Audit

1. Environment and Energy audit.

2. Risk Based Auditing.
3. Audit committee and how it is interrelated with corporate Governance.
4. Aspects to be governed in Reinsurance ceded.
5. Uses of CAAT (Computer Assisted Audit Technique).
6. Peer review.
7. What is engagement letter? What are its principle content?
8. What are the assertion concern of auditor while conducting substantive procedure?
9. What are to be considered in the audit program of Bank and Financial Institutions?
10. Mr. X auditor of Y ltd, he stays in the building which is owned by Y ltd. so he
provided 10% rebate than others.
11. ABC Co. has suspended large amount on training staff Project to be started in
future, which will generate future income. Management wants to capitalize that
expense.
12. Mr. Ram was appointed as tax auditor and consultant of ABC Co. after the year-
end tax office charge legal proceeding to ABC co. for understated income.
13. Mr. X accepted audit of Z ltd. for less fee than the preceding auditor of Z ltd. The
preceding auditor had come from the far away the cost of which was not charged as
audit fees.
14. SCB provided credit card facilities to professional CAs. Now he used it to withdraw
Rs. 25,000 how can that CA be appointed as auditor of that bank?
15. KBC and Co. CA firm was provided Rs.200, 000 in Baisakh 1st By Ram Br. who is
client of that firm KBC & Co deposited in bank to give back Ram Br. in Ashad..
16. Related party Disclosure

Related with 2nd paper

1. tax practice of code of ethics
2. Working papers ( can management ask back)
3. You have issued a modified report as you are not agreed with the method of
accounting folloed by the co. for gratutity .The BOD suggests a note in FS may be
added.
4. Purchase of equipment for 1 cr..The 30 lacs is govt. grant depreciation at
15%.Accountant insists to credit the capital reserve for gratn received and charge
the deprn on original cost to revenue

Physical capital maintenance and financial cap Maintain acne ( NAS Framework)
Control environment and Control procedure (8*2=16 marks)

Special point to be considered in audit of public sector enterprise

Internal control 16

Management representation letter and reliance on it by the auditor

An auditor can give only reasonable assurance not absolute. 16

Short notes 16
Fair value accounting
Management representation letter
Qualitative characteristics of financial statements
Corporate governance
Auditor responsibility in detecting fraud and error
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 Indicators for assuming going concern assumption 16

1. Environmental and energy audit

Environmental Audit: Environmental reporting deals with the disclosure by an entity of environmentally related
data, regarding environmental risks, environmental impacts, policies, strategies, targets, costs, liabilities or
environmental performance to those who have an interest in such information as an aid to enabling/enriching
their relationship with the reporting entity via either the annual report; a stand-alone corporate environmental
performance report; or some other medium (e.g. staff newsletter, video, CD ROM, internet site). The reports
that are generated after such audits can be either compliance-based reporting or impact-based performance
reporting.
Environmental audit deals with verification of information contained in such reports with a view
to expressing an opinion thereon. Environmental audit can be performed by external agencies or
internal experts (including internal auditors). In practice, environmental audit is not done by a
single agency but by various agencies who are experts in the field. Since the subject matter of
environmental audit involves multi-disciplinary knowledge and skill, it is preferable to form a
team of persons drawn from different disciplines who may assist the chartered accountant in
performing the task in an effective manner, generally environmental audits are not required by
any statute but are sometimes done at the request of the management to address issues like
compliance with environmental laws and regulations, etc.

Key functions of Energy Auditor

Energy auditing is defined as an activity that serves the purposes of assessing energy use pattern of a factory
or energy consuming equipment and identifying energy saving opportunities . In that context, energy
management involves the basis approaches reducing avoidable losses, improving the effectiveness of energy
use, and increasing energy use efficiency. The function of an energy auditor could be compared with that of a
financial auditor. The energy auditor is normally expected to give recommendations on efficiency
improvements leading to monetary benefits and also advise on energy management issues . Generally, energy
auditor for the industry is an external party. The following are some of the key functions of the energy auditor:
(i) Quantification of energy costs and quantities
(ii) To correlate trends of production or activity to energy cost.
(iii) To devise energy database formats to depict to correct picture – By product, department or consumer.

