director and is required only in the Board Meetings of the
company and not paid any remuneration except for attending such meetings.
(ii) A member in practice is permitted generally to be a Director Simplicitor in any Company
including a board-managed Company and as such he is not required to obtain any specific
permission of the Council in this behalf unless he or any of his partners is interested in such
Company as an auditor, irrespective of whether he and/or his relatives hold substantial
interest in that Company.
A question arises, whether the auditor of a Subsidiary Company can be a Director of its Holding
Company-
The Ethical Standard Board (ESB) noted that, in terms of Clause (11) of Part I of the First Schedule
to the Chartered Accountants Act, 1949 a Chartered Accountant in practice cannot engage (unless
permitted by the Council so to engage) in any business or occupation other that the profession of
Chartered Accountant but he can be a director of a Company (not being a managing director or
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19.82 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
whole-time director) wherein he or any of his partners is not interested in such company as an
auditor. The Board further noted that Public conscience is expected to be ahead of the law.
Members, therefore, are expected to interpret the requirement as regards independence much more
strictly than what the law requires and should not place themselves in positions which would either
compromise or jeopardise their independence. In view of the above, the Board, via a clarification,
decided that the auditor of a Subsidiary Company can’t be a Director of its Holding Company, as it
will affect the independence of an auditor.
(b) Promoter/Promoter Director - There is no bar for a member to be a promoter / signatory to
the Memorandum and Articles of Association of any company. There is also no bar for such a
promoter / signatory to be a Director Simplicitor of that company irrespective of whether the object
of the company include areas which fall within the scope of the profession of Chartered Accountants.
Therefore, members are not required to obtain specific permission of the Council in such cases. It
must be clarified that under Section 25 of the Chartered Accountants Act, no Company can practise
as a Chartered Accountant.
(c) Member in practice in a HUF doing business - “A member of the Institute can acquire
interest in family business in any of the following manner:
(i) as a proprietary firm
(ii) as a partnership firm
(iii) in the name and style of Hindu Undivided Family as its Karta or a member.
It would be necessary for the members to provide evidence that interest in the family business
concern devolved on him as a result of inheritance/succession/partition of the family business. It is
also necessary for the member to show that he was not actively engaged in carrying on the said
business and that the family business concern in question was not created by himself.
To establish his case, the member should furnish a declaration in the prescribed format and the
documents evidencing above for consideration to the concerned Decentralized Office.”
A member in practice engaged as Karta of a HUF doing family business, will be within the limit
prescribed by Council if he makes investments from the funds pertaining to HUF only, provided, he
is not actively engaged in the management of the said business.
Students may also note that as per decision taken by appropriate authority in Council, Regulation
190A of the Chartered Accountants Regulations, 1988 provides that a chartered accountant in
practice shall not engage in any business or occupation other than the profession of accountancy,
except with the permission granted in accordance with a resolution of the Council. The Council has
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passed a Resolution under Regulation 190A granting general permission (for private tutorship, and
part-time tutorship under Coaching organization of the Institute) and specific permission (for part-
time or full-time tutorship under any educational institution other than Coaching organization of the
Institute). Such general and specific permission granted is subject to the condition that the direct
teaching hours devoted to such activities taken together should not exceed 25 hours a week in order
to be able to undertake attest functions.
Illustration 20
A chartered accountant holding certificate of practice and having four articled clerks registered
under him accepts appointment as a full-time lecturer in a college. Also, he becomes a partner
with his brother in a business. Examine his conduct in the light of Chartered Accountants Act,
1949 and the regulations thereunder.
Specific Permission to be Obtained: Clause (11) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 debars a chartered accountant in practice from engaging in any business
or occupation other than the profession of chartered accountancy unless permitted by the Council
of the Institute so to engage. This clause, in effect, has empowered the Council of the Institute to
permit chartered accountants in practice to engage in any other business or occupation
considered fit and proper. Accordingly, the Council had formulated Regulations 190A and 191 to
the Chartered Accountants Regulations, 1988 to provide a basis for considering applications of
chartered accountants seeking permission to engage in other business or occupation. A member
can accept full- time lecturer-ship in a college only after obtaining the specific and prior approval
of the Council as also becoming a partner in a business with his brother would require specific
permission.
Conclusion: Thus, the chartered accountant is liable for professional misconduct since he failed
to obtain specific and prior approval of the Council in each case.
Illustration 21
Mr. A, a practicing Chartered Accountant, took over as the executive chairman of Software
Company on 1.4.2023. On 10.4.2023 he applied to the Council for permission.
Specific Permission to be Obtained: As per Clause (11) of Part I of First Schedule to the
Chartered Accountants Act, 1949, a Chartered Accountant in practice will be deemed to be guilty
of professional misconduct if he engages in any business or occupation other than the profession
of Chartered Accountant unless permitted by the Council so to engage.
In the instant case, Mr. A took over as the executive chairman on 01.04.2023 and applied for
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19.84 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
permission on 10.04.2023. On the basis of these facts, he was engaged in other occupation
between the period 01.04.2023 and 10.04.2023, without the permission of the Council.
Conclusion: Therefore, Mr. A is guilty of professional misconduct in terms of Clause (11) of Part
I of First Schedule to the Chartered Accountants Act, 1949.
Illustration 22
CA. Prabhu is a leading income tax practitioner and consultant for derivative products. He resides
in Mumbai near to the ABC commodity stock exchange and does trading in commodity derivatives.
Every day, he invests nearly 50% of his time to settle the commodity transactions. Is C.A. Prabhu
liable for professional misconduct?
Engaging into a Business: As per Clause (11) of Part I of First Schedule of Chartered
Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional
misconduct if he engages in any business or occupation other than the profession of Chartered
Accountant unless permitted by the Council so to engage.
However, the Council has granted general permission to the members to engage in certain
specific occupation. In respect of all other occupations specific permission of the Institute is
necessary.
In this case, CA. Prabhu is engaged in the occupation of trading in commodity derivatives which
is not covered under the general permission.
Conclusion: Hence, specific permission of the Institute has to be obtained otherwise he will be
deemed to be guilty of professional misconduct under Clause (11) of Part I of First Schedule of
Chartered Accountants Act, 1949.
Clause (12) Allows a person not being a member of the institute in practice 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 above clause prohibits a member from allowing another member who is not his partner to sign
any balance sheet, profit and loss account or financial statements on his behalf or on behalf of his
firm.
This clause is to be read in conjunction with Section 26 of the Chartered Accountants Act, 1949
which stipulates that ‘No person other than a member of the Institute shall sign any document on
behalf of a Chartered Accountant in practice or a firm of Chartered Accountants in his or its
professional capacity’.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.85
The term ‘financial statement’ for the purposes of this clause would cover an examination of the
accounts or of financial statements given under a statutory enactment or otherwise. A report,
however, may cover a wider range of documents but in the context in which it is used in this clause,
it would mean only a report arising out of a professional assignment undertaken by him or his firm
and submitted by him or his firm to the client(s) or where so required, to an outsider on behalf of
himself or on behalf of the firm. The subject matter of report should be the expression of a
professional opinion whether, financial or non-financial. The financial statements and the reports
referred to in this clause obviously means the financial statements and reports as ultimately finalized
and submitted to the outside authorities.
The Council has clarified that the power to sign routine documents on which a professional opinion
or authentication is not required to be expressed may be delegated in the following instances and
such delegation will not attract provisions of this clause:
(i) Issue of audit queries during the course of audit.
(ii) Asking for information or issue of questionnaire.
(iii) Letter forwarding draft observations/financial statements.
(iv) Initiating and stamping of vouchers and of schedules prepared for the purpose of audit.
(v) Acknowledging and carrying on routine correspondence with clients.
(vi) Issue of memorandum of cash verification and other physical verification or recording the
results thereof in the books of the clients.
(vii) Issuing acknowledgements for records produced.
(viii) Raising of bills and issuing acknowledgements for money receipts.
(ix) Attending to routine matters in tax practice, subject to provisions of Section 288 of Income
Tax Act.
(x) Any other matter incidental to the office administration and routine work involved in practice
of accountancy.
It is also clarified that where the authority to sign documents given above is delegated by a chartered
accountant or by a firm of chartered accountants the fact that the documents have not been signed
by a chartered accountant is not a defence to him or to the firm in an enquiry relating to professional
misconduct.
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However, the Council has decided that where a Chartered Accountant while signing a report or, a
financial statement or any other document is statutorily required to disclose his name, the member
should disclose his name while appending his signature on the report or document. Where there is
no such statutory requirement, the member may sign in the name of the firm. It may be noted that
the revised SA 700 mandates mentioning of Membership No. and Firm Registration No. Members’
attention is also drawn towards UDIN Guidelines of the Institute in 2018.
Illustration 23
S, a practicing chartered accountant gives power of attorney to an employee chartered accountant
to sign reports and financial statements on his behalf.
Power of Signing Reports and Financial Statements: Under Clause (12) of Part I of First
Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed
to be guilty of professional misconduct if he allows a person not being a member of the Institute
in practice 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.
This clause read in conjunction with Section 26 of the Chartered Accountants Act, 1949 stipulates that
no person other than the member of the institute shall sign any document on behalf of a Chartered
Accountant in practice or a firm of Chartered Accountants in his or its professional capacity.
The term ‘Financial Statement’ for this purpose would cover an examination of the accounts or
financial statements given under a statutory enactment or otherwise.
Further, Clause (1) of Part II of the Second Schedule to the Chartered Accountants Act, 1949
states that a member of the Institute, whether in practice or not, shall be deemed to be guilty of
professional misconduct, if he contravenes any of the provisions of this Act or the regulations
made there under or any guidelines issued by the Council.
Conclusion: Accordingly, S is guilty of professional misconduct under Clause (12) of Part I of
First Schedule and also under Clause (1) of Part II of Second Schedule for contravening
Section 26.
Illustration 24
CA. Smart, a practicing Chartered Accountant was on Europe tour between 15-9-23 and 25-9-23.
On 18-9-23 a message was received from one of his clients requesting for a stock certificate to
be produced to the bank on or before 20-9-23. Due to urgency, CA. Smart directed his assistant,
who is also a Chartered Accountant, to sign and issue the stock certificate after due verification,
on his behalf.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.87
Allowing a Member Not Being a Partner to Sign Certificate: As per Clause (12) of Part I of the
First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is
deemed to be guilty of professional misconduct “if he allows a person not being a member of the
Institute in practice 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”.
In this case, CA. Smart allowed his assistant who is not a partner but a member of the Institute of
Chartered Accountants of India to sign stock certificate on his behalf and thereby commits
misconduct.
Conclusion: Thus, CA. Smart is guilty of professional misconduct under Clause (12) of Part I of
First Schedule to the Chartered Accountants Act, 1949.
PART II - Professional misconduct in relation to members of the Institute in service
A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he being an employee of any company, firm or person-
Clause (1) pays or allows or agrees to pay directly or indirectly to any person any share in
the emoluments of the employment undertaken by him.
A member of the Institute in service is deemed to be guilty of professional misconduct, if he is an
employee of any company, firm or person and during that course whatever emoluments he
receives, if he either pays or allows to pay or agree to pay any part or share thereof whether
directly or indirectly. However, this clause dose not restricts such sharing or commitments among
relatives, dependents, friends etc., if there is no relationship in procuring or retaining the job and
payment is not a consideration for job procurement or retainership.
The clear verdict of this clause is that job must be procured and retained with own professional
capabilities and not by any financial deal impairing professional dignity.
Clause (2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, a
chartered accountant or broker engaged by such company, firm or person or agent or
customer of such company, firm or person by way of commission or gratification.
This clause restricts to accept or agrees to accept any part of fee, profits or gains from a lawyer,
a chartered accountant or broker engaged by such company, firm or person or agent or customer
of such company, firm or person by way of commission or gratification. The objective is that when
a member is in employment, he must maintain high level of ethics and should not accept any other
amount from anyone for which he is not entitled from employer under contractual agreement of
service.
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[Note: A member in the foregoing circumstances would be guilty of misconduct regardless
of the fact that he was in whole-time or part-time employment or that he was holding
Certificate of Practice along with his employment.]
Illustration 25
Mr. 'C', a Chartered Accountant holds a certificate of practice while in employment also,
recommends a particular lawyer to his employer in respect of a case. The lawyer, out of the
professional fee received from employer paid a particular sum as referral fee to Mr. 'C'.
Referral Fee from Lawyer: According to Clause (2) of Part II of First Schedule of the Chartered
Accountant Act, 1949, a member of the Institute(other than a member in practice) shall be guilty
of professional misconduct, if he being an employee of any company, firm or person accepts or
agrees to accept any part of fee, profits or gains from a lawyer, a chartered accountant or broker
engaged by such company, firm or person or agent or customer of such company, firm or person
by way of commission or gratification.
In the present case, Mr. C who beside holding a certificate of practice, is also an employee and
by referring a lawyer to the company in respect of a case, he receives a particular sum as referral
fee from the lawyer out of his professional fee.
Conclusion: Therefore, Mr. C is guilty of professional misconduct by virtue of Clause (2) of
Part II of First schedule.
PART III - Professional misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he -
Clause (1) not being a fellow of the Institute, acts as a fellow of the Institute.
Clause (2) does not supply the information called for, or does not comply with the
requirements asked for, by the Institute, Council or any of its Committees, Director
(Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the
Appellate Authority.
Clause (11) of Part I and Clauses (1) and (3) of Part III where a Chartered Accountant had not
disclosed to the Institute at any time about his engagement as a proprietor of a non-chartered
accountant’s firm while holding certificate of practice and had not furnished particulars of his
engagement as Director of a company despite various letters of the institute which remained
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.89
unreplied. Held that he was guilty under Clause (11) of Part I and Clauses (1) and (3) of Part III of
the First Schedule.
Where a Chartered Accountant had continued to train an articled clerk though his name was removed
from the membership of the Institute and he had failed to send any reply to the Institute asking him
to send his explanation as to how he was training as his articled clerk when he was not a member
of the Institute. Held that he was guilty under Clause (2) of Part III of the First Schedule.
Illustration 26
Mr. 'G', while applying for a certificate of practice, did not fill in the columns which solicit
information about his engagement in other occupation or business, while he was indeed engaged
in a business.
Disclosure of Information: As per Clause (2) of Part III of First Schedule to the Chartered
Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant, in practice or not,
does not supply the information called for, or does not comply with the requirements asked for,
by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline,
Disciplinary Committee, Quality Review Board or the Appellate Authority;
In the given case, Mr. “G”, a Chartered Accountant while applying for a certificate of practice, did
not fill in the columns which solicit information about his engagement in other occupation or
business, while he was indeed engaged in a business. Details of engagement in business need
to be disclosed while applying for the certificate of practice as it was the information called for in
the application, by the Institute.
Conclusion: Thus, Mr. G will be held guilty for professional misconduct under the Clause (2) of
Part III of First Schedule of the Chartered Accountants Act, 1949.
Illustration 27
Mr. X, a Chartered Accountant, employed as a paid Assistant with a Chartered Accountant firm,
leaves the services of the firm on 31st December, 2023. Despite many reminders from ICAI he
fails to reply regarding the date of leaving the services of the firm.
Failed to Supply Information Called For: As per Clause (2) of Part III of the First Schedule to
the Chartered Accountants Act, 1949, a member, whether in practice or not, will be deemed to be
guilty of professional misconduct if he does not supply the information called for, or does not
comply with the requirements asked for, by the Institute, Council or any of its Committees, Director
(Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the Appellate
authority.
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19.90 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Conclusion: Thus, in the given case, Mr. X has failed to reply to the letters of the Institute asking
him to confirm the date of leaving the service as a paid assistant. Therefore, he is held guilty of
professional misconduct as per Clause (2) of Part III of the First Schedule to the Chartered
Accountants Act, 1949.
Clause (3) while inviting professional work from another chartered accountant or while
responding to tenders or enquiries or while advertising through a write up, or anything as
provided for in items (6) and (7) of Part I of this Schedule, gives information knowing it to be
false.
Any member of the Institute, in the course of procurement of professional work from another
Chartered Accountant or from any other source provides or renders any information which he knows
to be false through any documents, or acts (like tenders, enquiries, response to advertisement, CV
type write ups etc.), he would be deemed guilty of professional misconduct under Clause (3), Part
III of First Schedule.
PART IV- Other misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other
misconduct, if he -
Clause (1) is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term not exceeding six months.
Clause (2) in the opinion of the Council, brings disrepute to the profession or the Institute as
a result of his action whether or not related to his professional work.
Illustration 28
YKS & Co., a proprietary firm of Chartered Accountants was appointed as a concurrent auditor of
a bank. YKS, the proprietor, used his influence to get a loan and thereafter failed to repay the
loan.
Disrepute to the Profession:This is a case which is covered under the expression in other
misconduct of the Chartered Accountants Act, 1949. As per Clause (2) of Part IV of First Schedule
to the Chartered Accountants Act, 1949, a member of the Institute, whether in practice or not,
shall be deemed to be guilty of other misconduct, if he, in the opinion of the Council, brings
disrepute to the profession or the Institute as a result of his action whether or not related to his
professional work. Here the Chartered Accountant is expected to maintain the highest standards
of integrity even in his personal affairs and any deviation from these standards calls for
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.91
disciplinary action.
In the present case, YKS & Co, being a concurrent auditor used his position to obtain the funds
and failed to repay the same to the bank. This brings disrepute to the profession of a Chartered
Accountant. This act of YKS & Co is not pardonable.
Conclusion: Therefore, YKS & Co will be held guilty of other misconduct under Clause (2) of Part
IV of First Schedule to the Chartered Accountants Act, 1949.
These Clauses (1) & (2) are self-explanatory and any of the member of the Institute is found
guilty by any civil or criminal court and prosecuted for an imprisonment in an offence
involving moral turpitude or his acts bring disrepute to the profession or the Institute,
irrespective of the fact whether such acts are related to profession or not, such member will
be deemed to be guilty of other misconduct in Part IV of First Schedule.
The important point to note is that if imprisonment tenure exceeds six months, this case will be
covered in the Clause of Part III of Second Schedule.
8.2 The Second Schedule
Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other
misconduct mentioned in the second schedule or in both the Schedule, he shall place the matter
before the Disciplinary Committee.
Part I - Professional Misconduct in relation to Chartered Accountants in Practice
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he-
Clause (1) Discloses Information acquired in the course of his professional engagement to
any person other than his client so engaging him without the consent of his client or
otherwise than as required by any law for the time being in force.
An accountant in public practice has access to a great deal of information of his client, which is of a
highly confidential character. It is important for the work of an accountant and for maintaining the
dignity and status of the profession that he should treat such information as having been provided
to him, only to facilitate the performance of his professional duties for which his services have been
engaged. To divulge such information would be a breach of professional confidence, which may give
rise to the most serious consequences, even to an action by the client for the loss suffered by him
through such a breach. The accountant’s duty not to disclose continues even after the completion
of his assignment.
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19.92 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
If disclosure is required as a part of performance of professional duty by a practicing member in
relation to a client, the fact that such performance is required by the client would itself amount to the
client consenting to such disclosure. Thus, a member in practice submitting information to, say,
exchange control authorities, while performing his professional duties cannot be considered to have
made disclosure without the aforesaid consent. But, in all cases, the request or the initiative that the
members does prefer the service, which would entail such disclosure, must come from the client in
relation to whose affairs the disclosure would be entailed.
If disclosure is required in other cases, it would be necessary to ensure that the consent of the client
is given by a person who is competent to accord such consent. Thus, in the case of a sole proprietary
concern, the consent may be given by the proprietor or his constituted attorney who is legally
empowered to give such consent. In the case of partnership firm, since in turn, every partner has
the authority to bind the firm by his acts, the consent may be given by any partner. In the case of a
company, by virtue of section 179 of the Companies Act, 2013, the Board of Directors is empowered
to do all that the company in a general meeting may do unless a resolution by the company in general
meeting is required by the Act or by the Memorandum or Articles of the company. Hence, the consent
may be sought from the Managing Director if the powers of the Board of Directors are delegated to
him comprehensively enough to include the power to give such consent, but if the powers of the
Board of Directors are not so delegated, the consent should be obtained by means of resolution of
the Board of Directors of the Company.
