3:Auditing standards

Q1) S.A. 250: Consideration of laws and regulations in an audit of financial statements?

Ans: > When planning and performing audit procedures and in evaluating and reporting the results
thereof, the auditor should recognise that non-compliance by the entity with laws and regulations
may materially affect the financial statements.

> Non-compliance are acts of omissions by the entity which are company to prevailing laws and
regulations. It is the management’s responsibility to comply with laws and regulations. The
auditor is not and cannot be held responsible for detection of non compliances. The risk of non
detection of non-compliances is greater than risk of nondetection of fraud.

> Whether an act constitutes non-compliance is a legal determination that is ordinarily beyond the
auditor’s professional competence. The auditor’s training, experience and understanding of the
entity and its industry may provide a basis for recognition that some acts coming to the auditor’s
attention may constitute non-compliance with laws and regulations.

> The auditor should verify whether the company has complied with Schedule VI requirements
regarding disclosure in financial statements. He should also check whether the organisation has
complied with laws relating to gratuity, bonus, Provident Fund, etc.

> Other than the above laws and regulations, the auditor should verify whether other laws and
regulations have been complied with. He must evaluate the effect of the noncompliance on the
financial statements. Even immaterial non-compliance should not be overlooked as these have
implication on the integrity of the management.

> In accordance with specific statutory requirements, the auditor may be specifically required to
report as part of the financial statements whether the entity complies with certain provisions of
laws or regulations. In these circumstances, the auditor should plan to test of compliance with
these provisions of the laws and regulations.

> In order to plan the audit, the auditor should obtain a general understanding of the legal and
regulatory framework applicable to the entity and how the entity is complying with that
framework.

> After obtaining the general understanding the auditor should perform procedures to identify
instances of non-compliance with those laws and regulations.

> The auditor should obtain written representations that management has disclosed to the auditor
all known. Actual or possible non-compliance with laws and regulations whose effects should be
considered when preparing financial statements.

> When the auditor believes that there may be non-compliance, the auditor should document the
finding and discuss them with the management. If management does not provide satisfactory
information. The auditor should consult the entity’s legal department about the application of the
laws and the possible effects on the financial statements.
> If the auditor finds that non-compliance affects the true and fair position of the financial
statements, he must communicate to the Board of Directors, the Audit Committee and senior
management, especially where he is of opinion that it is intentional.

> If the entity does not take remedial action on his communication of the noncompliance, he may
feel that withdrawal from the engagement is necessary. If he decides to withdraw from
engagement on account of non-compliances, he should, in response to the incoming auditor’s
communication, mention the facts to him without disclosing unnecessary details.

Q2) S.A. 210: Agreeing the terms of audit engagement?

Ans: > An “Engagement Letter” is a written contract between the auditor and the client that serves
to minimize misunderstanding. Though the objective and scope of the audit and the auditor’s
obligation are normally laid down in the applicable statute or regulations and the
pronouncements of the ICAI, the audit engagement letters would be information to the client.

> In the interest of both the client and the auditor, the auditor should send an engagement letter,
preferably before the commencement of the engagement. The engagement letter documents and
confirms the auditor’s acceptance of the appointment, the objective and scope of the audit and
the extent of the auditor’s responsibilities to the client.

> An engagement letter would normally include-

1) Objective of audit of financial statements

2) Management’s responsibility for making judgment and estimates that are reasonable and
prudent so as to give true and fair view of the state of affairs of the entity at the end of the
financial year and of the profit or loss of the entity for that period.

3) Management’s responsibility for maintenance of adequate accounting records and internal

controls for safeguarding the assets of the company and for preventing and detecting frauds or
other irregularities.

4) The scope of the audit, including – reference to the applicable legislation, regulation and the
pronouncements of the ICAI.

5) The fact that having regard to the test nature of an audit, persuasive rather than conclusive
nature of audit evidence together with inherent limitations of any accounting and internal control
system there is an unavoidable risk that even some material misstatements, resulting from fraud,
and to a lesser extent error exist may remain undetected.