2. Risk Based Auditing

Traditional audits focus primarily on compliance with rules and procedures, and their recommendations
may not give management enough information about the achievement of organizational goals. RBA
involves high-level risk profiling of the audit portfolio over time; thus it facilitates strategic use of scarce audit
resources, aligns audit efforts with management objectives, facilitates institutional development, and reduces
risk exposure by focusing attention on areas of weakness. In RBA, risk is measured by assessing the ethical
climate, competence of personnel, size of assets and of operations, materiality, and results of previous audits.
Direct probability estimates, normative tables, and comparative risk ranking are typically used to identify risk.
Risk factors are then converted from conceptual and subjective (qualitative) data into quantitative data. An
overall risk score is derived by scoring and weighing the risk factors. The result is a risk-based engagement
plan that guides the deployment of audit resources to high-risk areas.

The risk-based audit (RBA) approach seeks to improve audit effectiveness and efficiency by shifting the
function from a policing activity to one that contributes effectively to managing risk and achieving wider
organizational goals. The approach aims to increase the accountability of government ministries and line
agencies by ensuring transparency, validating key systems of internal control, and committing resources
against key risks. Underlying the early signs of success of a recent RBA pilot in Kenya were strong

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support for the pilot from the Bank’s Auditor General and the incorporation of some key lessons the
Bank has learned about development interventions— particularly about the importance of country
ownership, local champions, partners, and a long-term perspective.

3. Audit committee and how it is interrelated with corporate Governance.

164. Audit Committee:

(1) A listed company with paid up capital of thirty million rupees or more or a company
which is fully or partly owned by the Government of Nepal shall form an audit
committee under the chairmanship of a director who is not involved in the day-to-day
operations of the company and consisting of at least three members.
(2) Any person who is a close relative of the chief executive of a company shall not be
eligible to be a member of the audit committee formed pursuant to sub-section (1).
(3) At least one member of the audit committee shall be and experienced person having
obtained professional certificate on accounting or a person having gained experience
in accounting and financial field after having obtained at least bachelor’s degree in
accounts, commerce, management, finance or economics.
(4) The report of board of directors required to be prepared by a company shall set out a short
description of the activities of the audit committee, working policies adopted by the board of
directors to implement the suggestions, if any, given by the audit committee, the
allowances or facilities, if any, received by the members of the audit committee and the
names of the members of audit committee.
(5) The audit committee may, for inquiring into any matter, notify the managing directo r of the
company, chief executive of the company or other director, auditor, internal auditor and
accounts chief involved in the day-to-day operations of the company to attend its meeting;
and shall it be their duty to be present in the meeting of that committee if they are so
notified.
(6) The board of director shall implement the suggestions given by the audit committee in
respect of the accounts and financial management of the company; and where any
suggestion cannot be implemented, the board of directors shall also mention the reasons
for the same in its report.
(7) Any company shall arrange for such means and resources as may be adequate for the
fulfillment of responsibilities of the audit committee; and the audit committee may fix
its internal rules of procedures on its own.
(8) The chairman of the audit committee shall be present in the annual general meeting of
the company.
(9) The audit committee shall meet as per necessity.

165. Functions, Duties and Powers of the Audit Committee:

The functions, duties and powers of the audit committee formed pursuant to sub-section (1) of
section 164 shall be as follows:
(a) To review the accounts and financial statements of the company and ascertain
the truth of the facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system of
the company;
(c) To supervise and review the internal auditing activity of the company;
(d) To recommend the names of potential auditors for the appointment of the
auditor of the company, fix the remuneration and terms and conditions of
appointment of the auditor and present the same in general meeting for the
ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed
such conduct, standards and directives determined by the competent body

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 pursuant to the prevailing law as required to be observed in the course of doing
auditing work;
(f) Based on the conduct, standards and directives determined by the competent
body pursuant to the prevailing law, to formulate to policies required to be
observed by the company in respect of the appointment and selection of the
auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause
to be enforced, the same;
(h) Where any regulator body has provided for the long form audit report to be
set out in the audit report of the company, to comply with the terms required
to prepare such report;
(i) To perform such other terms as prescribed by the board of directors in respect
of the accounts, financial management and audit of the company.