An auditor is not required to provide the client or other auditors of the same enterprise or its related
enterprise such as a parent or a subsidiary, access to his audit working papers. The main auditors
of an enterprise do not have right of access to the audit working papers of the branch auditors. In
the case of a company, the statutory auditor has to consider the report of the branch auditor and
has a right to seek clarifications and/or to visit the branch if he deems it necessary to do so for the
performance of the duties as auditor. An auditor can rely on the work of another auditor, without
having any right of access to the audit working papers of the other auditor. For this purpose, the
term ‘auditor’ includes ‘internal auditor’.
However, the auditor may, at his discretion, in cases considered appropriate by him, make portions
of or extracts from his working papers available to the client.
There is a difference between sharing of working papers and sharing of information. So far
as the information is concerned, he can provide the same to the client or to a Regulatory body
after obtaining the consent of the client.
It is not possible to set out all the circumstances under which disclosure of information may be
required by law. If under any legal compulsion and if it is not legally permissible to claim privilege
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under the Evidence Act, 1872 (Section 126), the disclosure made by a member of such information
may not be considered as misconduct. However, such matters involve niceties of law and expert
legal advice may be sought prior to such disclosure.
The only circumstance in which this duty of confidence may give rise to a difficulty is where the
accountant has reason to believe that the client has been guilty of some unlawful act or default. This
matter is of special significance in the case where the client is guilty of tax evasion.
Further, students may note that 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 within 60 days of
his knowledge and after following the prescribed procedure.
Illustration 29
Mr. P, a Chartered Accountant was invited by the Chamber of Commerce to present a paper in
a symposium on the issues facing Indian Leather Industry. During the course of his presentation,
he shared some of the vital information of his client’s business under the impression that it will
help the Nation to compete with other countries at international level.
Disclosure of Client’s Information: Clause (1) of Part I of the Second Schedule to the
Chartered Accountants Act, 1949 deals with the professional misconduct relating to the
disclosure of information by a chartered accountant in practice relating to the business of his
clients to any person other than his client without the consent of his client or otherwise than as
required by any law for the time being in force would amount to breach of conduct. The Code of
Ethics further clarifies that such a duty continues even after completion of the assignment. The
Chartered Accountant may however, disclose the information in case it is required as a part of
performance of his professional duties. In the given case, Mr. Ph has disclosed vital information
of his client’s business without the consent of the client under the impression that it will help the
nation to compete with other countries at International level.
Conclusion: Thus, it is a professional misconduct covered by Clause (1) of Part I of Second
Schedule to the Chartered Accountants Act, 1949.
Clause (2) Certifies or submits in his name or in the name of his firm, a report of an
examination of financial statements unless the examination of such statements and the
related records has been made by him or by a partner or an employee in his firm or by another
chartered accountant in practice.
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The above clause restrains a member from subscribing to the report on a financial statement so long
as it has not been examined by him or by a partner or an employee of his firm or by another chartered
accountant in practice. It has been introduced to ensure that the work entrusted to him has been
carried out by the member either directly or under his supervision before he renders his report.
An exception however has been made in respect of an examination carried out by another chartered
accountant in practice. This enables two or more members to accept a joint assignment or enables
a member also to carry out the examination of financial statements by or with the assistance of all
or either any chartered accountant in practice.
Where the joint auditors are appointed, the work is normally divided among themselves in terms of
identifiable units or areas, or with reference to the items of liabilities, or income or expenditure or to
the period of time etc. Such division should be adequately documented and communicated to the
auditee.
In the course of his work, where a joint auditor comes across matters requiring discussion with or
application of judgement by the joint auditors, he must communicate to the other joint auditors before
submission of the report.
In respect of audit work divided among the joint auditors, each joint auditor is responsible only for
the work allocated to him, whether or not he has prepared a separate report on the work performed
by him. On the other hand, all the joint auditors are jointly and severally responsible in accordance
with SA 299 “Joint Audit of Financial Statements”:
Each joint auditor should decide for himself the appropriateness of using test checks or sampling,
the nature, timing and extent of audit procedures to be applied in relation to the work allotted to him.
Obtaining and evaluating the information and explanations from the management is the joint
responsibility of the joint auditors unless they agree upon a specific pattern of distribution of this
responsibility. In case of distribution of the responsibility, the liability of the joint auditors is limited
to the area allotted to that auditor.
Clause (3) Permits his name or the name of his firm to be used in connection with an estimate
of earnings contingent upon future transactions in manner which may lead to the belief that
he vouches for the accuracy of the forecast.
As per the opinion of the Council while finalising the Guidance Note on Accountant’s Report on Profit
Forecasts and/or Financial Forecasts at its 100th meeting held on 22 nd through 24th July 1982, a
chartered accountant can participate in the preparation of profit or financial forecasts and can review
them, provided he indicates clearly in his report the sources of information, the basis of forecasts
and also the major assumptions made in arriving at the forecasts and so long as he does not vouch
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for the accuracy of the forecasts. The Council has further opined that the same opinion would also
apply to projections made on the basis of hypothetical assumptions about future events and
management actions which are not necessarily expected to take place so long as the auditor does
not vouch for the accuracy of the projection.
Further, the attention of the members is drawn to “Guidance Note on Reports in Company
Prospectuses (Revised 2019)” issued by the Council in January 2019. This Guidance Note
provides guidance on compliance with the provisions of the Companies Act, 2013 and the Securities
and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations
2018 relating to the reports required to be issued by chartered accountants in prospectus issued by
the companies for the offerings made in India.
A Chartered Accountant issued 97 Projection Statements for certain Individuals without verifying the
basic documents and on the basis of which the Bank had extended the loan amount. Afterwards, the
Bank revealed that persons for whom the Respondent had issued Financial Statements did not have
any business/source for repayment of loan. Accordingly, Chartered Accountant will be held, guilty of
professional misconduct falling within the meaning of Clauses (3), (7) and (8) of Part I of the Second
Schedule to the Chartered Accountants Act, 1949.
Clause (4) Expresses his opinion on financial statements of any business or enterprise in
which he, his firm, or a partner in his firm has a substantial interest.
(i) If the opinions of auditors are to command respect and the confidence of the public, it is
essential that it must be free of any interest which is likely to affect their independence. Since
financial interest in the business can be a substantial interest and one of the important factors
which may disturb independence, the existence of such an interest direct or indirect affects
the opinion of the auditors. As per this clause, an auditor should not express his opinion on
financial statements of any business or enterprise wherein he has a substantial interest. This
is intended to assure the public as regards the faith and confidences that could be reposed
on the independent opinion expressed by the auditors.
(ii) For the purpose of this Clause, the expression “Substantial Interest” shall have meaning as
is assigned thereto, under Appendix (9) of the Chartered Accountants Regulations, 1988.
(see Clause 11 of Part I of First Schedule).
(iii) The words “financial statements” used in this clause would cover both reports and certificates
usually given after an examination of the accounts or the financial statement or any attest
function under any statutory enactment or for purposes of income-tax assessments. This
would not, however, apply to cases where such statements are prepared by members in
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19.96 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
employment purely for the information of their respective employers in the normal course of
their duties and not meant to be submitted to any outside authority.
(iv) Public conscience is expected to be ahead of the law. Members, therefore, are expected to
interpret the requirement as regards independence much more strictly than what the law
requires and should not place themselves in positions which would either compromise or
jeopardise their independence.
(v) Member must take care to see that they do not land themselves in situations where there
could be conflict of interest and duty.
6. For example, where a Chartered Accountant is appointed the Liquidator of a
Company, he should not qua a Chartered Accountant himself, audit the
Statement of Accounts to be filed under Section 348(1) of the Companies Act,
2013. The audit in such circumstances should be done by a Chartered Accountant other
than the one who is the Liquidator of the Company.
(vi) In this connection, the Council has decided not to permit a Chartered Accountant in
employment to certify the financial statements of the concern in which he is employed, or of
a concern under the same management as the concern in which he is employed, even though
he holds certificate of practice and that such certification can be done by any Chartered
Accountant in practice. This restriction would not however apply where the certification is
permitted by any law. The Council has also decided that a Chartered Accountant should not
by himself or in his firm name:-
a. accept the Auditorship of a college, if he is working as a part-time lecturer in the
college.
b. accept the Auditorship of a Trust where his partner is either an employee or a trustee
of the Trust.
The Council has, in this connection, issued the following guidelines:
Requirements of Clause applicable to all Attest Functions
(vii) Many new areas of professional work have been added, e.g., Tax Audit, GST Audit,
Concurrent Audit of Banks, Concurrent Audit of Borrowers of Financial institutions, Audit of
non-corporate borrowers of Banks and Financial Institutions, Audit of Stock Exchange,
Brokers, etc. The Council wishes to emphasize that the aforesaid requirement of Clause (4)
are equally applicable while performing all types of attest functions by the members.
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(viii) Some of the situations which may arise in the applicability of Clause (4) read with the
definition of “Substantial Interest” (see Clause 11 of Part I of First Schedule).and other
statutory prohibitions are discussed below for the guidance of members:-
1. Where the member, his firm or his partner or his relative has substantial interest in the
business or enterprise (not being a company).
The independence of mind is a fundamental concept of audit and/or expression of
opinion on the financial statements in any form and, therefore, must always be
maintained. Nothing can substitute for the essential and fundamental requirements of
independence. Therefore, the Council’s views are clarified in the following
circumstances.
(a) An enterprise/concern of which a member is either an owner or a partner
The holding of interest in the business or enterprise (not being a company) by
a member himself whether as sole-proprietor or partner in a firm, in the opinion
of the Council, would affect his independence of mind in the performance of
professional duties in conducting the audit and/or expressing an opinion on
financial statements of such enterprise. Therefore, a member shall not audit
financial statements of such business or enterprise.
(b) Where the partner or relative of a member has substantial interest
The holding of substantial interest by the partner or relative of the member in
the business or enterprise (not being a company) of which the audit is to be
carried out and opinion is to be expressed on the financial statement, may also
affect the independence of mind of the member, in the opinion of Council, in
the performance of professional duties. Therefore, the member may, for the
same reasons as not to compromise his independence, desist from undertaking
the audit of financial statements of such business or enterprise.
2. Where the member or his partner or relative is a director or in the employment of an
Officer or an Employee of the Company.
(a) Where the member is holding a position in the Company as Director, officer or
employee
Section 141(3)(b) of the Companies Act, 2013 specifically prohibits a member
from auditing the accounts of a Company in which he is an officer or employee
of the Company, or in the employment of an officer or an employee of the
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19.98 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Company (irrespective of the question of substantial interest).
Moreover, in case the member who is Director Simplicitor (general permission)
in a Company, the Council has prohibited such member from auditing the
accounts of a Company, whether or not he holds substantial interest in the
Company.
In case the member seeks specific permission of the Council to be Whole Time
or Managing Director in a Company, he would, on grant of such permission, not
be entitled either to engage in attest functions (which includes audit), or to hold
substantial interest in the Company. Although the provisions of the aforesaid
section are not specifically applicable in the context of audits performed under
other statutes, e.g. Tax Audit, yet the underlying principle of independence of
mind is equally applicable in those situations also.
(b) Where the member is not holding a position in the Company, but holding any
security or interest
Section 141(3) (d)(i) of Companies Act, 2013 disqualifies a person from being
Auditor of a Company, if he holds any security or interest in the Company, or
its subsidiary, or holding or associate company or a subsidiary of such holding
Company.
(c) Where the partner of the member is an officer or employee of a company
Section 141(3)(c) of Companies Act, 2013 disqualifies a member from being
the auditor of a Company, where the partner of such member is an officer or
employee of the Company.
(d) Where the partner of the member is holding any security or interest in the
Company
Section 141(3) (d)(i) of Companies Act, 2013 bars a person from being auditor
of a Company, if his partner holds any security or interest in the Company, or
its subsidiary, or holding or associate company or a subsidiary of such holding
Company.
(e) Where the relative of the member is a director or is in the employment of the
Company as a director or key managerial person
Section 141 (3) (f) of Companies Act, 2013 bars a person from accepting audit
of a Company where the relative of the member is director or is in the
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employment of the Company as a director or key managerial person.
(f) Where the relative of the member is holding any security or interest in the
Company
Section 141(3)(d) (i) of Companies Act, 2013, read with Rule 10 of Companies
(Audit and Auditors) Rules, 2014 bars a person from being auditor of a
Company, if his relative holds security or interest in the Company, or its
subsidiary, or holding or associate company or a subsidiary of such holding
Company of face value exceeding Rupees One Lakh.
(ix) It is not permissible for a member to undertake the assignment of certification, wherein the
client is relative of the member. The "relative" for this purpose would refer to the definition
mentioned in Accounting Standard (AS)-18.
(x) An accountant is expected to be no less independent in the discharge of his duties as a tax
consultant or as a financial adviser than as auditor. In fact, it is necessary that he should bear
the same degree of integrity and independence of mind in all spheres of his work. Unless this
is done, the accounts of entities audited by Chartered Accountants or statements made by
them during the course of assessment proceedings would not be relied upon as correct by
the authorities.
(xi) Members not to write Books of Account for auditee clients: The Council has clarified that
the members are not permitted to write the books of account of their auditee clients.
(xii) Statutory auditor not to be the Internal Auditor simultaneously: An Auditor appointed by
an entity under the Companies Act or any other statute shall not be the Internal Auditor of the
same entity.
(xiii) Internal auditor not to be the Tax auditor simultaneously: An Internal Auditor of an
assessee, whether working with the organization or an independently practicing Chartered
Accountant irrespective of being an individual Chartered Accountant or a firm of Chartered
Accountants cannot be appointed as its Tax Auditor.
(xiv) Internal Auditor not to be the GST Auditor simultaneously: The Internal Auditor of an
entity cannot undertake GST Audit of the same entity.
(xv) Cooling off period after completion of tenure as Director: A member shall not accept the
assignment of audit of a Company for a period of two years from the date of completion of
his tenure as Director, or resignation as Director of the said Company.
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(xvi) Members to satisfy whether appointment is as per the statute: A member should satisfy
himself before accepting an appointment as an auditor of an entity that his appointment is in
accordance with the statute governing the entity. In case the entity is constituted under a trust
deed/instrument, the member should satisfy whether his appointment is valid according to
the instrument constituting the entity and rules and regulations made thereunder.
(xvii) In case the appointment is to be authorised by the regulatory authorities such as in the case
of co-operative societies, trusts etc. then the member must satisfy whether such regulatory
authorities have authorised the managing committee of the society/trust for appointment of
the auditors. In a case where any entity is being managed by a Managing Committee or Board
of Trustees or Board of Governors by whatever name called he should ensure that his
appointment is duly made by a resolution passed of such Managing Committee or Board of
Trustees or Board of Governors. Even in case of partnership or sole proprietary concerns,
the member must ensure that a letter of appointment/engagement is given by the firm/sole
proprietor before he accepts the appointment/ engagement.
(xviii) Section 288 of Income Tax Act, 1961 describe the disqualifications for the purpose of Tax
Audit.
Clause (5) fails to disclose a material fact known to him which is not disclosed in a financial
statement, but disclosure of which is necessary in making such financial statement where he
is concerned with that financial statement in a professional capacity.
It may be observed that this clause refers to failure to disclose a material fact, which is known to
him, in a financial statement reported on by the auditor. It is obvious, that before a member could
be held guilty of misconduct, materiality has to be established. The determination of materiality has
been provided in SA 320, “Materiality in Planning and Performing an Audit”.
It should be borne in mind that there may be cases where an item may not be material from the point
of view of the balance sheet, but may have material significance in relation to the profit and loss
account for that year and vice-versa. It is therefore essential that care should be taken to ensure
that the aspect of materiality should be judged in relation to both the balance sheet and the profit
and loss account.
The word “financial statements” used in this clause would cover both reports and certificate usually
given after an examination of the accounts or of financial statements under any statutory enactment,
or/for purposes of income tax assessments. This would not however, apply to cases where such
statements are prepared by members in employment purely for the information of their respective
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employers in the normal course of their duties and not meant to be submitted to any outside
authority.
Illustration 30
Mr. J, a Chartered Accountant during the course of audit of M/s XYZ Ltd. came to know that the
company has taken a loan of ` 10 lakhs from Employees Provident Fund. The said loan was not
reflected in the books of account. However, the auditor ignored this information in his report.
Failure to Disclose Material Facts: As per Clause (5) of Part I of Second Schedule to the
Chartered Accountants Act, 1949, a chartered Accountant in practice will be held liable for
misconduct if he fails to disclose a material fact known to him, which is not disclosed in the
financial statements but disclosure of which is necessary to make the financial statements not
misleading. In this case, Mr. J has come across information that a loan of ` 10 lakhs has been
taken by the company from Employees Provident Fund. This is contravention of Rules and the
said loan has not been reflected in the books of accounts. Further, this material fact has also to
be disclosed in the financial statements. The very fact that Mr. J has failed to disclose this fact in
his report, he is attracted by the provisions of professional misconduct under Clause (5.
Conclusion: Mr. J will be liable of professional misconduct under Clause (5) of Part I of Second
Schedule to the Chartered Accountants Act, 1949.
Clause (6) Fails to report a material misstatement known to him to appear in a financial
statement with which he is concerned in a professional capacity.
This clause refers to failure on the part of a member to point out in his report a material misstatement
appearing in a financial statement and he has knowledge of the same. Here also, it is obvious, that
before a member could be held guilty of misconduct, materiality has to be established and the
observations made under the preceding Clause (5), in this connection, will equally apply to this
clause.
Illustration 31
A practicing Chartered Accountant was appointed to represent a company before the tax
authorities. He submitted certain information and explanations to the authorities on behalf of his
clients, which were found to be false and misleading.
Submitting Information as Authorised Representative: As per Clause (5) of Part I of Second
Schedule to the Chartered Accountant Act, 1949, if a member in practice fails to disclose a
material fact known to him which is not disclosed in a financial statement, but disclosure of which
is necessary to make the financial statement not misleading, where he is concerned with that
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financial statement in a professional capacity, he will be held guilty under Clause (5). As per
Clause (6) of Part I of Second Schedule if he fails to report a material misstatement known to him
to appear in a financial statement with which he is concerned in a professional capacity, he will
be held guilty under Clause (6).
In given case, the Chartered Accountant had submitted the statements before the taxation
authorities. These statements are based on the data provided by the management of the
company. Although the statements prepared were based on incorrect facts and misleading, the
Chartered Accountant had only submitted them acting on the instructions of his client as his
authorized representative.
Conclusion: Hence the Chartered Accountant would not be held liable for professional
misconduct.
Clause (7) does not exercise due diligence, or is grossly negligent in the conduct of his
professional duties.
Though very simply worded, it is a vital clause which unusually gets attracted whenever it is
necessary to judge whether the accountant has honestly and reasonably discharged his duties. The
expression negligence covers a wide field and extends from the frontiers of fraud to collateral minor
negligence. The meaning and significance of this clause is well contained in the following passage
quoted from the Judgement of the Karnataka High Court in a disciplinary case which came before it
in 1977:
“It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution
which a reasonably competent, careful, and cautious auditor would use. What is reasonable skill,
care and caution must depend on the particular circumstances of each case. An auditor is not bound
to be a detective, or, as was said, to approach his work with suspicion or with a foregone conclusion
that there is something wrong. He is a watchdog but not a bloodhound. If there is anything calculated
to excite suspicion he should probe it to the bottom; but in the absence of anything of that kind he
is only bound to be reasonably cautious and careful.”
Professional misconduct is a term of fairly wide import but generally speaking, it implies fairly serious
cases of misconduct of gross negligence. Negligence per se would not amount to gross negligence
in the case of minor errors and lapses, which do not constitute professional misconduct and which,
therefore, don’t require a reference to the Disciplinary Committee, the Council would nevertheless
bring the matter to the attention of its members so that greater care may be taken in the future in
avoiding errors and lapses of a similar type.
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Illustration 32
CA C who conducted statutory audit of a Haryana daily ‘New Era’ certified the circulation figures
based on Management Information System Report (M.I.S Report) without examining the books of
Account.
Failed to exercise Due Diligence: According to Clause (7) of Part I of Second Schedule of
Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of
professional misconduct if he “does not exercise due diligence or is grossly negligent in the
conduct of his professional duties”.
In the instant case, CA C did not exercise due diligence and is grossly negligent in the conduct of
his professional duties since he certified the circulation figures without examining the books of
accounts.