6) The fact that audit process may be started to a peer review under the Chartered Accounting Act,
1949.

7) Basis on which fees are computed.

8) Expectation of receiving from management written confirmation concerning representations

made in connection with the audit.

9) Arrangements concerning the involvement of other auditors and experts in some aspects of
audit.

10) Any restriction of the auditor’s liability when such possibility exists.

> Recurring audits

1) On recurring audits, the auditor should consider whether circumstances require the terms of
engagement to be reviewed and whether there is a need to remind the client of the existing terms
of the engagement.

2) The following factors may make it necessary to send a new letter:

i) Any indication that the client misunderstands the objective and scope of the audit.
ii) Any revised or special terms of the engagement.
iii) A recent change of senior management, Board of Directors.
iv) A significant change in nature and size of the client’s business.
v) Legal requirements or pronouncements of the ICAI, or changes in the existing ones.

> Changes in Audit Engagement – During the course of audit, if the terms of engagement are
changed to provide a lower level of assurance then the auditor should –

1) Examine the reason for such change along with its reasonableness.
2) Consider legal or contractual implications of the change.

If the auditor is of the opinion that change in terms of engagement is reasonable he should issue
audit report according to the changed terms. However, if he is of the opinion that change in terms
of engagement is unreasonable and is not allowed by the client to continue the original
engagement, he should withdraw and communicate the reasons of withdrawal to the Board of
Directors or to shareholders.

Q3) S.A. 505: External confirmations

> External confirmation is the process of obtaining and evaluating audit evidence through a direct
communication from a third party in response to a request for information about a particular item
affecting assertions made by management in the financial statements.

> External confirmation in the process ordinarily consists of the following:

1) Select the items like debtors, creditors, bank balances, etc for which confirmations are required.
2) Design the form of confirmation requests.
3) Communicate the requests to the third party concerned.
4) Obtaining the response from the third party.
5) Evaluating the information or non-receipt of confirmations.

> The auditor may use positive or negative external confirmations.

1) A positive external confirmation request asks the respondent to reply to the auditor in all
circumstances.
2) The use of a positive external confirmation is preferable when the individual account balances
are large, or when the internal controls are weak, or where the auditor has reasons to believe that
there may be substantial number of accounts in dispute inaccurate or irregular.
3) The auditor should perform alternative procedures when no response is received to a positive
external confirmation request. The alternative procedures should be such as to provide the
evidence about the financial statement assertion that the confirmation request was intended to
provide.
4) A negative confirmation request asks to respond only if he is in disagreement with the
information provided in the request.

> When performing confirmation procedures, the auditor should maintain control over the process
of selection of those to whom a request will be sent, the preparation and sending of confirmation
request, and the responses to those requests. The auditor should ensure that the requests are
properly addressed, and that it is requested that all replies and undelivered confirmations are
delivered directly to the auditor.

> The auditor should consider whether there is any indication that external confirmations received
may not be reliable. The auditor should consider the authenticity of the response and perform
appropriate procedures to dispel any doubts.

> Any discrepancies revealed by the external confirmations received or by the procedures carried
out by the auditor might have a bearing on the assertion and the accounts within the given
assertion not selected for external confirmation. In such a case, the auditor should request the
management to verify and reconcile the discrepancies.

> If auditor wants to confirm a particular debtor/creditor balance and management requests him
not to do so, the auditor should

1) Ask the management to give the request in writing with reasons.

2) Ascertain gentility of management’s reasons by examining documentary evidence.

> If the auditor accepts management’s request, he should

1) Document the reasons for accepting the request.
2) Perform alternative procedures to obtain evidence regarding that matter.

> If the auditor does not accept the request and is prevented from confirming
1) It is a limitation on scope of auditor’s work.
2) He should consider its possible impact on his report.
3) He should consider the reliability of management’s explanations.

Q4)Meaning of auditing standards?