4. Aspects to be governed in Reinsurance ceded.

Steps in Audit of Reinsurance ceded:

(i) Evaluate internal control system in the area of reinsurance ceded to ensure determination of correct
amount for reinsurance ceded, proper valuation of assets and liabilities arising out of reinsurance
transaction and adherence to legal provisions and regulations.
(ii) Ascertain whether adequate guidelines and procedures are established with respect to obtaining
reinsurance.
(iii) Reconcile reinsurance underwriting returns received from various units with the figures of premium,
claims paid and outstanding claims for the company as a whole.
(iv) Examine whether commission on reinsurance ceded is as per the terms of the agreement with the
re-insurers.
(v) Examine the computation of profit commission for automatic treaty arrangements in the light of the
periodic accounts rendered and in relation to outstanding loss pertaining to the treaty.
(vi) Examine whether loss recoveries have been claimed and accounted on a regular basis.
(vii) Examine whether outstanding losses recoverable have been confirmed by re-insurers.
(viii) Examine whether remittances to foreign re-insurers are as per foreign exchange regulations.
(ix) Examine whether confirmations have been obtained regarding balances with re-insurers.
(x) Review individual accounts of re-insurers to evaluate whether any provision/write off or write back is
required.

5. Uses of CAAT (Computer Assisted Audit Technique).

Computer Assisted Audit Techniques (CAATs) refer to those auditing techniques that take assistance of a
computer for being applied to an audit in a computer environment. The use of computer-assisted audit
techniques may be required because:
(i) the absence of input documents (e.g. order entry in on-line systems), or the generation of accounting
transactions by computer program (e.g. automatic calculation of discounts) may preclude the auditor
from examining documentary evidence;
(ii) the lack of a visible audit trail will preclude the auditor from visually following transactions through
the computerised accounting system; and
(iii) the lack of visible output may necessitate access to data retained on files readable only by the
computer.
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 The auditor may, however, decide to take advantage of the fact that much of the information is available
in a form, which can be tested electronically. Alternatively, the auditor could be forced to abandon manual
tests because there is no visible audit trail. In either case, the auditor must use either software or
specially prepared audit data to test the inner workings of the company's system. This is known as
auditing 'through the machine'. The methods by which this is done are known as 'computer assisted audit
techniques' (CAATs).
CAATs enable the auditor to save time by examining data stored on computer media rather than on print-
outs or other documents and, in some cases, to conduct tests which cannot be done manually because
there is no visible evidence or audit trail. CAATs can be used for both compliance and substantive testing.
CAATs may be used in performing various auditing procedures, including:
(i) Tests of details of transactions and balances for example the use of audit software to test all (or a
sample) of the transactions in a computer file.
(ii) Analytical review procedures - for example, the use of audit software to identify unusual fluctuations
of items.
(iii) Compliance test of general EDP controls - for example, the use of test data to test access
procedures to the program libraries.
(iv) Compliance tests of EDP application controls - for example, the use of test data to test the
functioning of a program procedure.
The most common types of CAA Ts used for audit purposes are discussed below:
(a) Audit Software: Audit software consists of computer program used by the auditor as a part of his
auditing procedure to process data of audit significance. It may consist of:
(i) Package programs: These are generalised computer programs designed to perform data
processing which includes reading computer files, selecting information, performing
calculations, creating data files and printing reports in a format as specified by the auditor.
(ii) Purpose written programs: These are computer programs designed to perform audit tasks is
specific circumstances. These programs may be prepared by the auditor, by the organisation or
by an outside programmer engaged by the auditor. In some cases, the programs existing in the
organisation may be used by the auditor in their original or in a modified state because it may
be more economical and effective than developing independent program.
(iii) Utility programs: These are used by the organisation to perform common data processing
functions, such as sorting, creating and printing files. These programs are generally not
designed for audit purposes and therefore may not contain such features as automatic record
counts or control totals.
(b) Test Data: Test data techniques are used in conducting audit procedures by entering data into the
computer system of the organisation and comparing the results obtained with pre-determined results.
For example:
(i) Test data used to test specific controls in computer programs, such as, on line password and
data access controls.
(ii) Test transactions selected from previously processed transactions preferably historical data or
data treated by the auditor to test specific processing characteristics of the organisation's
computer system. Such transactions are generally processed separately from the entity's
normal processing.
 (iii) Test transactions used in an integrated test facility where a 'dummy' unit is
established and to which test transactions are posted during the normal processing.
When test data is processed with the organisation's normal processing the auditor should ensure
that the test transactions are subsequently eliminated from accounting records of the organisations.

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6. What is engagement letter? What are its principle content?

NSA 2 Audit Engagement Letters

05 The auditor and the client should agree on the terms of the engagement. The agreed
terms would need to be recorded in an audit engagement letter or other suitable form of
contract. It is in the interest of both client and auditor that the auditor sends an engagement
letter, preferably before the commencement of the engagement, to help in avoiding
misunderstandings with respect to the engagement. The engagement letter documents and
confirms the auditor's acceptance of the appointment, the objective and scope of the audit,
the extent of the auditor's responsibilities to the client and the form of any reports.
Principal Contents

The form and content of audit engagement letters may vary for each client , but they would
generally include reference to :

 The objective of the audit of financial statements.