To ascertain the number of paid copies verification of remittances from the agents, credit allowed
to the agents for unsold copies returned, examination of books of account is essential. Further
certification of circulation figures based on statistical information without cross verification with
financial records amounts to gross negligence and failure to exercise due diligence.
Conclusion: Hence, CA C is guilty of professional misconduct as per Clause (7) of Part I of
Second Schedule of Chartered Accountants Act, 1949.
Illustration 33
Mr. D, a practicing Chartered Accountant, did not complete his work relating to the audit of the
accounts of a company and had not submitted his audit report in due time to enable the company
to comply with the statutory requirements.
Not Exercising Due Diligence: According to Clause (7) of Part I of Second Schedule of
Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of
professional misconduct if he does not exercise due diligence or is grossly negligent in the
conduct of his professional duties.
It is a vital clause which unusually gets attracted whenever it is necessary to judge whether the
accountant has honestly and reasonably discharged his duties. The expression negligence covers
a wide field and extends from the frontiers of fraud to collateral minor negligence.
Where a Chartered Accountant had not completed his work relating to the audit of the accounts
a company and had not submitted his audit report in due time to enable the company to comply
with the statutory requirement in this regard. He was guilty of professional misconduct under
Clause (7).
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Since Mr. D has not completed his audit work in time and consequently could not submit audit
report in due time and consequently, company could not comply with the statutory requirements.
Conclusion: Therefore, the auditor is guilty of professional misconduct under Clause (7) of Part
I of the Second Schedule to the Chartered Accountants Act, 1949.
Clause (8): Fails to obtain sufficient information which is necessary for expression of an
opinion or its exceptions are sufficiently material to negate the expression of an opinion.
It is expected of a Chartered Accountant to express his opinion on the truth and fairness of
statements of accounts after examining their authenticity with reference to information and
explanations given to him. A Chartered Accountant must determine the extent of information, which,
should be obtained by him before he expresses an opinion on the financial statements submitted to
him for report.
The chartered accountant should not express an opinion before obtaining the required data and
information. The latter part of the clause enjoins that where due to inadequacy of information or data
the report has to be circumscribed to an extent that it would cease to be of any expression of a
categorical opinion, the auditor should clearly express his disclaimer in no uncertain terms.
7. For example, if the auditor has not seen any evidence of the existence and/or
valuation of the investment which constitute the only asset of a company, he should
not say that:
“Subject to the verification of the existence and value of the investments the balance sheet shows
a true and fair view etc.”
For manner of auditor’s reporting in such situations, reference may be made to SA 705(Revised),
“Modifications to the Opinion in the Independent Auditor’s Report”.
Where a Chartered Accountant issued a certificate of circulation of a periodical without going into
the most elementary details of how the circulation of a periodical was being maintained i.e. by not
looking into the financial records, bank statements or bank pass books, by not examining evidence
of actual payment of printers bills and by not caring to ascertain how many copies were sold and
paid for. Held he was guilty under Clause (8). [Registrar of Newspapers for India vs K. Rajinder
Singh (1971)]
“a certificate is a written confirmation of the accuracy of the facts stated therein and does not
involve any estimate or opinion.” A Chartered Accountant is required to clearly state his
limitations/assumptions in his certificates, while in the said matter, the Respondent in none of
the 12 certificates either mentioned his limitation or assumptions. Though, in his written
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statements he submitted that his job was not to verify the assets physically or verification of
original bills or whether promoters contribution have come in actually in the Bank account etc.
If his assignment did not include the same, he ought to have disclosed or mentioned in the
certificates that while issuing the certificate he had relied upon the following documents, so as
not to mislead the users of the said certificate(s). In the instant matter, the Respondent did not
disclose any assumptions/limitations whatsoever while issuing the certificates. Moreover, the
Respondent in none of the certificates issued by him had mentioned the basis/papers relied
upon by him. Consequently, the same misled the IDBI Bank in approving the loan based on
such certificates which did not mention the basis of issuance.
The Respondent while issuing the Certificates ought to have exercised diligence but he failed
to do so. Accordingly, the Committee is of the view that the Respondent was grossly negligent
in conduct of his professional duties and also failed to obtain sufficient information while issuing
the aforestated certificates. Thus, he was guilty under clause (7) and (8).
The Committee noted that since the transaction of land took place between the Shivdarshan Firm
i.e., a partnership firm and Siddheshwari Developers, the same should have been reflected in the
books of Shivdarshan Firm and not in the books of Shivdarshan Construction which was a proprietary
concern. The Respondent being the auditor of Shivdarshan Construction failed to report the said
discrepancy in his audit report. Since, the amount of loan was material and the Respondent failed
to submit any evidence based on which he had chosen not to qualify the appearance of housing
loan from Navsarjan Industrial Co. Op. Bank Ltd in the financial statements, hence, the Committee
is of the view that the Respondent is guilty of professional misconduct falling within the meaning of
Clauses (6), (7) and (8) of Part I of the Second Schedule to the Chartered Accountants Act, 1949
[Shri Mukesh M. Kelawala vs. CA. Sukhdev Manilal Soni (2013)]
Where the Respondent had failed to report on the Bank Account which was opened by the client in
the capacity as a proprietor which included lot of variations, i.e., Account Number was different and
the capacity in which Account was opened was also different. As a Professional, the Respondent
ought to have copies of Bank Account which could easily establish the fact that the Bank Account
was opened and operated proprietary name but he could not do that. Hence, it was observed that
the Respondent was not only negligent in his duties in respect of auditing of bank transactions but
also, failed to obtain sufficient information for expressing an opinion. The Respondent was held
guilty of professional misconduct falling within the meaning of Clauses (7) & (8) of Part I of the
Second Schedule to the Chartered Accountants Act 1949. [P. Arun vs. N. Raja Ganesh, (2014)]
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Illustration 34
Mr. A, a Chartered Accountant was the auditor of 'A Limited'. During the financial year
2022-23, the investment appeared in the Balance Sheet of the company of ` 12 lakh and was the
same amount as in the last year. Later on, it was found that the company's investments were only
` 25,000, but the value of investments was inflated for the purpose of obtaining higher amount of
Bank loan.
Grossly Negligent in Conduct of Duties: As per Part I of Second Schedule to the Chartered
Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of
professional misconduct, if he, certifies or submits in his name or in the name of his firm, a report
of an examination of financial statements unless the examination of such statements and the
related records has been made by him or by a partner or an employee in his firm or by another
chartered accountant in practice, under Clause (2); does not exercise due diligence, or is grossly
negligent in the conduct of his professional duties, under Clause (7); or fails to obtain sufficient
information which is necessary for expression of an opinion or its exceptions are sufficiently
material to negate the expression of an opinion, under Clause (8).
The primary duty of physical verification and valuation of investments is of the management.
However, the auditor’s duty is also to verify the physical existence and valuation of investments
placed, at least on the last day of the accounting year. The auditor should verify the documentary
evidence for the cost/value and physical existence of the investments at the end of the year. He
should not blindly rely upon the Management’s representation.
In the instant case, such non-verification happened for two years. It also appears that auditors
failed to confirm the value of investments from any proper source. In case auditor has simply
relied on the management’s representation, the auditor has failed to perform his duty.
Conclusion: Accordingly, Mr. A, will be held liable for professional misconduct under Clauses
(2), (7) and (8) of Part I of the Second Schedule to the Chartered Accountants Act, 1949.
Clause (9) Fails to invite attention to any material departure from the generally accepted
procedure of audit applicable to the circumstances.
This clause implies that the audit should be performed in accordance with “generally accepted
procedure of audit applicable to the circumstances” and if for any reason the auditor has not been
able to perform the audit in accordance with such procedure, his report should draw attention to the
material departures from such procedures. What constitutes “generally accepted audit procedure”
would depend upon the facts and circumstances of each case, but guidance is available in general
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terms from the various pronouncements of the Institute is issued by way of Engagement and Quality
Control Standards, Statements, General Clarifications, Guidance Notes Technical Guides, Practice
Manuals, Studies and Other Papers. (ref.)
Audit of Listed Companies: Pursuant to SEBI Notification, Statutory Audit of Listed Companies
under the Companies Act, 2013 shall be done by only those auditors who have subjected themselves
to the Peer Review process of the Institute, and hold a valid certificate issued by the Peer Review
Board of the ICAI.
FRN and Membership No.: The members are required to mention the Membership number and
Firm registration number to all reports issued pursuant to any attestation engagements, including
certificates, issued by them as proprietor of/ partner in the said firm.
Unique Document Identification Number (UDIN): The members may note that UDIN is mandatory
from 1st July, 2019 on all Corporate/ Non- Corporate Audit, Attest and Assurance Functions. Thus,
a member of the Institute in practice shall generate Unique Document Identification Number (UDIN)
for all kinds of the certification, GST and Tax Audit Reports and other Audit, Assurance and
Attestation functions undertaken/signed by him.
An auditor of a company is appointed by the shareholders to perform certain statutory functions and
duties and it is expected of him that he will in fact, perform these functions and duties. The failure to
perform a statutory duty in the manner required is not excused merely by giving a qualification or
reservation in auditor’s report.
8. For example, if an auditor fails to verify the cash balance in circumstances where
such verification was necessary, feasible and material, it is not sufficient for him
merely to state in his report that he did not verify the cash balance in circumstances
when giving any reservations or qualifications in the auditor’s report as required under this
clause, a member would be well advised to indicate clearly the reasons why he was unable to
perform the audit in accordance with generally accepted procedures and standards.
It is not possible to exhaustively deal with instances or accepted procedure of audit applicable to
special cases. Two instances of an audit requiring a special procedure are given below:
Certifying figures of circulation of Newspapers etc.: Very often members are required to certify
the figures of circulation of newspapers, magazines etc. by their clients on behalf of the Audit Bureau
of Circulations Ltd. Members are normally supplied by the ABC with the Rules and Regulations under
which the certification of circulation is to be carried out. Members are also asked to give their
acceptance in writing that they will observe the rules of procedure envisaged to report upon any
lapse of such special requirements, even of an insignificant nature.
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Verification on behalf of Banks: Similarly, in the case of verification on behalf of banks, the rules
or procedure for conducting such audit are different from the normal rules applicable to audits under
the Companies Act. Members are required to be very familiar with the special procedure required in
these matters and act accordingly.
Clause (10) fails to keep moneys of his client other than fees or remuneration or money meant
to be expended in a separate banking account or to use such moneys for purposes for which
they are intended within a reasonable time.
In the course of his engagement as a professional accountant, a member may be entrusted with
moneys belonging to his client. If he should receive such funds, it would be his duty to deposit them
in a separate banking account, and to utilize such funds only in accordance with the instructions of
the client or for the purposes intended by the client. In this connection the Council has considered
some practical difficulties of the members and the following suggestions have been made to remove
these difficulties:
(i) An advance received by a Chartered Accountant against services to be rendered does not
fall under Clause (10) of Part I of the Second Schedule.
(ii) Moneys received for expenses to be incurred, for example, payment of prescribed statutory
fees, purchase of stamp paper etc., which are intended to be spent within a reasonably short
time need not be put in a separate bank account. For this purpose, the expression;
“reasonably short time”, would depend upon the circumstances of each case.
(iii) Moneys received for expenses to be incurred which are not intended to be spent within a
reasonably short time as aforesaid, should be put in a separate bank account immediately.
(iv) Moneys received by a Chartered Accountant, in his capacity as trustee, executor liquidator,
etc. must be put in a separate bank account immediately.
Illustration 35
A charitable institution entrusted ` 10 lakhs with its auditors M/s R & Co., a Chartered Accountant
firm, to invest in a specified securities. The auditors deposited it in their Savings bank account
and no investment was made in the next three months.
Failure to Keep Money in Separate Bank Account: If a Chartered Accountant in practice fails
to keep moneys of his clients in a separate bank account or fails to use such moneys for purposes
for which they are intended then his action would amount to professional misconduct under Clause
(10) of Part I of Second Schedule to the Chartered Accountants Act, 1949. In the course of his
engagement as a professional accountant, a member may be entrusted with moneys belonging
to his client. If he should receive such funds, it would be his duty to deposit them in a separate
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banking account, and to utilise such funds only in accordance with the instructions of the client or
for the purposes intended by the client.
Conclusion: In the given case by depositing the client’s money by M/s R & Co., a firm of Chartered
Accountants, in their own savings bank account, the auditors have committed a professional
misconduct. Hence in the given case, M/s R & Co. will be held guilty of professional misconduct.
PART II - Professional misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he -
Clause (1) contravenes any of the provisions of this Act or the regulations made there under
or any guidelines issued by the Council.
This clause is very important. It requires every member of the Institute to act within the framework
of the Chartered Accountants Act and the Regulations and Guidelines made by Council thereunder.
Any violation either of these Guidelines or the Act or the Regulations by a member would amount to
misconduct under this part.
The Regulations under which cases of contravention have generally come to the notice of the
Council are the following:
Regulation 43 Engagement of Articled Assistant
Regulation 46 Registration of Articled Assistant
Regulation 47 Premium from Articled Assistant
Regulation 48 Stipend to Articled Assistant
Regulation 56 Termination or assignment of Articles
Regulation 65 Articled Assistant not to engage in any other occupation
Regulation 67 Complaint against the employer (from Articled Assistant)
Regulation 68 to 80 Audit Assistant
Regulation 190 Register of offices and firms
Regulation 190-A Chartered Accountants not to engage in any other business or occupation
Regulation 191 Part time employment's a Chartered Accountant may accept
Regulation 192 Restriction on fees
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Clause (2) being an employee of any company, firm or person, discloses confidential
information acquired in the course of his employment except as and when required by any
law for the time being in force or except as permitted by the employer.
This is an adaptation of the well-accepted principle of the law of agency. A member in the
forthcoming circumstance would be guilty of misconduct regardless of the fact that he was in whole
time or part-time employment or that he was carrying on practice of accountancy along with his
employment. Since as employee, a member may have access to a confidential information, hence
for maintaining the status and dignity of the profession in general, he should treat such information
as having been provided to him only to facilitate the performance of his duties as an employee. In
order to keep the confidence of the people, Chartered Accountants, should take special care not to
divulge such information.
Clause (3) Includes in any information, statement, return or form to be submitted to the
Institute, Council or any of its Committees, Director (Discipline), Board of Discipline.
Disciplinary Committee, Quality Review Board or the Appellate Authority any particulars
knowing them to be false.
If a Chartered Accountant includes in any information, statement, return or form to be submitted to
the Institute Council etc. any particular knowing it to be false, he will be held guilty of misconduct.
Where a Chartered Accountant who was employed as a manager of a firm of Registered
Accountants, applied for admission as Fellow of the Institute stating that he was a partner, while he
was not. Held that the Chartered Accountant was guilty of misconduct as he had made the statement
that he was a partner knowing it to be false. [J.R. Chatrath, (1952)]
A Member had during the course of the hearing before Disciplinary Committee given a wrong
statement duly verified and also a statement on oath knowing it to be false. He was found guilty in
terms of this clause. [K.S. Dugar, (1987)]
In spite of repeated reminders a Chartered Accountant failed to reply to the letters of the Institute
asking him to confirm the date of leaving the services by the Paid Assistant. Held, the Chartered
Accountant was guilty of professional misconduct under the Clause. [A. Umanath Rao, [1965)]
Clause (4) Defalcates or embezzles money received in his professional capacity.
Defalcation and embezzlement of moneys received in professional capacity amounts to fraud
(Covered in SA-240) and such member will be deemed to be guilty of professional misconduct under
this clause.
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Part III - Other misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other
misconduct, if he is held guilty by any civil or criminal court for an offence which is
punishable with imprisonment for a term exceeding six months.
Imprisonment awarded for a term exceeding six months in any civil/criminal matter treated as a major
offence under ‘other misconduct’ is included in this Schedule.
9 COUNCIL GUIDELINES
The relevant extracts of the Council General Guidelines, 2008 (issued under Clause (1) of
Part-II of Second Schedule to The Chartered Accountants Act, 1949) are given below:
Chapter I
Preliminary
1.0 Short title, commencement, etc.
(a) These Guidelines have been issued by the Council of the Institute of Chartered
Accountants of India under the provisions of The Chartered Accountants Act, 1949, as
amended by The Chartered Accountants (Amendment) Act 2006, These Guidelines
be called the ‘Council General Guidelines, 2008’.
(b) These guidelines shall be applicable to all the Members of the Institute whether in
practice or not wherever the context so requires.
Chapter II
Conduct of a Member being an employee
A member of the Institute who is an employee shall exercise due diligence and shall not be grossly
negligent in the conduct of his duties.
Chapter III
Appointment of a Member as Cost auditor
This Chapter is being omitted.
Chapter IV
Opinion on financial statements when there is substantial interest
This Chapter is being omitted.
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Chapter V
Maintenance of books of account
A member of the Institute in practice or the firm of Chartered Accountants of which he is a partner,
shall maintain and keep in respect of his / its professional practice, proper books of account including
the following-
(i) a Cash Book;
(ii) a Ledger.
Illustration 36
L, a chartered accountant did not maintain books of account for his professional earnings on the
ground that his income is less than the limits prescribed u/s 44AA of the Income Tax Act, 1961.
Maintenance of Books of Account: As per the Council General Guidelines 2008, under Chapter
5 on maintenance of books of accounts, it is specified that if a chartered accountant in practice
or the firm of Chartered Accountants of which he is a partner fails to maintain and keep in respect
of his/its professional practice, proper books of account including the Cash Book and Ledger, he
is deemed to be guilty of professional misconduct. Accordingly, it does not matter whether section
44AA of the Income Tax Act, 1961 applies or not.
Conclusion: Hence, Mr. L is guilty of professional misconduct.
Chapter VI
Tax Audit assignments under Section 44 AB of the Income-tax Act, 1961
A member of the Institute in practice shall not accept, in a financial year, more than the “specified
number of tax audit assignments” under Section 44AB of the Income-tax Act, 1961.
Provided that in the case of a firm of Chartered Accountants in practice, the “specified number of
tax audit assignments” shall be construed as the specified number of tax audit assignments for every
partner of the firm.
Provided further that where any partner of the firm is also a partner of any other firm or firms of
Chartered Accountants in practice, the number of tax audit assignments which may be taken for all
the firms together in relation to such partner shall not exceed the “specified number of tax audit
assignments” in the aggregate.
Provided further that where any partner of a firm of Chartered Accountants in practice accepts one
or more tax audit assignments in his individual capacity, the total number of such assignments which
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may be accepted by him shall not exceed the “specified number of tax audit assignments” in the
aggregate.
Provided also that the audits conducted under Section 44AD, 44ADA 1 and 44AE of the Income Tax
Act, 1961 shall not be taken into account for the purpose of reckoning the “specified number of tax
audit assignments”.
Explanation:
For the above purpose, “the specified number of tax audit assignments” means -
(a) in the case of a Chartered Accountant in practice or a proprietary firm of Chartered
Accountant, **60 tax audit assignments, in a financial year, whether in respect of corporate
or non-corporate assesses.
(b) in the case of firm of Chartered Accountants in practice, **60 tax audit assignments per
partner in the firm, in a financial year, whether in respect of corporate or non-corporate
assesses.
According to a clarification on Tax Audit Assignments by Committee on Ethical Standards
Board) of the Institute, if there are 10 partners in a firm of Chartered Accountants in
practice, then all the partners of the firm can collectively sign 600 tax audit reports. This
maximum limit of 600 tax audit assignments may be distributed between the partners in
any manner whatsoever. For instance, 1 partner can individually sign 600 tax audit reports
in case remaining 9 partners are not signing any tax audit report.
In computing the “specified number of tax audit assignments” each year’s audit would be taken as
a separate assignment.
In computing the “specified number of tax audit assignments”, 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.
The audit of the head office and branch offices of a concern shall be regarded as one tax audit
assignment.
1As inserted by the Council pursuant to decision at its 368th Meeting held on 10th to 12th Aug., 2017 (Section
44AF, earlier appearing, was repealed).
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The audit of one or more branches of the same concern by one Chartered Accountant in practice
shall be construed as only one tax audit assignment.
A Chartered Accountant being a part time practicing partner of a firm shall not be taken into account
for the purpose of reckoning the tax audit assignments of the firm.
A Chartered Accountant in practice shall maintain a record of the tax audit assignments accepted
by him in each assessment year in the format as may be prescribed by the Council.
The limit on number of tax audit assignments per partner in a CA Firm may be distributed between
the partners in any manner whatsoever. However, it should be in accordance with the 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.
Illustration 37
A member of the institute shall not accept in a year more than the specified number of tax audits
under section 44AB of the Income Tax Act.
Mr. G is a partner in M/s. XYZ & Co., a firm of Chartered Accountants with 6 partners.
During the assessment year 2022-23, Mr. G alone had signed 290 tax audit reports consisting
of both corporate and non-corporate assesses.
Ceiling limit for signing the Tax Audit Reports: As per Council General Guidelines 2008, a
member of the Institute in practice shall not accept, in a financial year, more than the “specified
number of tax audit assignments” under Section 44AB of the Income-tax Act, 1961. It is also
provided further that where any partner of a firm of Chartered Accountants in practice accepts
one or more tax audit assignments in his individual capacity, the total number of such
assignments which may be accepted by him shall not exceed the “specified number of tax audit
assignments” in the aggregate.
In the case of firm of Chartered Accountants in practice “the specified number of tax audit
assignments” means, 60 tax audit assignments per partner in the firm, in a financial year,
whether in respect of corporate or non-corporate assesses.
Further, as per clarification issued by the Institute on Tax Audit Assignments, tax audit reports
may be signed by the partners in any manner whosoever in accordance with specified audit
limits. Thus, one partner can individually sign all the tax audit reports subject to specified tax
audit assignment limits on behalf of all the partners in the firm of Chartered Accountants in
practice or all the partners of the firm can collectively sign the tax audit reports.
In the instant case, there are 6 partners in M/s XYZ & Co., a Chartered Accountants firm,
accordingly, specified ceiling limit for the firm will be (60 tax audit assignments per partner X 6
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partners) = 360. Therefore, all the 6 partners of the firm can collectively sign 360 tax audit
reports. This maximum limit of 360 tax audit assignments may be distributed between the
partners in any manner whatsoever. For instance, 1 partner can individually sign 360 tax audit
reports in case remaining 5 partners are not signing any tax audit report.
Assuming Mr. G has signed 290 tax audit reports consisting of both corporate and non-corporate
assesse on behalf of firm and remaining partners are signing audit reports within the specified
number of tax audit assignments u/s 44AB i.e. upto 70.
Conclusion: Hence, Mr. G shall not be deemed to guilty of professional misconduct provided
total number of tax audit reports on behalf of firm do not exceeds 360.
Chapter VII
Appointment of an Auditor in case of non-payment of undisputed fees
A member of the Institute in practice shall not accept the appointment as auditor of an entity in case
the undisputed audit fee of another Chartered Accountant for carrying out the statutory audit under
the Companies Act, 2013 or various other statutes has not been paid:
Provided that in the case of sick unit, the above prohibition of acceptance shall not apply.
Explanation 1: For this purpose, the provision for audit fee in accounts signed by both - the auditee
and the auditor along with other expenses, if any, incurred by the auditor in connection with
the audit, shall be considered as “undisputed audit fees”.
Explanation 2: For this purpose, “sick unit” shall mean a unit registered for not less than five years,
which has at the end of any financial year accumulated losses equal to or exceeding its entire net
worth.
Illustration 38
Mr. C accepted the statutory audit of M/s PSU Ltd., whose net worth is negative for the year
2021-22. The audit was to be conducted for the year 2022-23. The audited accounts for the year
2022-23 showed liability for payment of tax audit fees of ` 15,000 in favour of Mr. E, the previous
auditor.
Accepting Appointment as an Auditor: As per Chapter 7 of Council General Guidelines 2008,
a member of the Institute of Chartered Accountants of India in practice shall be deemed to be
guilty of professional misconduct if he accepts appointment as auditor of an entity in case the
undisputed audit fee of another chartered accountant for carrying out the statutory audit under
Companies Act or various other statutes has not been paid.
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As per the proviso, such prohibition shall not apply in case of a sick unit where a sick unit is
defined to mean “where the net worth is negative”.
Conclusion: In the instant case, though the undisputed fees are unpaid, Mr. C would still not
be guilty of professional misconduct since the M/s PSU Ltd. is a sick unit having negative net
worth for the year 2021-22.
Chapter VIII
Specified number of audit assignments
A member of the Institute in practice shall not hold at any time appointment of more than the
“specified number of audit assignments” of Companies under Section 141 of the Companies Act
2013.
Provided that in the case of a firm of Chartered Accountants in practice, the “specified number of
audit assignments” shall be construed as the specific number of audit assignments for every partner
of the firm.
Provided further 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.
Provided further where any partner of a firm or firms of Chartered Accountants in practice accepts
one or more audit of Companies in his individual capacity, or in the name of his proprietary firm, the
total number of such assignments 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.
Explanation:
1. For the above purpose, the “specified number of audit assignments” means –
(a) in the case of a Chartered Accountant in practice or a proprietary firm of Chartered
Accountant, 30 audit assignments whether in respect of private Companies or other
Companies, with the exception of one person Companies and dormant companies.
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(b) in the case of Chartered Accountants in practice, 30 audit assignments per partner in
the firm, whether in respect of private Companies or other Companies, with the
exception of One person Companies and dormant companies 2.
2. In computing the “specified number of audit assignments”-
(a) the number of audit of such Companies, 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 audit of the head office and branch offices of a Company by one Chartered
Accountant or firm of such Chartered Accountants in practice shall be regarded as one
audit assignment.
(c) the audit of one or more branches of the same Company by one Chartered Accountant
in practice or by firm of Chartered Accountants in practice in which he is a partner shall
be construed as one audit assignment only.
(d) the number of partners of a firm on the date of acceptance of audit assignment shall
be taken into account.
A Chartered Accountant in practice, whether in full-time or part time employment elsewhere, shall
not be counted for the purpose of determination of “specified number of audit of Companies” by firms
of Chartered Accountants.
A Chartered Accountant being a part time practicing partner of a firm shall not be taken into account
for the purpose of reckoning the audit assignments of the firm.
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 partners of the firm in his individual name or as a partner of any other firm, as far
as possible in the prescribed format.
Chapter IX
Appointment as Statutory auditor
A member of the Institute in practice shall not accept the appointment as statutory auditor of Public
Sector Undertaking(s)/ Government Company(ies)/Listed Company(ies) and other Public
Company(ies) having turnover of ` 50 crores or more in a year where he accepts any other work(s)
or assignment(s) or service(s) in regard to the same Undertaking(s)/ Company(ies) on a
2 As incorporated pursuant to decision of Council at its 388th Meeting held on 6th and 7th Feb., 2020.
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19.118 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
remuneration which in total exceeds the fee payable for carrying out the statutory audit of the same
Undertaking/company.
Provided that in case appointing authority(ies)/regulatory body(ies) specify(ies) more stringent
condition(s)/restriction(s), the same shall apply instead of the conditions/restrictions specified under
these Guidelines.
The above restrictions shall apply in respect of fees for other work(s) or service(s) or assignment(s)
payable to the statutory auditors and their associate concern(s) put together.
For the above purpose,
(i) the term “other work(s)” or “service(s)” or “assignment(s)” shall include Management
Consultancy and all other professional services permitted by the Council pursuant to Section
2(2)(iv) of the Chartered Accountants Act, 1949 but shall not include:-
(a) audit under any other statute;
(b) certification work required to be done by the statutory auditors; and
(c) any representation before an authority;
(ii) the term “associate concern” means any corporate body or partnership firm which renders
the Management Consultancy and all other professional services permitted by the Council
wherein the proprietor and/or partner(s) of the statutory auditor firm and/or their “relative(s)”
is/are Director/s or partner/s and/or jointly or severally hold “substantial interest” in the said
corporate body or partnership;
(iii) the terms “relative” and “substantial interest” shall have the same meaning as are assigned
thereto under Appendix (9) to the Chartered Accountants Regulations, 1988.
In regard to taking up other work(s) or service(s) or assignment(s) of the undertaking/company
referred to above, it shall be open to such associate concern or corporate body to render such
work(s) or service(s) or assignment(s) so long as aggregate remuneration for such other work(s) or
service(s) or assignment(s) payable to the statutory auditor/s together with fees payable to its
associate concern(s) or corporate body(ies) do/does not exceed the aggregate of fee payable for
carrying out the statutory audit.
Illustration 39
A is the auditor of Z Ltd., which has a turnover of ` 200 crore. The audit fee for the year is fixed
at ` 50 lakhs. During the year, the company offers A an assignment of management consultancy
within the meaning of Section 2(2)(iv) of the CA Act, 1949 for a remuneration of ` 1 crore. A
seeks your advice on accepting the assignment.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.119
Appointment as a Statutory Auditor of a PSUs’/Govt Company(ies)/Listed Company(ies)
and Other Public Company(ies): As per the Council General Guidelines 2008, under Chapter
IX on appointment as statutory auditor a member of the Institute in practice shall not accepts the
appointment as a statutory auditor of a PSUs’/Govt company(ies)/Listed company(ies) and other
public company(ies) having a turnover of ` 50 crores or more in a year and where he accepts
any other work(s) or assignment(s) or service(s) in regard to same undertaking(s) on a
remuneration which in total exceeds the fee payable for carrying out the statutory audit of the
same undertaking. For this purpose, the other work/services include Management Consultancy
and all other professional services permitted by Council excluding audit under any other statute,
Certification work required to be done by the statutory auditor and any representation before an
authority.
Conclusion: In view of the above position it would be a misconduct on A’s part if he accepts the
management consultancy assignment for a fee of ` 1 crore.
Chapter X
Appointment of an auditor when he is indebted to a concern
A member of the Institute in practice or a partner of a firm in practice or a firm or a relative of such
member or partner shall not accept appointment as auditor of a concern while indebted to the
concern or given any guarantee or provided any security in connection with the indebtedness of any
third person to the concern, for limits fixed in the statute and in other cases for amount exceeding
` 100,000/-.
Illustration 40
D, who conducts the tax audit u/s 44AB of the Income Tax Act, 1961 of M/s ABC, a partnership
firm, has received the audit fees of ` 2,50,000 on progressive basis in respect of the tax audit
for the year ended 31.3.2023. The audit report was, however, signed on 25.5.2023.
Entire Audit Fees Received in Advance: As per Chapter X of Council General Guidelines, 2008
a member of the Institute in practice or a partner of a firm in practice or a firm shall not accept
appointment as auditor of a concern while indebted to the concern or given any guarantee or
provided any security in connection with the indebtedness of any third person to the concern, for
limits fixed in the statute and in other cases for amount exceeding ` 1,00,000/-.
However, the Research Committee of the ICAI has expressed the opinion that where in
accordance with the terms of engagement of auditor by a client, the auditor recovers his fees on
a progressive basis as and when a part of the work is done without waiting for the completion of
the whole job, he cannot be said to be indebted to the company at any stage.
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19.120 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Conclusion: In the instant case, Mr. D is appointed to conduct a tax audit u/s 44AB of the Income
Tax Act, 1961. He has received the audit fees of ` 2,50,000 in respect of the tax audit for the
year ended 31.3.2023 which is on progressive basis. Therefore, Mr. D will not be held guilty for
misconduct.
Chapter XI
Directions in case of unjustified removal of auditors
A member of the Institute in practice shall follow the direction given, by the Council or an appropriate
Committee or on behalf of any of them, to him being the incoming auditor(s) not to accept the
appointment as auditor(s), in the case of unjustified removal of the earlier auditor(s).
Chapter XIII
Guidelines on Tenders
A member of the Institute in practice shall not respond to any tender issued by an organization or
user of professional services in areas of services which are exclusively reserved for chartered
accountants, such as audit and attestation services. However, such restriction shall not be applicable
where minimum fee of the assignment is prescribed in the tender document itself or where the areas
are open to other professionals along with the Chartered Accountants.
Chapter XIV
Unique Document Identification Number (UDIN) Guidelines
Whereas, to curb the malpractice of false certification/attestation by the unauthorized persons & to
eradicate the practice of bogus certificates and to save various regulators, banks, stakeholders etc.
from being misled, the Council of the Institute decided to implement an innovative concept to
generate Unique Document Identification Number (UDIN) mandatorily for all kinds of the
certificates/GST and Tax Audit Reports and other attest function in phased manner, for which
members of the ICAI were notified through the various announcements published on the website of
ICAI www.icai.org at the relevant times.
A member of the Institute in practice shall generate Unique Document Identification Number (UDIN)
for all kinds of the certification, GST and Tax Audit Reports and other Audit, Assurance and
Attestation functions undertaken/signed by him which made mandatory from the following dates
through announcements published on the website of the ICAI www.icai.org at the relevant time: -
• For all Certificates w.e.f. 1st February, 2019.
• For all GST and Tax Audit Reports w.e.f. 1st April, 2019.
• For all other Audit, Assurance and Attestation functions w.e.f. 1st July, 2019.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.121
Chapter XV
Guidelines for Networking
Concept: To enhance their ability to provide professional services, firms frequently form larger
structures with other firms and entities. Whether these larger structures create a network depends
on the particular facts and circumstances and does not depend on whether the firms and entities are
legally separate and distinct.
For example, a larger structure may be aimed only at facilitating the referral of work, which in itself
does not meet the criteria necessary to constitute a network. Alternatively, a larger structure might
be such that it is aimed at co-operation and the firms share a common brand name, a common
system of quality control, or significant professional resources and consequently is deemed to be a
network.
The judgment as to whether the larger structure is a network shall be made in light of whether a
reasonable and informed third party would be likely to conclude, weighing all the specific facts and
circumstances, that the entities are associated in such a way that a network exists. This judgment
shall be applied consistently throughout the network.
Where the larger structure is aimed at co-operation and it is clearly aimed at profit or cost sharing
among the entities within the structure, it is deemed to be a network. However, the sharing of
immaterial costs does not in itself create a network. In addition, if the sharing of costs is limited only
to those costs related to the development of audit methodologies, manuals, or training courses, this
would not in itself create a network. Further, an association between a firm and an otherwise
unrelated entity to jointly provide a service or develop a product does not in itself create a network.
Where the larger structure is aimed at cooperation and the entities within the structure share
common ownership, control or management, it is deemed to be a network. This could be achieved
by contract or other means.
Where the larger structure is aimed at co-operation and the entities within the structure share
common quality control policies and procedures, it is deemed to be a network. For this purpose,
common quality control policies and procedures are those designed, implemented and monitored
across the larger structure.
Where the larger structure is aimed at co-operation and the entities within the structure share a
common business strategy, it is deemed to be a network. Sharing a common business strategy
involves an agreement by the entities to achieve common strategic objectives. An entity is not
deemed to be a network firm merely because it co- operates with another entity solely to respond
jointly to a request for a proposal for the provision.
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Where the larger structure is aimed at co-operation and the entities within the structure share the
use of a common brand name, it is deemed to be a network. A common brand name includes
common initials or a common name. A firm is deemed to be using a common brand name if it
includes, for example, the common brand name as part of, or along with, its firm name, when a
partner of the firm signs an audit report.
Even though a firm does not belong to a network and does not use a common brand name as part
of its firm name, it may give the appearance that it belongs to a network if it makes reference in its
stationery or promotional materials to being a member of an association of firms. Accordingly, if care
is not taken in how a firm describes such memberships, a perception may be created that the firm
belongs to a network.
Where the larger structure is aimed at co-operation and the entities within the structure share a
significant part of professional resources, it is deemed to be a network. Professional resources
include:
• Common systems that enable firms to exchange information such as client data, billing and
time records;
• Partners and staff;
• Technical departments that consult on technical or industry specific issues, transactions or
events for assurance engagements;
• Audit methodology or audit manuals; and
• Training courses and facilities.
The determination of whether the professional resources shared are significant, and therefore the
firms are network firms, shall be made based on the relevant facts and circumstances. Where the
shared resources are limited to common audit methodology or audit manuals, with no exchange of
personnel or client or market information, it is unlikely that the shared resources would be significant.
The same applies to a common training endeavor. Where, however, the shared resources involve
the exchange of people or information, such as where staff are drawn from a shared pool, or a
common technical department is created within the larger structure to provide participating firms with
technical advice that the firms are required to follow, a reasonable and informed third party is more
likely to conclude that the shared resources are significant.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.123
Forms of the Network :
The different forms of Network can be as under:-
A network can be constituted as a mutual entity which will act as a facilitator for the
constituents of the Network. In such a case the Network itself will not carry out any
professional practice.
A network can be constituted as a partnership firm subject to the condition that the total
number of partners does not exceed twenty.
A network can be constituted as a Limited Liability Partnership subject to the provision
of the Chartered Accountant Act and Rules and such other laws as may be applicable.
A network can be constituted as company subject to the guidelines prescribed by
Institute for corporate form of practice and formation of management consultancy
services company.
Network Firms shall consist of sole Practitioner/proprietor, partnership or any such
entity of professional accountants as may be permitted by the Act.
A firm is allowed to join only one network.
Firms having common partners shall join only one Network.
Approval of Name of Network amongst firms registered with Institute:
1. The Network may have distinct name which should be approved by the Institute. To
distinguish a “Network” from a “firm” of Chartered Accountants, the words “& Affiliates” shall
be used after the name of the network and the words “& Co.” / “& Associates” shall not be
used. The prescribed format of application for approval of Name for Network is at Form ‘A’
(enclosed). The names of the network may be as mentioned in Appendix II.
2. Provisions of Regulation 190 of the Chartered Accountants Regulations, 1988 shall be
applicable to the name of Network. However, even if a name is approved and subsequently
it is found that the same is undesirable then, the said name may be withdrawn at any time by
the Institute. The Institute shall reject any undesirable name and the provisions in respect of
names of companies as prescribed in the Companies Act, 1956 shall be applicable in spirit.
3. The Institute shall approve or reject the name of the Network and intimate the same to the
Network at its address mentioned in Form ‘A’ within a period which shall not be later than 30
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19.124 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
days from the date of receipt of the said Form.
4. Mere approval of the name of the Network shall not entitle the Network to carry on practice
in its own name.
Registration of Network with entities in India
1. After the name of a Network is approved as per provision under Guideline 5, the
Institute same shall reserve such name for a period of three (3) months from the
date of approval.
2. The Network shall get itself registered with the Institute by applying in Form B
within the period of 3 months, failing which the name assigned shall stand
cancelled on the expiry of the said period.
3. Registration of Network with Institute is mandatory.
4. If different Indian firms are networked with a common Multinational Accounting
Firm, they shall be considered as a part of network.
Listing of Network with entities outside India
1. The duly authorized representative(s) of the Indian Member firm (s)/Member
constituting the Network with entities outside India shall file a declaration with the
Institute in Form `D’ for Listing of such Network within 30 days from the date of
entering into the Network arrangement.
2. Proprietary/individual members, partnership firms as well as members in LLP or
any such other entity of members as may be permitted by the Act, shall be
permitted to join such network with entities outside India provided that the
proprietary/individual members, partnership firms as well as members in LLP or
any such other entity of members are allowed to join only one network and firms
having common partners shall join only one such network.
Change in constitution of registered Network:
In case of change in the constitution of registered Network on account of any entry into or exit from
the Network, the network shall communicate the same to the Institute by filing Form ‘C’ within a
period of thirty (30) days from the date of change in the constitution.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.125
Ethical Compliance:
Once the relationship of network arises, it will be necessary for such a network to comply with
all applicable ethical requirements prescribed by the Institute from time to time in general and
the following requirements in particular: -
1. If one firm of the network is the statutory auditor of an entity then the associate [including
the networked firm(s)] or the said firm directly/indirectly shall not accept the internal audit
or book-keeping or such other professional assignments which are prohibited for the
statutory auditor firm.
2. The guidelines of ceiling on Non-audit fees is applicable in relation to a Network as
follows: -
i) For a Network firm who is doing statutory audit (including its associate concern
and/or firm(s) having common partnership), it shall be the same as mentioned in
the said notification; and
ii) For other firms of the same Network collectively, it shall be 3 times of the fee
payable for carrying out the statutory audit of the same undertaking/ company.
3. In those cases where rotation of firms is prescribed by any regulatory authority, no
member firm of the network can accept appointment as an auditor in place of any member
firm of the network which is retiring.
4. The Network may advertise the Network to the extent permitted by the Advertisement
Guidelines issued by Institute. The firms constituting the network are permitted to use the
words “Network Firms” on their professional stationery.