 Management's responsibility for the financial statements.
 The scope of the audit, including reference to applicable legislation, regulations or
pronouncements of the Institute of Chartered Accountants of Nepal (ICAN).
 The form of any reports or other communication of results of the engagement
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of any accounting and internal control system, there is an
unavoidable risk that even some material misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other information requested in
connection with the audit.

The auditor may also wish to include in the letter:

 Arrangements regarding the planning of audit.

 Expectation of receiving from management written confirmation concerning
representations made in connection with the audit.
 Request for the client to confirm the terms of the engagement by acknowledging receipt of the
engagement letter.
 Description of any other letters or reports the auditor expects to issue to the client.
 Basis on which fees are computed and any billing arrangement.

When relevant, the following points could also be made:

 Arrangements concerning the involvement of other auditors and experts in some aspects
of the audit.
 Arrangements concerning the involvement of internal auditors and other client staff.
 Arrangements to be made with the predecessor auditor, if any, in the case of an initial
audit.
 Any restriction of the auditor's liability when such possibility exists.
 A reference to any further agreements between the auditor and the client.
 An example of an audit engagement letter is set out in the Appendix of this NSA.

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7. What are the assertion concern of auditor while conducting substantive procedure?

Substantive Procedures: AAS- 1 on “Basic Principles Governing an Audit”, lists ‘audit evidence’ as one of the
basic principles governing an audit of financial statements. AAS-1 requires that an auditor should perform
audit procedures, viz., compliance procedures and substantive procedures to obtain sufficient and appropriate
evidence.
As per AAS- 1, substantive procedures are designed to obtain evidence as to the completeness, accuracy and
validity of the data produced by the accounting system. These procedures comprise tests of details of
transactions and balances and analysis of significant ratios and trends including the resulting investigation of
unusual fluctuations and items.
Obtaining audit evidence from substantive procedures is intended to reasonably assure the auditor in respect
of the following assertions:
Existence - that an asset or a liability exists at a given
date.
Rights and Obligations - that an asset is a right of the entity and a
liability is an obligation of the entity at a given
date.
Occurrence - that a transaction or event took place which
pertains to the entity during the relevant
period.

Completeness - that there are no unrecorded assets, liabilities

or transactions.
Valuation - that an asset or liability is recorded at an
appropriate carrying value.
Measurement - that a transaction is recorded in the proper
amount and revenue or expense is allocated
to the proper period.

Presentation and Disclosure - an item is disclosed, classified, and described

in accordance with recognised accounting
polices and practices and relevant statutory
requirements, if any.

The extent and nature of substantive procedures to be performed will vary with respect to each of the above
assertions. Obtaining evidence relevant to one of the above assertions will not compensate for failure to do so
with respect to another matter concerning the same item, e.g., existence of inventory and its valuation.
Substantive procedures are classified in two categories, viz., tests of detail and analytical procedures. Tests of
details involve vouching which primarily deals with transactions and verification normally deals with balances
contained in the balance sheet. By performing analytical procedures which aim at calculation of ratios, trends,
etc. also aim to provide the auditor with substantive evidence to validate the items contained in financial
statements. Such procedures are normally conducted after the auditor has conducted compliance procedures
and will be affected by the following factors:
 Results of the compliance procedures

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 Responses to inquiries as to whether the internal system is functioning
 Auditors’ evaluation of the internal control environment, especially supervisory controls
 Nature and amount of the transactions or balances involved

8. What are to be considered in the audit program of Bank and Financial Institutions?

9. Peer Review

"3.4 Peer Review means an examination and review of the systems and procedures to determine whether they
have been put in place by the practice unit for ensuring the quality of attestation services as envisaged and
implied/mandated by the Technical Standards and whether these were effective or not during the period under
review".
1.04 The examination and review of a practice unit would be carried out by a "reviewer", i.e., a member,
selected from a panel of reviewers maintained by the Board. The term "practice unit" means members in
practice, whether practising individually or in a trade name (either as a sole proprietor or as a firm).