5. The constituent member firms of a Network and the Network shall comply with all the
Ethical Standards prescribed by the Council from time to time.
Consent of Client:
The effect of registration of network with Institute will be deemed to be a public notice of the network
and therefore consent of client will be deemed to be obtained.
Framework of Internal Byelaws of Network:
To streamline the networking, a network shall formulate operational bye-laws. Bye-laws may contain
the following clauses on which the affiliates of the network may enter into a written agreement among
themselves:
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19.126 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(i) Appointment of a Managing Committee, from among the managing partners of the member
firms of the network and the terms and conditions under which it should function. The
minimum and maximum number of members of the Managing Committee shall also be agreed
upon.
(ii) Administration of the network
(iii) Contribution of membership fees to meet the cost of the administration of the network.
(iv) Identifying a partner of any of the member firms of the network to be responsible for the
assignment (engagement partner)
(v) Dispute settlement procedures through arbitration and conciliation
(vi) Development of training materials for members of the network
(vii) Issue of News-letters for staff and clients
(viii) Development of software for different types of assignments
(ix) Development and maintenance of data bases relevant for different types of assignments
(x) Library
(xi) Appointment of a technical director to whom references can be made
(xii) Determining the methodology for drawing resources from each member firm
(xiii) Determining compensation to member firms for resources to be drawn from them
(xiv) Peer review of the member firms
These clauses are illustrative.
9. Illustrative examples of names of Network: -
(a) If the Network is a Mutual Entity or Partnership Firm:
AB & Affiliates
(b) If the Network is a LLP:
AB Affiliates LLP
(c) If the Network is a Limited Company:
AB Affiliates P. Ltd/Limited
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.127
Chapter XVI
Logo Guidelines
The logo consists of letter ‘CA’ with a tick mark inside a rounded rectangle with white background.
The letters CA have been put in blue, the corporate colour which not only stands out on the
background but also denotes creativity, innovativeness, knowledge, integrity, trust, truth, stability
and depth. The upside down tick mark typically used by Chartered Accountants, has been used to
symbolize the wisdom and value of the professional. The green colour in the tick mark signifies
growth, prosperity, harmony and freshness.
Members are encouraged to use the new logo, as published here as it is. Do not change the design
and colours, including the white background. Refrain from rotating or tilting the logo. The correct and
incorrect usage of the logo is explained as under:
Chapter XVII
Guidelines for Corporate Form of Practice
The Council decided to allow members in practice to hold the office of Managing Director, Whole-
time Director or Manager of a body corporate within the meaning of the Companies Act provided
that the body corporate is engaged exclusively in rendering Management Consultancy and Other
Services permitted by the Council in pursuant to Section 2(2)(iv) of the Chartered Accountants Act,
1949 and complies with the conditions(s) as specified by the Council from time to time in this regard.
The members can retain full time Certificate of Practice besides being the Managing Director, Whole-
time Director or Manager of such Management Consultancy Company. There will be no restriction
on the quantum of the equity holding of the members, either individually and/ or along with the
relatives, in such Company. Such members shall be regarded as being in full- time practice and
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19.128 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
therefore can continue to do attest function either in individual capacity or in
Proprietorship/Partnership firm in which capacity they practice and wherein they are also entitled to
train articled/audit assistants.
The name of the Management Consultancy Company is required to be approved by the Institute and
such Company has to be registered with the Institute. The guidelines alongwith the prescribed
application forms for approval of name and registration, provisions of ethical compliance and other
details have been issued and the same will come into force w.e.f. 1.10.2006.
On abundant caution, it may be clarified that no audit practice can be done in Corporate Form. The
consultancy practice hitherto done in Individual or Firm Status alone is now intended to be permitted
in Corporate Form also.
Ethical Compliance: (i) Once the Management Consultancy Company is Registered with the
Institute as per the Guidelines, it will be necessary for such a Company to comply with the following
requirements: -
(a) If the individual practitioner/sole-proprietorship firm/partnership firm is the statutory auditor of
an entity then the Management Consultancy Company should not accept the internal audit or
book-keeping or such other professional assignments, which are prohibited for the statutory
auditor firm.
(b) The Notification No. 1-CA(7)/60/2002 dated 8th March, 2002 (enclosed) in respect of ceiling
on Non-audit fees is applicable in relation to a Management Consultancy Company.
(c) The Management Consultancy Company shall comply with clauses (6) & (7) of Part-I of the
First Schedule to the Chartered Accountants Act, 1949 and such other directives as may be
issued by the Institute from time to time.
(ii) The Management Consultancy Company shall give an undertaking that it shall comply with
clauses (6) & (7) of Part-I of the First Schedule to the Chartered Accountants Act, 1949 and such
other directives as may be issued by the Institute from time to time.
Object of Management Consultancy Company: The Management Consultancy Company shall
engage itself only in Management Consultancy & Other Services. The Management Consultancy
Company shall give an undertaking that it shall render only Management Consultancy & Other
Services prescribed by the Council pursuant to powers under section 2 (2)(iv) of the Chartered
Accountants Act, 1949.
Note: Students are advised to refer Appendix ‘D’ of the Code for more details.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.129
9.1 Council Guidelines for Advertisement, 2008
1. Write up -
The Members may advertise through a write up setting out their particulars or of their firms and
services provided by them subject to the following Guidelines and must be presented in such a
manner as to maintain the profession’s good reputation, dignity and its ability to serve the public
interest.
The Member(s)/Firm(s) should ensure that the contents of the Write up are true to the best of their
knowledge and belief and are in conformity with these Guidelines and be aware that the Institute of
Chartered Accountants of India will neither approve a propose write-up, nor owns any responsibility
whatsoever for such contents or claims by the writer Member(s)/ Firm(s).
The write-up shall comply with the following conditions:-
A. It shall be honest and truthful.
B. There shall be no exaggerated claims for the services offered by the member or the Firm, or
the qualifications or experience of the member or any of the partners or any other person
associated with the Firm.
C. It must not make any disparaging references or unsubstantiated comparisons to the work of
others.
D. It should not be of a nature that may bring the profession into disrepute.
E. It should not contain testimonials or endorsements concerning Member(s) or names of clients
(both the past and present) or the fees charged.
F. It should not contain any information about achievements /awards (except the awards given
by the Central or State Governments or Regulatory bodies) or any other position held, or
accreditation(s) granted by any organisation.
G. Monogram of any kind or use of any kind of catch words is not permissible.
H. The Membership No./FRN (as may be applicable) is mandatory to be mentioned in the write-
up.
I. It should not be of font size exceeding 14.
J. It must not be violative of any provisions of Chartered Accountants Act, 1949, Chartered
Accountants Regulations, 1988, Code of Ethics, 2020 or any Guideline of the Council
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19.130 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
The Institute of Chartered Accountants of India may issue a reasoned directive for removal or
withdrawal of the whole write-up or of any part(s) thereof.
Advertisement through write-up
While advertising the services or details of Firms, the write-up may include only the following
information:
(A) For Members
(i) CA…………..Name
(ii) Membership No. with Institute
(iii) Age
(iv) Date of becoming ACA
(v) Date of becoming FCA
(vi) Date from which COP held
(vii) Recognized qualifications
(viii) Languages known
(ix) Telephone/Mobile/Fax No.
(x) Professional Address
(xi) Website
(xii) E-mail
(xiii) CA Logo
(xiv) Passport style 3 photograph
(xv) Details of Employees (Nos. - )
(a) Chartered Accountants -
(b) Other Professionals –
(c) Articles/Audit Assistants
(d) Other Employees
3 As ameanded by Council at its 388th Meeting held on 6th and 7th Feb., 2020.
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PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.131
(xvi) Names of the employees and their particulars on the lines allowed for a member as
stated above.
(xvii) Services provided
(a) ………………………………
(b) ………………………………
(c) ………………………………
(xviii) Position held as Director or Managing Director in a Management Consultancy
Company registered with the Institute 4.
(B) For Firms
(i) Name of the Firm …………………… Chartered Accountants
(ii) Firm Registration No. with Institute
(iii) Year of establishment.
(iv) Professional Address(s) registered with the Institute (both Head Office and Branches)
(v) Working Hours
(vi) Tel. No(s)/Mobile No./Fax No(s)
(vii) E-mail
(viii) No. of partners
(ix) Name of the proprietor/partners and their particulars on the lines allowed for a member
as stated above including passport style 5 photograph.
(x) CA Logo
(xi) Details of Employees (Nos. - )
(a) Chartered Accountants -
(b) Other professionals –
(c) Articles/Audit Assistants
(d) Other employees
4 As incorporated pursuant to decision of Council at its 388th Meeting held on 6th and 7th Feb., 2020.
5 As amended by Council at its 388th Meeting held on 6th and 7th Feb., 2020.
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19.132 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(xii) Names of the employees of the firm and their particulars on the lines allowed for a
member as stated above.
(xiii) Services provided:
(a) ……………………………….
(b) ………………………………
(c) ………………………………
(xiv) Affiliation with a Network registered with the Institute 6
The write-up may have the Signature, Name of the Member/ Name of the Partner signing on
behalf of the firm, Place and Date.
2. Website of the CA Firms7
The Council has approved the detailed guidelines for posting the particulars on Website by
Chartered Accountant(s) in practice and firm(s) of Chartered Accountants in practice :-
1. The Chartered Accountants and/or Chartered Accountants’ Firms would be free to create
their own Website. The following stipulations will be applicable on such websites:-
2. The actual format of the Website is not being prescribed nor any standard format of the
Website is being given to provide independence to the Members.
3. The Chartered Accountants and/or Chartered Accountants’ Firms would ensure that their
Websites are run on a “pull” model and not a “push” model of the technology to ensure that
any person who wishes to locate the Chartered Accountants or Chartered Accountants’ firms
would only have access to the information and the information should be provided only on
the basis of specific “pull” request.
4. The Chartered Accountants and/or Chartered Accountants’ Firms should ensure that none of
the information contained in the Website be circulated on their own or through E-mail or by
any other mode or technique except on a specific “pull” request.
5. The Chartered Accountants would also not issue any circular or any other advertisement or
any other material of any kind whatsoever by virtue of which they solicit people to visit their
6As incorporated pursuant to decision of Council at its 388th Meeting held on 6th and 7th Feb. 2020.
7As amended and included under Guidelines for Advertisement pursuant to decision of Council at its 388th
Meeting held on 6th and 7th Feb., 2020.
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Website. The Chartered Accountants would, however, be permitted to mention their Website
address on their professional stationery and email.
6. The following information may be allowed to be displayed on the Firms/Members’ Websites:
(i) Member/Trade/Firm name.
(ii) Year of establishment.
(iii) Member/Firm’s Address (both Head Office and Branches)
Tel. No(s)
Fax No(s)
E-mail ID(s)
(iv) Nature of services rendered (to be displayable only on specific “pull” request)
(v) Partners
Partners Year of Other Tel.. Area of
Name Qualification Qualification(s) Off.- Direct Res. Experience (to
Mobile be displayable
E-mail address only on specific
“pull” request)
(vi) Details of Employees -
Professional Others Name Designation Area of experience (to be
displayable only on specific
“pull” request)
(vii) Job vacancies for the Chartered Accountant/firm of Chartered Accountants (including
articleship).
(viii) No. of articled assistants. (to be displayable only on specific “pull” request).
(ix) Nature of assignments handled (to be displayable only on specific “pull” request).
Names of clients and fee charged cannot be given. While the mention of names of
clients is not permissible, members may take note of the following with regard to
website of the Firm:-
Note: Disclosure of names of clients and/or fees charged, on the website is permissible only
where it is required by a regulator, whether or not constituted under a statute, in India or
outside India, provided that such disclosure is only to the extent of requirement of the
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19.134 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
regulator and is made only till such period that the member works under the purview of such
Regulator/ such requirements of the Regulator are in force. Where such disclosure of names
of clients and/or fees charged is made on the website, the member/ firm shall ensure that it
is mentioned on the website [in italics], below such disclosure itself, that “This disclosure is
in terms of the requirement of [name of the regulator] having jurisdiction in [name of the
country/ area where such regulator has jurisdiction] vide [Rule/ Directive etc. under which the
disclosure is required by the Regulator].
7. Display of Passport style photograph is permitted.
8. The members may include articles, professional information, bulletin boards, professional
updation and other matters of larger importance or of professional interest on the website.
Educational videos on topics of professional relevance are permissible.
9. The chat rooms can be provided which permit chatting amongst members of the ICAI and
between Firms and its clients. The confidentiality protocol would have to be observed. The
Firms can provide document management facility with distinct log in and password facility to
the clients to access copies of their documents on the Firm website.
10. The Firm can provide link of its page on Social Networking site. However, the members should
not solicit people to visit or like their respective page(s) on such social Networking site.
11. The members/firms can provide on line advice to their clients who specifically request for the
advice whether free of charge or on payment.
12. The details in the Website should be so designed that it does not amount to soliciting client
or professional work. In case any content or technical feature of Website is against the
professional Code of Conduct and Ethics as well as the restrictions contained in the
schedules to the Chartered Accountants Act, 1949 or against the guidelines or directions
issued by ICAI from time to time, appropriate action will be initiated by the ICAI in terms of its
disciplinary mechanism either suo moto or on complaint as provided under the Chartered
Accountants Act, 1949.
13. The Website should ensure adequate secrecy of the matters of the clients handled through
Website.
14. No Advertisement in the nature of banner or any other nature will be permitted on the Website.
15. The Website should be befitting the profession of Chartered Accountants and should not
contain any information or material which is unbecoming of a Chartered Accountant.
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16. The Website may provide a link to the Website of ICAI, its Regional Councils and Branches
and also the Website of Govt./Govt. Departments/Regulatory authorities/other Professional
Bodies.
17. The Website address should be as near as possible to the individual name/trade name, firm
name of the Chartered Accountant in practice or firm of Chartered Accountants in practice.
But it should not amount to soliciting clients or professional work or advertisement of
professional attainments or services. The Ethical Standards Board (ESB) of ICAI will decide
in case there is any difficulty.
18. The Website should mention the information which is not at material variance from the
information as per the ICAI’s records.
3 Online Third Party Platforms
A number of non-Chartered Accountants’ firms, corporates including banks, finance Companies and
newspapers have set up their own Websites providing advisory services on taxation and other areas
where Chartered Accountants are rendering professional service. Some of such Websites may
request Chartered Accountants or Chartered Accountants’ firms to provide consultation and advice
through their Websites. No other service, besides consultancy and advice can be rendered through
such websites, This would be permitted subject to the condition that on the Website, contact address
of the Chartered Accountant concerned is not provided nor such Website will contain any material
which advertises professional achievements or status of such Chartered Accountant except making
a statement that they are Chartered Accountants. The name of Chartered Accountants’ firm with
suffix “Chartered Accountants” would not be permitted.
4. Publication of Name or Firm Name by Chartered Accountants in the Telephone
or other Directories published by Telephone Authorities or Private Bodies
The Chartered Accountants and Chartered Accountants Firms may have entries made in a
Telephone Directory (in printed and electronic form) either by making a special request or by means
of an additional payment. The Council has also considered the question of permitting entries in
respect of Chartered Accountants and their firms under specified groups in telephone/trade
directories subject to the following additional restrictions :-
(i) The entry should not appear in any other section/category except that of ‘Chartered
Accountants’.
(ii) The member/firm should belong to the town/city in respect of which the directory is being
published.
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(iii) The order of the entries should not be in any manner other than alphabetical.
(iv) The entry should not be made in a differential or prominent manner giving the impression of
publicity/advertisement.
(v) The entries should not be restricted and should be open to all the Chartered
Accountants/firms of Chartered Accountants in the particular city/town in respect whereof the
directory is published.
(vi) The members can also include their names in trade/ social directories.
6. Application based Service provider Aggregators
It is not permissible for members to list themselves with online Application based service provider
Aggregators, wherein other categories like businessmen, technicians, maintenance workers, event
organizers etc. are also listed.
7. Specialised Directories for limited circulation
The name, description and address of member (or firm) may appear in any directory or list of
members of a particular body in which the names are listed alphabetically. For a specialised directory
or a publication such as a “Who’s Who” (including those compiled on purely local basis), a member
should use his discretion in supplying information, bearing in mind the nature and purpose of the
publications. In addition to his name, description and address and those of his firm, a member may
give where appropriate, directorships held and reasonable personal details and may state his outside
interests. He should not, however, give the names of any of his clients.
8 Exemptions
1 A special exemption has been made as regards publication of the name and address of a
member or that of his firm, with the description Chartered Accountant(s), in an advertisement
appearing in the press in the following circumstances, provided that the advertisement is not
displayed more prominently than is usual for such advertisements or the name of the member or
that of his firm with the designation Chartered Accountant(s) appears in type not bolder than the
substance of the advertisement:-
(a) Advertisement for recruiting staff in the member’s own office.
(b) Advertisement inserted on behalf of clients requiring staff or wishing to acquire or dispose of
business or property.
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(c) Advertisement for the sale of a business or property by a member acting in a professional
capacity as trustee, liquidator or receiver.
2 When advertising for staff, it is desirable that members should avoid the expression such as
“a well-known firm”, since this would savour of advertisement. Similar considerations apply
to advertisements for articled assistants. The advertisements should not contain any
promotional element nor should there be any suggestion that the services offered by the
Chartered Accountant or his firm are superior to those offered by other accountants.
10 RECOMMENDED SELF-REGULATORY MEASURES
As the members are aware, the Council has decided upon certain self-regulatory measures in order
to ensure a healthy growth of the profession and an equitable flow of professional work among the
members. These measures are reviewed from time to time and are published in the Journal of the
Institute for observance by the members. The self-regulatory measures are recommendatory.
However, considering the spirit underlying these measures, the Council expects that each and every
member will effectively implement them. The Council earnestly believes that implementation of these
measures would go a long way in ensuring equitable flow of work among the members and would
also further enhance the prestige of the profession in the society.
The more important of these recommendations are as under:
10.1 Branch Audits
The branch audits of a company should not be conducted by its statutory auditors consisting of ten
or more members, but should be conducted by the local firms of auditors consisting of less than ten
members. This should not be understood to mean any restriction on the right of the statutory auditors
to have access over branch accounts conferred under the Companies Act, 2013. This restriction
may not apply in the following cases.
(i) where the accounting records of the branches are maintained at the head office of the
respective companies, and
(ii) where significant operations of an undertaking or a company are carried out at its branch
office.
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10.2 Joint Audit
In the case of large companies, the practice of associating a practicing firm with less than five
members as Joint auditors should be encouraged. Where a client desires to appoint such a firm as
joint auditor, the senior firm should not object to the same.
10.3 Ratio Between Qualified and Unqualified Staff
In the Council’s view, a practicing firm of Chartered Accountants engaged in audit work should have
at least one member for every five non-qualified members of the staff, excluding articled and audit
assistants, typists, peons and other persons not engaged directly in such professional work.
10.4 Disclosure of Interest by Auditors in other Firms
The Council has decided that as a good and healthy practice, auditors should make a disclosure of
the payments received by them for other services through the medium of a different firm or firms in
which the said auditor may be either a partner or proprietor.
10.5 *Recommended Minimum Scale of Fees
The Institute has issued revised Minimum scale of Fees for the professional assignments of the
members of ICAI. The recommended scale of Fees is to be charged as per the work performed for
various professional assignments. The Fees has been recommended separately for Class-A, B and
C cities.
10.5.1 Fees - Relative Size:
Differentiated disclosure requirements for non public interest entities and public interest entities are
following:-
1. For non Public Interest Entities (PIE)-Disclosure is required where for two consecutive years,
the gross annual professional fees from an audit client represent more than 40% of the total fees of
the firm.
2. For public interest entities- Disclosure is required where for two consecutive years, the gross
annual professional fees from an audit client represent more than 20% of the total fees of the firm.
Exemption from applicability of the above provision will be in case where total Fees received by
Firm does not exceed 20 lacs of rupees.
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In addition, exemption from applicability of the above provision is also given in the case of audit of
government Companies, public undertakings, nationalised banks, public financial institutions,
regulators or where appointments of auditors are made by the Government.
Case Scenario
Synopsis: The case scenario underscores ethical and quality requirements to be complied with
by statutory auditor of a listed company. Failure to perform audit of financial statements in
accordance with Standards on Auditing can result in breakdown of trust of investors and public
at large. The case involves issue of non-adherence to requirements of SA 501, SA 550 and SA
505 by statutory auditor of a listed company.