The main objective of Peer Review is to ensure that in carrying out their attestation services assignments ;
the members of the Institute (a) comply with the Technical Standards made mandatory for application
by the Institute and (b) have in place proper systems ( including documentation systems) for
maintaining the quality of the attestation services work they perform. The Council has specified
in this Statement on Peer Review, the Technical Standards in relation to which peer reviews are
to be carried out. Peer review does not seek to redefine the scope and authority of the Technical
Standards promulgated by the respective Standards Boards but seeks to ensure their
implementation both in letter and spirit.

Scope of Peer Review

7.1 The peer review process is directed at the attestation services of a practice unit.
7.2 Once a practice unit is selected for review, its attestation engagement records pertaining to
the immediately preceding three completed financial years shall be subjected to review. Provided that the
records of audit reports/attestation services relating to years prior to the accounting year
beginning 1 Srawan 2062 (15.07.2005) shall not be subjected to review.
7.3 The Review shall focus on:
(i) Compliance with Technical Standards.
(ii) Quality of Reporting.
(iii) Office systems and procedures for carrying out attestation services
(iv) Training Programs for staff (including Articled Trainees) concerned with attestation functions, including
availability of appropriate infrastructure thereof.

(a) Mr. Rahul, a locally based Chartered Accountant, accepted an audit assignment at a fee lower than that
charged by the previous auditor, who was stationed in another town and had to spend a lot of money on
travel for which he did not charge separately. (4 Marks)

Undercutting of fees: The case of Mr. Rahul should be analysed in the light of clause 12 of Part I of First
Schedule to the Chartered Accountants Act, 1949. Clause 12 of the said Schedule deems a Chartered
Accountant in practice to be guilty of professional misconduct “if he accepts a position as auditor
previously held by some other chartered Accountant or a restricted state auditor in such conditions as to
constitute undercutting’’. In considering whether variation in fees charged would constitute undercutting
the following factors should be considered:
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 - the quantum of work;
- incidental and out of pocket expenses and
- other terms of appointment.
Since the previous auditor was stationed in another town and therefore, had to incur higher cost on
account of conveyance, and the previously the fee was decided on a composite basis inclusive of
traveling expenses of the auditor, it cannot be said that Mr. Rahul has accepted an audit assignment
based on under cutting of fees. Accordingly, Clause 12 will not be attracted.

Other sets

1. Physical capital maintenance and Financial capital maintenance

Concepts of capital maintenance and the determination of profit

104. The concepts of capital in paragraph 102 give rise to the following concepts of capital
maintenance:
(a) Financial capital maintenance. Under this concept a profit is earned only if the financial (or money)
amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at
the beginning of the period, after excluding any distributions to, and contributions from, owners during
the period. Financial capital maintenance can be measured in either nominal monetary units or units of
constant purchasing power.
(b) Physical capital maintenance. Under this concept a profit is earned only if the physical productive
capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at
the end of the period exceeds the physical productive capacity at the beginning of the period, after
excluding any distributions to, and contributions from, owners during the period.
105. The concept of capital maintenance is concerned with how an entity defines the capital that it seeks
to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it
provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between
an entity’s return on capital and its return of capital; only inflows of assets in excess of amounts needed
to maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the
residual amount that remains after expenses (including capital maintenance adjustments, where
appropriate) have been deducted from income. If expenses exceed income the residual amount is a net
loss.
106. The physical capital maintenance concept requires the adoption of the current cost basis of
measurement. The financial capital maintenance concept, however, does not require the use of a
particular basis of measurement. Selection of the basis under this concept is dependent on the type of
financial capital that the entity is seeking to maintain.
107. The principal difference between the two concepts of capital maintenance is the treatment of the
effects of changes in the prices of assets and liabilities of the entity. In general terms, an entity has
maintained its capital if it has as much capital at the end of the period as it had at the beginning of the
period. Any amount over and above that required to maintain the capital at the beginning of the period is
profit.
108. Under the concept of financial capital maintenance where capital is defined in terms of nominal
monetary units, profit represents the increase in nominal money capital over the period. Thus, increases
in the prices of assets held over the period, conventionally referred to as holding gains, are, conceptually,
profits. They may not be recognised as such, however, until the assets are disposed of in an exchange
transaction. When the concept of financial capital maintenance is defined in terms of constant purchasing
power units, profit represents the increase in invested purchasing power over the period. Thus, only that
part of the increase in the prices of assets that exceeds the increase in the general level of prices is
regarded as profit. The rest of the increase is treated as a capital maintenance adjustment and, hence, as
part of equity.