Only major lapses have been considered for developing this case scenario for the sake of brevity.
The case scenario is presented in the following manner: -
I. Relevant provisions of Companies Act, 2013 and requirements of relevant Standards on
Auditing
II. Relevant Clauses of Part I of Second Schedule to Chartered Accountants Act, 1949
III. Facts of the case
IV. Major lapses pointed out by NFRA, engagement partner’s submissions and NFRA’s
contentions/findings
V. Conclusion including its basis
I. Relevant provisions of Companies Act, 2013 and requirements of relevant Standards on
Auditing
[1] Section 132(4) of Companies Act, 2013
NFRA has power to investigate into matters of professional or other misconduct committed by
any member or firm of chartered accountants registered under Chartered Accountants Act, 1949
for certain classes of bodies corporate. By virtue of this section, it has also got power to impose
penalty on erring members and debarring members of firm from undertaking audit work.
[2] Relevant requirements of Standards on Auditing
• SA 501 requires that when inventory is material to the financial statements, the auditor
shall obtain sufficient appropriate audit evidence regarding the existence and condition
of inventory by attendance at physical inventory counting unless impracticable.
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It further requires that if attendance at physical inventory counting is impracticable,
the auditor shall perform alternative audit procedures to obtain sufficient appropriate
audit evidence regarding the existence and condition of inventory. If it is not possible to
do so, the auditor shall modify the opinion in the auditor’s report in accordance with SA
705.
• SA 550 requires auditor to obtain sufficient appropriate audit evidence about whether
related party relationships and transactions have been appropriately identified,
accounted for and disclosed in the financial statements in accordance with the applicable
financial reporting framework.
• SA 505 requires that in case management refuses to allow the auditor to send a
confirmation request, reasons adduced by management need to be inquired and audit
evidence has to be sought for as to validity and reasonableness of reasons. Further,
implications of such refusal on risks of material misstatement including risk of fraud and
on nature, timing and extent of other audit procedures are to be evaluated.
It further requires auditor to perform alternative audit procedures designed to obtain
relevant and reliable audit evidence.
II. Relevant clauses of Part I of Second Schedule to Chartered Accountants Act, 1949
• Under clause 7 of Part I of Second Schedule to Chartered Accountants Act, 1949, a
chartered accountant in practice shall be deemed to be guilty of professional misconduct,
if he does not exercise due diligence, or is grossly negligent in the conduct of his
professional duties.
• Under clause 8 of Part I of Second Schedule to Chartered Accountants Act, 1949, a
chartered accountant in practice shall be deemed to be guilty of professional misconduct,
if he fails to obtain sufficient information which is necessary for expression of an opinion
or its exceptions are sufficiently material to negate the expression of an opinion
• Under clause 9 of Part I of Second Schedule to Chartered Accountants Act, 1949, a
chartered accountant in practice shall be deemed to 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.
III. Facts of the case
NFRA initiated action u/s 132(4) of Companies Act, 2013 for investigating into professional
misconduct of engagement partner of an audit firm pursuant to information received from ROC,
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Mumbai regarding investigation conducted by Regional Director into affairs of WNLL, listed on
SME segment of BSE. The key financial data for company for financial year 2016-17 was as
under: -
Particulars Amount (in ` crores)
Revenue from Operations 51.77
PBT 1.44
Inventory 20.60
Trade receivables 14.93
Trade payables 13.78
The engagement partner had issued an unmodified opinion for financial year 2016-17. The
engagement partner was requested on 18.02.2022 to submit audit file and SQC1 policy of firm
which was submitted by him vide email dated 18.03.2022. Subsequently, a show-cause notice
was issued to engagement partner charging him with professional misconduct for failure to
perform his duties as engagement partner.
IV. Major lapses pointed out by NFRA, engagement partner’s submissions and NFRA’s
contentions/findings
[1] Failure to obtain audit evidence regarding existence and condition of inventory
The EP was charged with failure to obtain sufficient appropriate audit evidence regarding
existence and condition of inventory by not attending physical inventory counting in accordance
with SA 501.
EP’s submissions NFRA’s contentions/findings
1. The appointment as statutory auditor SA 501 requires if attendance at physical
was made on 18.4.2017. Therefore, it inventory count is impracticable,
was not possible to attend physical alternative audit procedures shall be
verification of inventories as on performed to obtain sufficient appropriate
31.3.2017. audit evidence regarding existence and
condition of inventories. If it is not
possible to so, the auditor shall modify
opinion in accordance with SA 705. There
was no documentation in audit file of audit
procedures having been performed in this
respect. Reliance was also placed on
decision of PCAOB, US regulator in a
similar case.
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2. Inventory holding level was in There was no documentation in audit file
accordance with past trends. Stock of audit procedures having been
records were cross verified in respect performed in this respect.
of selected items and reconciled with
entries of receipts and issue in books
of accounts.
[2] Failure to identify related party and related party transactions
The EP was charged with failure to identify related parties and transactions with them. The
company made almost 100% of sales to a related party which was not identified as such in annual
report of the company for FY 2016-17.
EP’s submissions NFRA’s contentions/findings
1. It was tried to be ascertained from The related party to whom 100% of sales
management regarding existence of was made was previously identified as
related parties and previous audit related party in financial statements for
reports were also relied upon in this FY 2013-14. Since almost 100% of sales
regard. were to this party, EP should have applied
professional skepticism to probe further
into antecedents of the party. There is no
evidence in audit file regarding this.
Reliance was also placed on similar
decision of PCAOB where it was held that
auditor must evaluate whether related
party transactions have been properly
accounted for and disclosed in financial
statements.
[3] Failure to obtain external confirmations for Trade receivables and Trade payables
The EP was charged with gross negligence for not obtaining direct confirmations of balances from
debtors and creditors and with failure to perform any alternative audit procedure in absence of
confirmations from debtors and creditors in accordance with SA 505.
EP’s submissions NFRA’s contentions/findings
1. The company management had denied It shows that management had imposed a
contact details of parties due to fear of limitation on scope of audit. Limitations
losing the business information. Further, imposed by management may have other
all debtors and creditors were implications for audit such as evaluation
outstanding for less than 6 months. of fraud risks and continuance of
engagement as per SA 705.
No assessment of fraud risk having been
evaluated is available in audit file and there
is no evidence of additional procedures
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being performed by EP in absence of
external confirmations.
Reliance was also placed on PCAOB order
in Satyam case in which failure during
audit to obtain external confirmation of
bank balances was highlighted.
V. Conclusion including its basis
The engagement partner did not comply with provisions of Chartered Accountants Act, 1949 and
showed gross negligence and lack of due diligence in performing statutory audit. He didn’t ensure
audit quality and was grossly negligent of professional duties by not adhering to requirements
laid down in relevant Standards on Auditing as discussed above. It led to issuance of audit report
that was not backed by valid audit evidence and was lacking in audit quality.
The engagement partner was held guilty of professional misconduct under clauses 7, 8 and 9 of
Part I of Second Schedule to Chartered Accountants Act, 1949. He was also penalized and
debarred for a period of two years from undertaking any audit of financial statements or internal
audit of the functions and activities of any company or body corporate.
Key Takeaways
A Chartered Accountant, either in practice or in service, has to abide by these ethical
behaviours. They are expected to follow the fundamental principles of professional ethics
while performing their jobs.
Service users of professionals should be able to feel secure that there exists a framework of
professional ethics which governs the provision of those services. Any deviation from the
ethical responsibilities brings the disciplinary mechanism into action against the Chartered
Accountants.
A distinguishing feature of the accountancy profession is its acceptance of the responsibility
to act in the public interest. Code of Ethics seeks to protect the interests of the profession as
a whole. It is a shield that enables us to command respect.
Part 1 of Code of ethics deals with requirements relating to complying with the Code,
Fundamental Principles and Conceptual Framework, and is applicable to all professional
accountants.
The Code delineates integrity, objectivity, professional competence and due care,
confidentiality and professional behaviour as fundamental principles governing professional
ethics.
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Part 2 of Code of ethics sets out requirements and application material for professional
accountants in service when applying the conceptual framework. It does not describe all of
the facts and circumstances, including professional activities, interests and relationships that
could be encountered by professional accountants in service, which create or might create
threats to compliance with the fundamental principles. Therefore, the conceptual framework
requires professional accountants in service to be alert for such facts and circumstances.
Part 3 of Code of ethics sets out requirements and application material for professional
accountants in public practice when applying the conceptual framework.
Part 4A and 4B of Code of ethics deal with independence standards for audit and review
engagements (Part 4A) and assurance engagements other than audit and review
engagements (Part 4B) respectively.
There are specific provisions in Chartered Accountants Act, 1949 dealing with professional
misconduct and other misconduct.
Acts or omissions which comprise professional misconduct within the meaning of the
Chartered Accountants Act are defined in two Schedules viz. the First Schedule and the
Second Schedule.
The First Schedule is divided into four parts, Part I of the First Schedule deals with the
misconduct of a member in practice which would have the effect generally of compromising
his position as an independent person. Part II deals with misconduct of members in services.
Part III deals with the misconduct of members generally and Part IV deals with other
misconduct in relation to members of the institute generally.
The Second Schedule is divided into three parts. Part I deals with misconduct in relation to a
member in practice, Part II deals with misconduct of members generally and Part III deals
with other misconduct in relation to members of the Institute generally.
ANNEXURE – 1
The Chartered Accountants Act, 1949
The Chartered Accountants Act, 1949 (No. 38 of 1949) came into force on the 1st day of July, 1949.
Later in the year 1959, certain amendments were made therein through the Chartered Accountants
(Amendment) Act, 1959 (No.15 of 1959). After about 47 years extensive changes have been made
in the Act through the Chartered Accountants (Amendment) Act, 2006 (No.9 of 2006) which have
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been notified by the Central Government in the Gazette of India (Extra Ordinary) dated 23 rd March,
2006. Further, few insertions were made to the principle Act through the Chartered Accountants
(Amendment) Act, 2011 (No. 3 of 2012).
The entire Act is divided in nine chapters [Including chapter VIIA inserted by Chartered Accountants
(Amendment) Act, 2006].
The Complete enumeration of Contents is given below:
Chapter I - Preliminary
1. Short title, Extent and Commencement
2. Interpretation
This Chapter contains preliminary aspects of the Act like applicability of the Act, definition of various
terms like, Chartered Accountant, Council, holder of a restricted certificate, Registered Accountant,
etc.
Chapter II - The Institute of Chartered Accountants of India
3. Incorporation of the Institute
4. Entry of names in the Register
5. Fellows and Associates
6. Certificate of Practice
7. Members to be known as Chartered Accountants
8. Disabilities
This chapter deals with various things like who shall be entitled to have his name entered in the
register of members of the Institute, who shall be deemed to have become an associate member of
the Institute, who shall be entered in the Register as a fellow of the Institute. This Chapter also deals
with issues relating to certificate of practice and disabilities of a person for having his name entered
in the Register.
Chapter III - Council of the Institute
9. Constitution of the Council of the Institute
10. Re-election or re-nomination to Council [Substituted by Chartered Accountants (Amendment)
Act, 2006]
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10A. Settlement of dispute regarding election [Inserted by Chartered Accountants (Amendment)
Act, 2006]
10B. Establishment of Tribunal [Inserted by Chartered Accountants (Amendment) Act, 2006]
11. Nomination in default of election or nomination
12. President and Vice-President
13. Resignation of Membership and casual vacancies
14. Duration and dissolution of the Council
15. Function of the Council
15A. Imparting education by Universities and Other bodies [Inserted by Chartered Accountants
(Amendment) Act, 2006]
16. Officers and employees, salary, allowances etc. [substituted by Chartered Accountants
(Amendment) Act, 2006]
17. Committees of the Council
18. Finances of the Council
This Chapter deals with various issues like composition of Council of the Institute, manner of
conducting election to the Council, mode of tendering resignation from the membership of the
Council mode of filling a casual vacancy, various duties of the Council. This Chapter also deals with
the permission accorded to any University established by law or any Body affiliated to the Institute
to impact education on the subjects covered by the academic courses of the Institute.
Chapter IV - Register of Members
19. Register of Members
20. Removal from the Register
This chapter deals with the matters relating to register of members and removal from the register
the name of any member. The Council has to maintain a Register of Members of the Institute. This
Register shall include name, date of birth, domicile, residential and professional address,
qualification etc. Also, the Council may remove from the Register the name of any member in certain
circumstances like in case of death of the member or if the member does not pay the prescribed
fees, or when a member has become subject to any of the disabilities mentioned in section 8.
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Chapter V - Misconduct
21. Disciplinary Directorate [Substituted by Chartered Accountants (Amendment) Act, 2006]
21A. Board of Discipline [Inserted by Chartered Accountants (Amendment) Act, 2006]
21B. Disciplinary Committee [Inserted by Chartered Accountants (Amendment) Act, 2006]
21C. Authority, Disciplinary Committee, Board of Discipline and Director (Discipline) to have
powers of civil court [Inserted by Chartered Accountants (Amendment) Act, 2006]
21D. Transitional provisions [Inserted by Chartered Accountants (Amendment) Act, 2006]
22. Professional or other misconduct defined [Substituted by Chartered Accountants
(Amendment) Act, 2006]
22A. Constitution of Appellate Authority [Substituted by Chartered Accountants (Amendment) Act,
2006]
22B. Term of office of Chairperson and members of Authority [Inserted by Chartered Accountants
(Amendment) Act, 2006].
22C. Allowances and conditions of service of Chairperson and Members of Authority (Inserted by
Chartered Accountants (Amendment) Act, 2006)
22D. Procedure to be regulated by Authority [Inserted by Chartered Accountants (Amendment)
Act, 2006]
22E. Officers and other staff of Authority [Inserted by Chartered Accountants (Amendment) Act,
2006]
22F. Resignation and removal of Chairperson and Members [Inserted by Chartered Accountants
(Amendment) Act, 2006)]
22G. Appeal to Authority [Inserted by Chartered Accountants (Amendment) Act, 2006]
In this chapter professional and other misconduct has been defined. As per section 22 of the Act,
the expression “professional or other misconduct " shall be deemed to include any act or omission
provided in any of the Schedules. In this chapter, Section 21, 22 and 22A have been substituted by
new sections 21, 22 and 22A. Other sections (Section 21A, 21B, 21C, 21D, 22B, 22C, 22D, 22E,
22F and 22G) have been inserted by Chartered Accountants (Amendment) Act, 2006. These
Sections along with the Schedules deal with the new Disciplinary Mechanism.
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Chapter VI - Regional Councils
23. Constitution and Functions of Regional Councils
The Councils may constitute such Regional Councils for the purpose of advising and assisting it on
matters concerning its functions. The Regional councils shall exercise prescribed functions.
Chapter VII - Penalties
24. Penalty for falsely claiming to be a member etc.
24A. Penalty for using name of the Council, awarding degree of Chartered Accountancy etc.
25. Companies not to engage in accountancy
26. Unqualified persons not to sign documents
27. Maintenance of branch offices
28. Sanction to prosecute
This chapter lists penalties in various cases like, if a person who is not a member of the Institute
and represents himself as a member of the Institute or uses the designation Chartered Accountant,
he shall be punishable with fine which may extend to one thousand rupees (on first conviction) and
with imprisonment which may extend to six months or with fine which may extend to five thousand
rupees or with both (on subsequent conviction). Other provisions regarding penalties that are
included in this chapter provide that a Company (Incorporated in or outside India) shall not practice
as Chartered Accountant, a person other than a member of the Institute shall not sign any document
an behalf of a Chartered Accountant in practice or a firm of such Chartered Accountants in his or its
professional capacity, etc.
Chapter VII A Quality Review Board
[Inserted by Chartered Accountants (Amendment) Act, 2006]
28A. Establishment of Quality Review Board
28B. Functions of Board
28C. Procedure of Board
28D. Terms and conditions of services of Chairperson and Members of Board and its expenditure
After Chapter VII, the Chapter VIIA has been inserted by the Chartered Accountants (Amendment)
Act, 2006. It empowers the Central Government to constitute a Quality Review Board outside the
framework of the Institute. It will perform the functions like, to make recommendations to the Council
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with regard to the quality of services provided by the members of the Institute, to review the quality
of services provided by the members of the Institute including audit services and to guide the
members of the Institute to improve the quality of services and adherence to the various statutory
and other regulatory requirements.
Chapter VIII – Miscellaneous
29. Reciprocity
29A. Power of Central Government to make rules.
30. Power to make regulations
30A. Powers of the Central Government to direct regulation to be made or to make or amend
regulations
30B. Rules, Regulations and notification to be laid before Parliament [Substituted by Chartered
Accountants (Amendment) Act, 2006]
30C. Power of Central Government to issue directions [Inserted by Chartered Accountants
(Amendment) Act, 2006)]
30D. Protection of action taken in good faith [Inserted by Chartered Accountants (Amendment) Act,
2006)]
30E. Members etc. to be public servants [Inserted by Chartered Accountants (Amendment) Act,
2006)]
31. Construction of References
32. Act not to affect right of accountants to practice as such in Acceding States.
33. [Repealed]
This Chapter contains miscellaneous provisions. It empowers the Council to prescribe the conditions
subject to which foreign qualifications relating to accountancy shall be recognized for the purpose
of entry in the Register. It also empowers the Council to make regulations for the purpose of carrying
out the objects of this Act. It also empowers the Central Government to direct the Council to make
any regulations or to amend or revoke any regulations already made. Section 30C, 30D, and 30E
have been inserted by Chartered Accountants (Amendment) Act, 2006. Section 30C empowers the
Central Government to issue directions in the event of non-compliance by the Council of any
provisions of the Act. Section 30D protects Central Government, Council, Authority Disciplinary
Committee, Tribunal, Board, Board of Discipline, Disciplinary Directorate or any officer thereof, for
anything which is in good faith done or intended to be done under this Act or any rule, regulation,
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notification, direction or order made there under. Section 30E says that the Chairperson, Presiding
officer, Members and other officers and employees of the Authority, Disciplinary Committee,
Tribunal, Board, Board of Discipline or the Disciplinary Directorate shall be deemed to be public
servants within the meaning of Section 21 of the Indian Penal Code.
ANNEXURE – 2
SCHEDULES TO THE ACT
Acts or omissions which comprise professional misconduct within the meaning of Section 22 of the
Chartered Accountants Act are defined in two Schedules viz. the First Schedule and the Second
Schedule.
The First Schedule is divided into four parts, Part I of the First Schedule deals with the misconduct
of a member in practice which would have the effect generally of compromising his position as an
independent person. Part II deals with misconduct of members in services. Part-III deals with the
misconduct of members generally and part IV deals with other misconduct in relation to members of
the institute generally. The Second Schedule is divided into three parts. Part I deals with misconduct
in relation to a member in practice, Part II deals with misconduct of members generally and part III
deals with other misconduct in relation to members of the Institute generally. The implication of the
different clauses in the schedules are discussed below:
The First Schedule
PART I - Professional misconduct in relation to Chartered Accountants
in practice
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he:
Clause (1) allows any person to practice in his name as a chartered accountant unless such person
is also a chartered accountant in practice and is in partnership with or employed by him.
Clause (2) pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage in the fees or profits of his professional business, to any person other than a member of
the Institute or a partner or a retired partner or the legal representative of a deceased partner, or a
member of any other professional body or with such other persons having such qualification as may
be prescribed, for the purpose of rendering such professional services from time to time in or outside
India.
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Clause (3) accepts or agrees to accept any part of the profits of the professional work of a person
who is not a member of the Institute.
Clause (4) enters into partnership, in or outside India, with any person other then Chartered
Accountant in practice or such other person who is a member of any other professional body having
such qualifications as may be prescribed, including a resident who but for his residence abroad
would be entitled to be registered as a member under close (V) of sub-section (1) of section 4 or
whose qualifications are recognized by the Central Government or the Council for the purpose of
permitting such partnerships.
Clause (5) Secures either through the services of a person who is not an employee of such Chartered
Accountant or who is not his partner or by means which are not open to a Chartered Accountant,
any professional business.
Provided that nothing herein contained shall be construed as prohibiting any agreement permitted
in terms of item (2), (3) and (4) of this part.
Clause (6) Solicits clients or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means.
Provided that nothing herein contained shall be construed as preventing or prohibiting -
(i) Any Chartered Accountant from applying or requesting for or inviting or securing professional
work from another chartered accountant in practice; or
(ii) A member from responding to tenders or enquiries issued by various users of professional
services or organizations from time to time and securing professional work as a consequence.
However, as per the guideline issued by the Council of the Institute of Chartered Accountants
of India, a member of the Institute in practice shall not respond to any tender issued by an
organization or user of professional services in areas of services which are exclusively
reserved for chartered accountants, such as audit and attestation services. However, such
restriction shall not be applicable where minimum fee of the assignment is prescribed in the
tender document itself or where the areas are open to other professionals along with the
Chartered Accountants.
Clause (7) Advertises his professional attainments or services, or uses any designation or
expressions other than the Chartered Accountant on professional documents, visiting cards, letter
heads or sign boards unless it be a degree of a University established by law in India or recognized
by the Central Government or a title indicating membership of the Institute of Chartered Accountants
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19.152 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
or of any other institution that has been recognized by the Central Government or may be recognized
by the Council.
Provided that a member in practice may advertise through a write up, setting out the service provided
by him or his firm and particulars of his firm subject to such guidelines as may be issued by the
Council.
Clause (8) Accepts a position as auditor previously held by another chartered accountant or a
certified auditor who has been Issued certificate under the Restricted Certificate Rules, 1932 without
first communicating with him in writing.
Clause (9) Accepts an appointment as auditor of a company without first ascertaining from it whether
the requirements of Section 225 of the Companies Act, 1956, in respect of such appointment have
been duly complied with.
(Now Section 139 and 140 read with Section 141 of the Companies Act, 2013. Students may note
that till the time Code of Ethics etc. bare documents get updated from Ethical 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.)
Clause (10) Charges or offers to charge, accepts or offers to accept In respect of any professional
employment fees which are based on a percentage of profits or which are contingent upon the
findings, or results of such employment, except as permitted under any regulations made under this
Act.
The Council of the Institute has however framed Regulation 192 which exempts members from the
operation of this clause in certain professional services.
Clause (11) Engages in any business or occupation other than the profession of chartered
accountant unless permitted by the Council so to engage.
Provided that nothing contained herein shall disentitle a chartered accountant from being a director
of a company (Not being managing director or a whole time director) unless he or any of his partners
is interested in such company as an auditor.
Clause (12) Allows a person not being a member of the institute in practice 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.
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PART II - Professional misconduct in relation to members of the Institute
in service
A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he being an employee of any company, firm or person:
Clause (1) pays or allows or agrees to pay directly or indirectly to any person any share in the
emoluments of the employment undertaken by him.
Clause (2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, a chartered
accountant or broker engaged by such company, firm or person or agent or customer of such
company, firm or person by way of commission or gratification.
[Note: A member in the foregoing circumstances would be guilty of misconduct regardless of the fact
that he was in whole-time or part-time employment or that he was holding Certificate of Practice
along with his employment.]
PART III - Professional misconduct in relation to members of the Institute
generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of
professional misconduct, if he:
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he:
Clause (1) not being a fellow of the Institute, acts as a fellow of the Institute.
Clause (2) does not supply the information called for, or does not comply with the requirements
asked for, by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline,
Disciplinary Committee, Quality Review Board or the Appellate Authority.
Clause (3) while inviting professional work from another chartered accountant or while responding
to tenders or enquiries or while advertising through a write up, or anything as provided for in items
(6) and (7) of Part I of this Schedule, gives information knowing it to be false.
PART IV - Other misconduct in relation to members of the Institute
generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other
misconduct, if he:
(1) is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term not exceeding six months.
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(2) in the opinion of the Council, brings disrepute to the profession or the Institute as a result of
his action whether or not related to his professional work.
These clause (1) & (2) are self explanatory and any of the member of the Institute is found guilty by
any civil or criminal court and prosecuted for an imprisonment in an offence involving moral turpitude
or his acts bring disrepute to the profession or the Institute, irrespective of the fact whether such
acts are related to profession or not, such member will be deemed to be guilty of other misconduct
in Part IV of Schedule I.
The important point to note is that if imprisonment tenure exceeds six months, this case will be
covered in the clause of Part III of Schedule II.
The Second Schedule
PART I - Professional misconduct in relation to chartered Accountant in
practice
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct,
if he:
Clause (1) Discloses Information acquired in the course of his professional engagement to any
person other than his client so engaging him without the consent of his client or otherwise than as
required by any law for the time being in force.
Clause (2) If he certifies or submits in his name or in the name of his firm, a report of an examination
of financial statements unless the examination of such statements and the related records has been
made by him or by a partner or an employee In his firm or by another chartered accountant in
practice.
Clause (3) Permits his name or the name of his firm to be used in connection with an estimate of
earnings contingent upon future transactions in manner which may lead to the belief that he vouches
for the accuracy of the forecast.
Clause (4) Expresses his opinion on financial statements of any business or enterprise in which he,
his firm, or a partner in his firm has a substantial interest.
Clause (5) Fails to disclose a material fact known to him which is not disclosed in a financial
statement, but disclosure of which is necessary in making such financial statement not misleading
where he is concerned with that financial statement in a professional capacity.
Clause (6) Fails to report a material misstatement known to him to appear in a financial statement
with which he is concerned in a professional capacity.
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Clause (7) Does not exercise due diligence, or is grossly negligent in the conduct of his professional
duties.
Clause (8) Fails to obtain sufficient information which is necessary for expression of an opinion or
its exceptions are sufficiently material to negate the expression of an opinion.
Clause (9) Fails to invite attention to any material departure from the generally accepted procedure
of audit applicable to the circumstances.
Clause (10) Fails to keep moneys of his client other than fees or remuneration or money meant to
be expended in a separate banking account or to use such moneys for purposes for which they are
intended within a reasonable time.
PART II - Professional misconduct in relation to members of the Institute
generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he:
Clause (1) contravenes any of the provisions of this Act or the regulations made there under or any
guidelines issued by the Council.
Clause (2) being an employee of any company, firm or person, discloses confidential information
acquired in the course of his employment except as and when required by any law for the time being
in force or except as permitted by the employer.
Clause (3) Includes in any information, statement, return or form to be submitted to the Institute,
Council or any of its Committees, Director (Discipline), Board of Discipline. Disciplinary Committee,
Quality Review Board or the Appellate Authority any particulars knowing them to be false.
Clause (4) Defalcates or embezzles money received in his professional capacity.
Part III - Other misconduct in relation to members of the Institute
generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other mis-
conduct, if he is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term exceeding six months.
Imprisonment awarded for a term exceeding six months in any civil/criminal matter treated as a major
offence under ‘other misconduct’ is included in this Schedule.
Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other
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misconduct mentioned in the second schedule or in both the Schedule, he shall place the matter
before the Disciplinary Committee.
Recent Decisions of Ethical Standards Board
1. It is permissible for a practicing Chartered Accountant holding Certificate of Practice to become
a member of the 'Board of Management' in Primary (Urban) Co-operative Banks.The Ethical
Standards Board noted that the position of a member of 'Board of Management' in Primary
(Urban) Co-operative banks (UCBs) and the role attached to that position is similar to that of
a Director-Simiplicitor; where there is no involvement of a member in the day-to-day
functioning/operations and not signatory etc. and only sitting fees for the services rendered
are provided.
2. Member in practice cannot act as Trademark or Patent Attorney. However, Professional
advice in relation to Intellectual Property Rights (IPR) is a routine professional work for a
Chartered Accountants in practice and same is permissible under the provisions of the
Chartered Accountants Act, 1949.
3. It is not permissible for a member in practice to accept the appointment of statutory audit of
the society wherein immediate family member i.e., spouse or dependent, of member hold
honorary position of one of the managing committee of the institutes governed by the society.
4. The Council decided that for the purpose of Appointment of an auditor when he is indebted
to a concern, as dealt with under Chapter X of the Council General Guidelines, 2008, the
term “auditor’ shall not include internal auditor, concurrent auditor or an auditor giving report
to the Management. In other words, the provision relating to criteria/limit of indebtedness shall
apply only to statutory audits.
5. A CA Firm may register itself on Udyog Aadhar, a web portal of Ministry Micro, Small and
Medium Enterprises.
6. There is no prohibition for internal auditor of a company to acquire/purchase shares of the
said Company.
7. It is not permissible for a member to use Messaging Applications to send messages to make
people aware about his practice, and mention the services provided therein.
8. A Chartered Accountant in practice being Director Simplicitor in a Company cannot sign ROC
Forms of the Company as it is a direct conflict of role.
9. A Chartered Accountant in practice can act as Authorized Representative of a Foreign
Company, provided he is not the auditor of the said Company.
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10. It is permissible for two or more Chartered Accountants in practice collectively to have joint
training session for their clients on GST, and share the fees collected from the clients thereof.
11. A chartered accountant in practice can provide services through kiosk only if the services
provided are professional activities of a practicing chartered accountant, permitted under the
Act.
12. A Chartered Accountant in service is allowed to take e-return registration if it does not conflict
with employment obligation. However, he cannot certify the return.
13. In case where Chartered Accountant in practice is a non-executive director in a company, he
or a Firm in which he is a partner, should not accept the appointment as a statutory auditor
of a Company which is a joint venture of the original Company, as it would impact
independence.
14. A Chartered Accountant in practice may be an equity research adviser, but he cannot publish
retail report, as it would amount to other business or occupation.
15. There is no conflict of interest in a Chartered Accountant, who is a member of a Trust, being
the auditor of the said trust. It is subject to the exception where a particular statute governing
a Trust prescribes prohibition on the member of the Trust to be its Auditor or otherwise where
there is conflict of interest as per the provisions of Code of Ethics.
16. A Chartered Accountant in practice may engage himself as Registration Authority (RA) for
obtaining digital signatures for clients.
17. A Chartered accountant can hold the credit card of a bank when he is also the auditor of the
bank, provided the outstanding balance on the said card does not exceed Rs 100,000*
beyond the prescribed credit period limit on credit card given to him. (*As per the limit of
indebtedness existing as on date.)
18. A Chartered Accountant in practice can act as mediator in Court, since acting as a “mediator”
would be deemed to be covered within the meaning of “arbitrator’; which is inter-alia permitted
to members in practice as per Regulation 191 of the Chartered Accountants Regulations,
1988.
19. A Chartered Accountant in practice is not permitted to accept audit assignment of a bank in
case he has taken loan against a Fixed Deposit held by him in that bank.
20. The Ethical Standards Board in 2013 generally apply the stipulations contained in the then
amended Rule 11U of Income Tax generally, wherein statutory auditor /tax auditor cannot be
the valuer of unquoted equity shares of the same entity.The Board has at its recent Meeting
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(January, 2017) has reviewed the above, and decided that where law prohibits for instance
in the Income Tax Act and the rules framed thereunder, such prohibition on statutory
auditor/tax auditor to be the valuer will continue, but where there is no specific restriction
under any law, the said eventuality will be permissible, subject to compliance with the
provisions, as contained in the Code of Ethics relating to independence.
21. The Ethical Standards Board had in 2011 decided that it is not permissible for a member who
has been Director of a Company, upon resignation from the Company to be appointed as an
auditor of the said Company, and the cooling period for the same may be 2 years. The Board
has at its recent Meeting (January, 2017) has reviewed the above, and noted that the Section
141 of Companies Act, 2013 on disqualification of auditors does not mention such prohibition;
though threats pertaining to the said eventuality have been mentioned in Code of Ethics.
Further, the Board was of the view that a member may take decision in such situation based
on the provisions of Companies Act, 2013 and provisions of Code of Ethics.
22. A chartered accountant in practice cannot become Financial Advisors and receive
fees/commission from Financial Institutions such as Mutual Funds, Insurance Companies,
NBFCs etc.
23. A chartered accountant cannot exercise lien over the client documents/records for non-
payment of his fees.
24. It is not permissible for CA Firm to print its vision and values behind the visiting cards, as it
would result in solicitation and therefore would be violative of the provisions of Clause (6) of
Part-I of First Schedule to the Chartered Accountants Act, 1949.
25. It is not permissible for chartered accountants in practice to take agencies of UTI, GIC or
NSDL.
26. It is permissible for a member in practice to be a settlor of a trust.
27. A member in practice cannot hold Customs Brokers Licence under section 146 of the
Customs Act, 1962 read with Customs Brokers Licensing Regulations, 2013 in terms of the
provisions of Code of Ethics.
28. A Chartered accountant in service may appear as tax representative before tax authorities
on behalf of his employer, but not on behalf of other employees of the employer.
29. A chartered accountant who is the statutory auditor of a bank cannot for the same financial
year accept stock audit/inspection Audit of the same branch of the bank or any of the
branches of the same bank or sister concern of the bank, for the same financial year.
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30. A CA Firm which has been appointed as the internal auditor of a PF Trust by a Government
Company cannot be appointed as its Statutory Auditor.
31. A concurrent auditor of a bank ‘X’ cannot be appointed as statutory auditor of bank ‘Y’, which
is sponsored by ‘X’.
32. A CA/CA Firm can act as the internal auditor of a company & statutory auditor of its employees
PF Fund under the new Companies Act (2013).
33. The Ethical Standards Board while noting that there is requirement for a Director u/s 149(3)
of the Companies Act, 2013 to reside in India for a minimum period of 182 days in the previous
calendar year, decided that such a Director would be within the scope of Director Simplicitor
(which is generally permitted as per ICAI norms) , if he is non –executive director, required
in the Board Meetings only , and not paid any remuneration except for attending such Board
Meetings.
TEST YOUR KNOWLEDGE
Theoretical Questions
1. P, a Chartered Accountant in practice provides management consultancy and other services
to his clients. During 2023, looking to the growing needs of his clients to invest in the stock
markets, he also advised them on Portfolio Management Services whereby he managed
portfolios of some of his clients. Is P guilty of professional misconduct?
2. Mr. G, a Chartered Accountant in practice as a sole proprietor has an office in Mumbai near
Church Gate. Due to increase in professional work, he opens another office in a suburb of
Mumbai which is approximately 80 kilometers away from the municipal limits of the city. For
running the new office, he employs three retired Income-tax Officers. Is Mr. G guilty of
professional misconduct?
3. Write a short note on Other Misconduct.
4. Mr. K, a practicing Chartered Accountant gave 50% of the audit fees received by him to a
non-Chartered Accountant, Mr. L, under the nomenclature of office allowance and such an
arrangement continued for a number of years. Discuss this in the light of Professional Ethics
issued by ICAI.
5. Mr. X who passed his CA examination of ICAI on 18th July, 2022 and started his practice
from August 15, 2022. On 16th August 2022, one female candidate approached him for
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articleship. In addition to monthly stipend, Mr. X also offered her 1 % profits of his CA firm.
She agreed to take both 1 % profits of the CA firm and stipend as per the rate prescribed by
the ICAI. The Institute of Chartered Accountants of India sent a letter to Mr. X objecting the
payment of 1 % profits. Mr. X replies to the ICAI stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the financial position of the
articled clerk is very weak. Is Mr. X liable to professional misconduct?
6. M/s XYZ, a firm in practice, develops a website “xyz.com”. The colour chosen for the website
was a very bright green and the web-site was to run on a “push” technology where the names
of the partners of the firm and the major clients were to be displayed on the web-site without
any disclosure obligation from any regulator. Is this website in compliance with guidelines
issued by ICAI in this regard?
7. A partner of a firm of chartered accountants during a T.V. interview handed over a bio-data
of his firm to the chairperson. Such bio-data detailed the standing of the international firm
with which the firm was associated. It also detailed the achievements of the concerned partner
and his recognition as an expert in the field of taxation in the country. The chairperson read
out the said bio-data during the interview. Discuss whether this action by the Chartered
Accountant would amount to misconduct or not.
8. (a) An advertisement was published in a Newspaper containing the photograph of Mr. X,
a member of the institute wherein he was congratulated on the occasion of the opening
ceremony of his office.
(b) Mr. X, a Chartered Accountant and the proprietor of X & Co., wrote several letters to
the Assistant Registrar of Co-operative Societies stating that though his firm was on
the panel of auditors, no audit work was allotted to the firm and further requested him
to look into the matter.
9. A practising Chartered Accountant uses a visiting card in which he designates himself,
besides as Chartered Accountant, Cost Accountant. Is this a misconduct?
10. Mr. Nigal, a Chartered Accountant in practice, delivered a speech in the national conference
organized by the Ministry of Textiles. While delivering the speech, he told to the audience
that he is a management expert and his firm provides services of taxation and audit at
reasonable rates. He also requested the audience to approach his firm of chartered
accountants for these services and at the request of audience he also distributed his business
cards and telephone number of his firm to those in the audience. Comment.
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11. Mr. A is a practicing Chartered Accountant working as proprietor of M/s A & Co. He went
abroad for 3 months. He delegated the authority to Mr. Y a Chartered Accountant his
employee for taking care of routine matters of his office. During his absence Mr. Y has
conducted the under mentioned jobs in the name of M/s A & Co.
(i) He issued the audit queries to client which were raised during the course of audit.
(ii) He issued production certificate to a client under the GST Act.
(iii) He attended the Income Tax proceedings for a client as authorized representative
before Income Tax Authorities.
Please comment on eligibility of Mr. Y for conducting such jobs in name of M/s A & Co. and
liability of Mr. A under the Chartered Accountants Act, 1949.
12. XYZ Co. Ltd. has applied to a bank for loan facilities. The bank on studying the financial
statements of the company notices that you are the auditor and requests you to call at the
bank for a discussion. In the course of discussions, the bank asks for your opinion regarding
the company and also asks for detailed information regarding a few items in the financial
statements. The information is available in your working paper file. What should be your
response and why?
13. Mr. A, a newly qualified Chartered Accountant, started his practice and sought clients through
telephone calls from his family and friends, almost all of them employed in one or the other
retail trade business. One of his friends Mr. X gave him an idea to start online services and
give stock certifications to traders with Cash Credit Limits in Banks. Mr. A started a website
with colorful catchy designs and shared the website address on his all social media posts and
stories and tagged 30 traders of his local community with the caption “Easy Online Stock
Certification Services”. Besides, Mr. A entered in an agreement with a Digital Marketer to give
him 5% commission on each service procured through him. Discuss if the actions of Mr. A
are valid in the light of the Professional Ethics and various pronouncements and guidelines
issued by ICAI.
14. Mr. D, a practicing CA, is appointed as a Director Simplicitor in XYZ Pvt. Ltd. After one year
of appointment, Mr. D resigned as the Director and accepted the Statutory Auditor position of
the company. Is Mr. D right in accepting the auditor position?
15. Mr. F, a Chartered Accountant, gave advisory services to PQR Pvt. Ltd. Further, he gave
them GST consultancy, compilation engagement for historical financial information and
helped in ERP set up. Later, the company turned out to be a part of a group of companies
involved in money laundering. Mr. F was asked to provide details of the companies. Mr. F
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refused on the grounds that he gave only consultancy services to the company and wasn’t
supposed to keep any information about the company. Is Mr. F right as per the guidelines
issued by the ICAI?
16. Mr. S, the auditor of ABC Pvt. Ltd. has delegated following works to his articles and staff:
i. Issue of audit queries during the course of audit.
ii. Issue of memorandum of cash verification and other physical verification.
iii. Letter forwarding draft observations/financial statements.
iv. Issuing acknowledgements for records produced.
v. Signing financial statements of the company.
Is this correct as per the Professional Ethics and ICAI’s guidelines and pronouncements?
17. Mr. S is a practising chartered accountant based out of Chennai. During the weekends, he
involved himself in equity research and used to advise his friends, relatives and other known
people who are not his clients. Apart from this, he was also involved as a paper-setter for
Accountancy subject in the school in which he studied. He also owned agricultural land and
was doing agriculture during his free time. During the year 20X1, heavy losses were incurred
in agricultural activity due to natural calamities and misfortune, and he lost almost all of his
wealth and became undischarged insolvent. After a few court hearings, finally, in the year
20X3, he was declared discharged insolvent and obtained a certificate from the court stating
that his insolvency was caused by misfortune without any misconduct on his part. You are
required to comment on the above situation with reference to the Chartered Accountants Act,
1949 and Schedules thereto, (especially from the point of section 8: Entry of name in Register
of Members).
Hints/Answers to Theoretical Questions
1. Advising on Portfolio Management Services: The Council of the Institute of Chartered
Accountants of India (ICAI) pursuant to Section 2(2)(iv) of the Chartered Accountants Act,
1949 has passed a resolution permitting “Management Consultancy and other Services” by
a Chartered Accountant in practice. A clause of the aforesaid resolution allows Chartered
Accountants in practice to act as advisor or consultant to an issue of securities including such
matters as drafting of prospectus, filing of documents with SEBI, preparation of publicity
budgets, advice regarding selection of brokers, etc. It is, however, specifically stated that
Chartered Accountants in practice are not permitted to undertake the activities of broking,
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underwriting and portfolio management services. Thus, a chartered accountant in practice is
not permitted to manage portfolios of his clients.
In view of this, P would be guilty of misconduct under the Chartered Accountants Act, 1949.
2. In terms of section 27 of the Chartered Accountants Act, 1949, if a chartered accountant in
practice has more than one office in India, each one of these offices should be in the separate
charge of a member of the Institute. There is however an exemption for the above if the
second office is located in the same premises, in which the first office is located; or the second
office is located in the same city, in which the first office is located; or the second office is
located within a distance of 50 kms from the municipal limits of a city, in which the first office
is located. Since the second office is situated beyond 50 kms of municipal limits of Mumbai
city, he would be liable for committing a professional misconduct.
3. Refer Para 7.2
4. Sharing of Audit Fees with Non-Member: As per Clause (2) of Part I of First Schedule to
the Chartered Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant
in practice pays or allows or agrees to pay or allow, directly or indirectly, any share,
commission or brokerage in the fees or profits of his professional business, to any person
other than a member of the Institute or a partner or a retired partner or the legal representative
of a deceased partner, or a member of any other professional body or with such other persons
having such qualification as may be prescribed, for the purpose of rendering such
professional services from time to time in or outside India.
In the instant case, Mr. K, a practising Chartered Accountant gave 50% of the audit fees
received by him to a non-Chartered Accountant, Mr. L, under the nomenclature of office
allowance and such an arrangement continued for a number of years. In this case, it is not
the nomenclature to a transaction that is material but it is the substance of the transaction,
which has to be looked into.
The Chartered Accountant had shared his profits and, therefore, Mr. K will be held guilty of
professional misconduct under the Clause (2) of Part I of First Schedule to the Chartered
Accountants Act, 1949.
5. Sharing Fees with an Articled Clerk: As per Clause (2) of Part I of First Schedule to the
Chartered Accountants Act 1949, a Chartered Accountant in practice shall be deemed to be
guilty of professional misconduct if he pays or allows or agrees to pay or allow, directly or
indirectly, any share, commission or brokerage in the fees or profits of his professional
business, to any person other than a member of the Institute or a partner or a retired partner
© The Institute of Chartered Accountants of India
19.164 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
or the legal representative of a deceased partner, or a member of any other professional body
or with such other persons having such qualification as may be prescribed, for the purpose
of rendering such professional services from time to time in or outside India.
In view of the above, the objections of the Institute of Chartered Accountants of India, as
given in the case, are correct and reply of Mr. X, stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the position of the articled clerk
is weak is not tenable.
Hence, Mr. X is guilty of professional misconduct in terms of Clause (2) of Part I of First
Schedule to the Chartered Accountants Act 1949.
6. Posting of Particulars on Website: The Council of the Institute had approved posting of
particulars on website by Chartered Accountants in practice under Clause (6) of Part I of First
Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The
relevant guidelines in the context of the website hosted by M/s XYZ are:
♦ No restriction on the colours used in the website;
♦ The websites are run on a “pull” technology and not a “push” technology;
♦ Names of clients and fees charged not to be given.
However, disclosure of names of clients and/or fees charged, on the website is permissible
only where it is required by a regulator, whether or not constituted under a statute, in India or
outside India, provided that such disclosure is only to the extent of requirement of the
regulator. Where such disclosure of names of clients and/or fees charged is made on the
website, the member/ firm shall ensure that it is mentioned on the website [in italics], below
such disclosure itself, that “This disclosure is in terms of the requirement of [name of the
regulator] having jurisdiction in [name of the country/area where such regulator has
jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator].
In view of the above, M/s XYZ would have no restriction on the colours used in the website
but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional
misconduct since it would amount to soliciting work by advertisement.
7. Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits
solicitation of client or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means since it shall constitute
professional misconduct. The bio-data was handed over to the chairperson during the T.V.
interview by the Chartered Accountant which included details about the firm and the
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.165
achievements of the partner as an expert in the field of taxation. The chairperson simply read
out the same in detail about association with the international firm as also the achievements
of the partner and his recognition as an expert in the field of taxation. Such an act would
definitely lead to the promotion of the firms’ name and publicity thereof as well as of the
partner and as such the handing over of bio-data cannot be approved. The partner would be
held guilty of professional miscount under Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949.
8. (a) Publishing an Advertisement Containing Photograph: As per Clause (6) of Part I
of the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant
in practice shall be deemed to be guilty of misconduct if he solicits clients or
professional work either directly or indirectly by a circular, advertisement, personal
communication or interview or by any other means.
In the given case, Mr. X published an advertisement in a Newspaper containing his
photograph on the occasion of the opening ceremony of his office. On this context, it
may be noted that the advertisement which had been put in by the member is quite
prominent. If soliciting of work is allowed, the independence and forthrightness of a
Chartered Accountant in the discharge of duties cannot be maintained.
The above therefore amounts to soliciting professional work by advertisement directly
or indirectly. Mr. X would be therefore held guilty under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949.
(b) Soliciting Professional Work: As per Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed
to be guilty of misconduct if he solicits clients or professional work either directly or
indirectly by a circular, advertisement, personal communication or interview or by any
other means.
In the given case, Mr. X, a Chartered Accountant and proprietor of M/s X and Co.,
wrote several letters to the Assistant Registrar of Co-operative Societies, requesting
for allotment of audit work. In similar cases, it was held that the Chartered Accountant
would be guilty of professional misconduct under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949. The writing of continuous letter to
ascertain the reasons for not getting the work is quite alright but in case such either
amount to request for allowing the work then Mr. X will be liable for professional
misconduct.
© The Institute of Chartered Accountants of India
19.166 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Consequently, Mr. X would therefore be held guilty under Clause (6) of Part I of the
First Schedule to the Chartered Accountants Act, 1949.
9. Cost Accountant: As stated in the Illustration given in clause 7 with reference to tax
consultant, this would also constitute misconduct under section 7 of the Act read with Clause
(7) of Part I of the First Schedule to the Chartered Accountants Act, 1949. A chartered
accountant in practice cannot use any other designation than that of a chartered accountant.
Nevertheless, a member in practice may use any other letters or descriptions indicating
membership of accountancy bodies which have been approved by the Council. Thus, it is
improper for a chartered accountant to state in his documents that he is a “Cost Accountant”.
However as per the Chartered Accountants Act, 1949, the Council has resolved that the
members are permitted to use letters indicating membership of the Institute of Cost and Works
Accountants but not the designation "Cost Accountant".
10. Using Designation Other Than a CA and Providing Details of Services Offered:
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 states that
a Chartered Accountant in practice shall be deemed to be guilty of misconduct if he solicits
clients or professional work either directly or indirectly by a circular, advertisement, personal
communication or interview or by any other means. Such a restraint has been put so that the
members maintain their independence of judgment and may be able to command respect
from their prospective clients.
Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part I of the First
Schedule to the said Act prohibits advertising of professional attainments or services of a
member. It also restrains a member from using any designation or expression other than that
of a chartered accountant in documents through which the professional attainments of the
member would come to the notice of the public. Under the clause, use of any designation or
expression other than chartered accountant for a chartered accountant in practice, on
professional documents, visiting cards, etc. amounts to a misconduct unless it be a degree
of a university or a title indicating membership of any other professional body recognised by
the Central Government or the Council.
Member may appear on television and films and agree to broadcast in the Radio or give
lectures at forums and may give their names and describe themselves as Chartered
Accountants. Special qualifications or specialized knowledge directly relevant to the subject
matter of the programme may also be given but no reference should be made, in the case of
practicing member to the name and address or services of his firm. What he may say or write
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.167
must not be promotional of his or his firm but must be an objective professional view of the
topic under consideration.
Thus, it is improper to use designation "Management Expert" since neither it is a degree of a
University established by law in India or recognised by the Central Government nor it is a
recognised professional membership by the Central Government or the Council. Therefore,
he is deemed to be guilty of professional misconduct under both Clause (6) and Clause (7)
as he has used the designation “Management Expert” in his speech and also he has made
reference to the services provided by his firm of Chartered Accountants at reasonable rates.
Distribution of cards to audience is also a misconduct in terms of Clause (6).
11. Delegation of Authority to the Employee: As per Clause (12) of Part I of the First Schedule
of the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be
guilty of professional misconduct “if he allows a person not being a member of the Institute in
practice 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”.
In this case CA A proprietor of M/s A & Co., went to abroad and delegated the authority to
another Chartered Accountant Mr. Y, his employee, for taking care of routine matters of his
office who is not a partner but a member of the Institute of Chartered Accountants
The Council has clarified that the power to sign routine documents on which a professional
opinion or authentication is not required to be expressed may be delegated and such
delegation will not attract provisions of this clause like issue of audit queries during the course
of audit, asking for information or issue of questionnaire, attending to routing matters in tax
practice, subject to provisions of Section 288 of Income Tax Act etc.
(i) In the given case, Mr. Y, a chartered accountant being employee of M/s A & Co. has
issued audit queries which were raised during the course of audit. Here Y is right in
issuing the query, since the same falls under routine work which can be delegated by
the auditor. Therefore, there is no misconduct in this case as per Clause (12) of Part I
of First schedule to the Act.
(ii) Further, issuance of production certificate to a client under GST Act by Mr. Y being an
employee of M/s A & Co. (an audit firm), is not a routine work and it is outside his
authorities. Thus, CA A is guilty of professional misconduct under Clause (12) of Part
I of First Schedule of the Chartered Accountants Act, 1949.
(iii) In this instance, Mr. Y, CA employee of the audit firm M/s A & Co. has attended the
Income tax proceedings for a client as authorized representative before Income Tax
© The Institute of Chartered Accountants of India
19.168 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Authorities. Since the council has allowed the delegation of such work, the chartered
accountant employee can attend to routine matter in tax practice as decided by the
council, subject to provisions of Section 288 of the Income Tax Act. Therefore, there
is no misconduct in this case as per Clause (12) of Part I of First schedule to the Act.
12. As per Clause (1) of Part I of the Second Schedule of the Chartered Accountants Act, 1949,
a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
discloses information acquired in the course of his professional engagement to any person
other than his client, without the consent of the client or otherwise than as required by law for
the time being in force. SA 200 on " Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing" also reiterates that, "the
auditor should respect the confidentiality of information acquired in the course of his work
and should not disclose any such information to a third party without specific authority or
unless there is a legal or professional duty to disclose".
In the instant case, the bank has asked the auditor for detailed information regarding few
items in the financial statements available in his working papers. Having regard to the position
stated earlier, the auditor cannot disclose the information in his possession without specific
permission of the client. As far as working papers are concerned, working papers are the
property of the auditor. The auditor may at his discretion, make portions of or extracts from
his working papers available to his client".
Thus, there is no requirement compelling the auditor to divulge information obtained in the
course of audit and included in the working papers to any outside agency except as and when
required by any law.
13. As per Clause (6) of Part I of the First Schedule of the Chartered Accountants Act, 1949, a
Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
solicits clients or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means.
Mr. A is wrong in seeking clients through family and friends. Creating a website is not a non-
compliance provided it is in line with the guidelines issued by the Institute in this regard. One
of the guidelines is that the website should not be in push mode. Further, mentioning of
clients’ names is also prohibited as per the guidelines.
In the given situation, Mr. A shared the website address on his all social media posts and
stories and tagged 30 traders of his local community with the caption “Easy Online Stock
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.169
Certification Services” mentioning his current clients as well. This is in complete
contravention of the guidelines on website issued by the ICAI.
Thus, CA A would be held guilty of professional misconduct under clause 6 of Part 1 of First
Schedule of the Chartered Accountants Act, 1949.
14. As per Clause (4) of Part I of the Second Schedule of the Chartered Accountants Act, 1949,
a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
expresses his opinion on financial statements of any business or enterprise in which he, his
firm, or a partner in his firm has a substantial interest.
Section 141 of the Companies Act, 2013 specifically prohibits a member from auditing the
accounts of a company in which he is an officer or employee. Although the provisions of the
aforesaid section are not specifically applicable in the context of audits performed under other
statutes, e.g. tax audit, yet the underlying principle of independence of mind is equally
applicable in those situations also. Therefore, the Council’s views are clarified in the following
situations.
As per the clarifications issued by the Council, a member shall not accept the assignment of
audit of a Company for a period of two years from the date of completion of his tenure as
Director, or resignation as Director of the said Company.
In the instant case, Mr. D, a practicing CA, is appointed as a Director Simplicitor in XYZ Pvt.
Ltd. After one year of appointment, Mr. D resigned as the Director and accepted the Statutory
Auditor position of the company. In view of above provisions Mr. D cannot accept the
Directorship of the company until the completion of two years after his resignation.
Thus, CA D would be held guilty of professional misconduct under clause 4 of Part 1 of
Second Schedule of the Chartered Accountants Act, 1949.
15. The financial services industry globally is required to obtain information of their clients and
comply with Know Your Client Norms (KYC norms). Keeping in mind the highest standards
of Chartered Accountancy profession in India, the Council of ICAI issued such norms to be
observed by the members of the profession who are in practice.
In the given situation, CA. F, gave GST consultancy, compilation engagement for historical
financial information and helped in ERP set up along with advisory services to PQR Pvt. Ltd.
Mr. F was asked to provide details of the companies as the company, turned out to be a part
of a group of companies, involved in money laundering. Contention of Mr. F that he gave only
consultancy services and compilation engagement for historical financial information to the
company and wasn’t supposed to keep any information about the company is not valid as
© The Institute of Chartered Accountants of India
19.170 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
Mr. F should have kept following information in compliance with KYC Norms which are
mandatory in nature and shall apply in all assignments pertaining to attestation functions.
In the given case of PQR Pvt. Ltd., a Corporate Entity, Mr. F should have kept following
information:
A. General Information
Name and Address of the Entity
Business Description
Name of the Parent Company in case of Subsidiary
Copy of last Audited Financial Statement
B. Engagement Information
Type of Engagement
C. Regulatory Information
Company PAN No.
Company Identification No.
Directors’ Names & Addresses
Directors’ Identification No.
16. As per Clause (12) of Part I of the First Schedule of the Chartered Accountants Act, 1949, a
Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
allows a person not being a member of the institute in practice 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 Council has clarified that the power to sign routine documents on which a professional
opinion or authentication is not required to be expressed may be delegated in the following
instances and such delegation will not attract provisions of this clause:
(i) Issue of audit queries during the course of audit.
(ii) Asking for information or issue of questionnaire.
(iii) Letter forwarding draft observations/financial statements.
(iv) Initiating and stamping of vouchers and of schedules prepared for the purpose of audit.
© The Institute of Chartered Accountants of India
PROFESSIONAL ETHICS & LIABILITIES OF AUDITORS 19.171
(v) Acknowledging and carrying on routine correspondence with clients.
(vi) Issue of memorandum of cash verification and other physical verification or recording
the results thereof in the books of the clients.
(vii) Issuing acknowledgements for records produced. Raising of bills and issuing
acknowledgements for money receipts.
(ix) Attending to routine matters in tax practice, subject to provisions of Section 288 of
Income Tax Act.
(x) Any other matter incidental to the office administration and routine work involved in
practice of accountancy.
In the instant case, Mr. S, the auditor of ABC Pvt. Ltd. has delegated certain task to his
articles and staff such as issue of audit queries during the course of audit, issue of
memorandum of cash verification and other physical verification, letter forwarding draft
observations/financial statements, issuing acknowledgements for records produced and
signing financial statements of the company.
Therefore, Mr. S is correct in allowing first four tasks i.e. issue of audit queries during the
course of audit, issue of memorandum of cash verification and other physical verification,
letter forwarding draft observations/financial statements, issuing acknowledgements for
records produced to his staff and articles.
However, if the person signing the financial statements on his behalf is not a member of the
institute in practice or a member not being his partner to sign on his behalf or on behalf of his
firm, Mr. S is wrong in delegating signing of financial statements to his staff.
Conclusion: In view of this, S would be guilty of professional misconduct for allowing the
person signing the financial statements on his behalf to his articles and staff under Clause 12
of Part 1 of First Schedule of the Chartered Accountants Act, 1949.
17. Given situation can be visualised in following parts:
(A) Mr. S used to involve himself in equity research and used to advise his friends,
relatives and other known people: As per the recent decisions taken by the Ethical
Standards Board of ICAI, a Chartered Accountant in practice may be an equity
research adviser, but he cannot publish a retail report, as it would amount to other
business or occupation.
In the given case, though Mr. S is involved in doing equity research and in advising
people, it is clear that he does not publish any retail report of his research. Hence, this
act of Mr. S shall not make him guilty of professional misconduct.
© The Institute of Chartered Accountants of India
19.172 ADVANCED AUDITING, ASSURANCE AND PROFESSIONAL ETHICS
(B) Mr. S is involved in paper-setting for the Accountancy subject in the school where he
studied. He also owns agricultural land and does agriculture activities: As per Clause
11 of Part I of First Schedule of Chartered Accountants Act and regulation 190A of
Chartered Accountants Regulations, a Chartered Accountant in practice is deemed to
be guilty of professional misconduct if he engages in any business or occupation other
than the profession of chartered accountant unless permitted by the Council so to
engage.
Further, Regulation 190A mentions the 'Permissions granted Generally' to engage in
a certain category of occupations, for which no specific permission of Council is
required. Those cases include:
- Valuation of papers, acting as paper-setter, head examiner or a moderator, for
any examination.
- Owning agricultural land and carrying out agricultural activities.
Therefore, in the given case, the activities of Mr. S as a paper-setter and involvement
in agricultural activities do not make him guilty of professional misconduct.
(C) Mr. S was discharged insolvent: Disabilities for the Purpose of Membership :
Section 8 of the Chartered Accountants Act, 1949 enumerates the circumstances
under which a person is debarred from having his name entered in or borne on the
Register of Members, If he, being a discharged insolvent, has not obtained from the
court a certificate stating that his insolvency was caused by misfortune without any
misconduct on his part. Here it may be noted that a person who has been removed
from membership for a specified period shall not be entitled to have his name entered
in the Register until the expiry of such period.
In addition, failure on the part of a person to disclose the fact that he suffers from any
one of the aforementioned disabilities would constitute professional misconduct. The
name of the person, who is found to have been subject at any time to any of the
disabilities discussed in section 8, can be removed from the Register of Members by
the Council.
In the given case, it is clearly stated that Mr. S was discharged insolvent, and he has
also obtained from the court a certificate stating that his insolvency was caused by
misfortune without any misconduct on his part. Hence, Mr. S has not violated the
provisions of Section 8, and he is not debarred from having his name entered in the
Register of Members.
© The Institute of Chartered Accountants of India
AUDITING PRONOUNCEMENTS
S. No. Engagement & Quality Control Stadnards
1. SQC 1, “Quality Control for Firms that Perform Audit 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. Revised SA 260, Communication with Those Charged with Governance
9. SA 265, Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management
10. Revised 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
Organisation
16. SA 450, Evaluation of Misstatements Identified During the Audit
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. Revised SA 570, Going Concern
27. SA 580, Written Representations
28. SA 600, Using the Work of Another Auditor
29. Revised SA 610, Using the Work of Internal Auditors
30. SA 620, Using the Work of an Auditor’s Expert
31. Revised SA 700, Forming an Opinion and Reporting on Financial Statements
32. SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report
33. Revised SA 705, Modifications to the Opinion in the Independent Auditor’s
Report
34. Revised 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. Revised SA 720, The Auditor’s Responsibilities Relating to Other Information
37. SA 800, Special Considerations—Audits of Financial Statements Prepared in
Accordance with Special Purpose Frameworks
38. SA 805, Special Considerations—Audits of Single 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 (Revised), 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 (Revised), Compilation Engagements
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