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109. Under the concept of physical capital maintenance when capital is defined in terms of the physical
productive capacity, profit represents the increase in that capital over the period. All price changes
affecting the assets and liabilities of the entity are viewed as changes in the measurement of the physical
productive capacity of the entity; hence, they are treated as capital maintenance adjustments that are part
of equity and not as profit.
110. The selection of the measurement bases and concept of capital maintenance will determine the
accounting model used in the preparation of the financial statements. Different accounting models exhibit
different degrees of relevance and reliability and, as in other areas, management must seek a balance
between relevance and reliability. This Framework is applicable to a range of accounting models and
provides guidance on preparing and presenting the financial statements constructed under the chosen
model. At the present time, it is not the intention of the ASB to prescribe a particular model other than in
exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary
economy. This intention will, however, be reviewed in the light of development of accountancy
profession in the country.

Control environment and control procedures

11. “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. The internal control system extends beyond those matters which relate directly to
the functions of the accounting system and comprises:

(a) “The control environment” which means the overall attitude, awareness and actions of
directors and management regarding the internal control system and its importance in the
entity. The control environment has an effect on the effectiveness of the specific control
procedures. A strong control environment, for example, one with tight budgetary
controls and an effective internal audit function, can significantly complement specific
control procedures. However, a strong environment does not, by itself, ensure the
effectiveness of the internal control system. Factors reflected in the control environment
include:

• the function of the board of directors and its committees,

• management’s philosophy and operating style,

• the entity’s organisational structure and methods of assigning authority and

responsibility and

• management’s control system including the internal audit function, personnel

policies and procedures and segregation of duties.

(b) “Control procedures” which means those policies and procedures in addition to the
control environment which management has established to achieve the entity’s specific
objectives. Specific control procedures include:

• reporting, reviewing and approving reconciliations,

• checking the arithmetical accuracy of the records,

• controlling applications and environment of computer information systems, for

example, by establishing controls over:

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 • changes to computer programs

• access to data files.

• maintaining and reviewing control accounts and trial balances,

• approving and controlling of documents,

• comparing internal data with external sources of information,

• comparing the results of cash, security and inventory counts with accounting
records,

• limiting direct physical access to assets and records and

• comparing and analysing the financial results with budgeted amounts.

12. In the audit of financial statements, the auditor is only concerned with those policies and
procedures within the accounting and internal control systems that are relevant to the financial
statement assertions. The understanding of relevant aspects of the accounting and internal control
systems, together with the inherent and control risk assessments and other considerations, will
enable the auditor to:
AUDITING
(a) identify the types of potential material misstatements that could occur in the financial
statements;

(b) consider factors that affect the risk of material misstatements; and

(c) design appropriate audit procedures.

13. When developing the audit approach, the auditor considers the preliminary assessment of control
risk (in conjunction with the assessment of inherent risk) to determine the appropriate detection
risk to accept for the financial statement assertions and to determine the nature, timing and extent
of substantive procedures for such assertions.

Scope of Audit of pubic sector undertakings

3.1 The audit should be organized to cover adequately all aspects of the enterprise as

far as these are relevant to the financial statements being audited and should be

reasonably satisfied that:

a) The information contained in the underlying accounting records and other source data is
reliable and sufficient; and

b) Whether the relevant information is properly disclosed in the financial statements subject to
statutory requirements, where applicable.

3.2 Assess the reliability and sufficiency of the information by:

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a) Studying and evaluating accounting systems and internal controls to determine the
nature, extent and timing of other auditing procedures; and

b) Carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as considered appropriate in the circumstances.

3.3 Determine whether the relevant information is properly disclosed in the financial

statements by:

a) Comparing the financial statements with the underlying accounting records and other
source data; and

b) Considering the judgment that management has made in preparing the financial
statements, accordingly, assess the selection and consistent application of accounting
policies, the manner in which the information has been classified, and the adequacy of
disclosure.

3.4 Because of the test nature and other inherent limitations of an audit, together with

the inherent limitations of any system of internal control, there is an unavoidable risk that

some material misstatement may remain undiscovered. The auditor should design audit

steps and procedures to provide reasonable assurance of detecting errors, irregularities

and illegal acts that could have a direct and material effect on the financial statement

amounts or the results of regularity audits. The audit cannot, therefore, be relied upon to

ensure discovery of all frauds or errors but where the auditor has any indication that

some fraud or error may have occurred, which could result into material misstatement it

should extend its procedures to confirm or dispel its suspicions.

3.5 the auditor should consider items which either individually or as a group are

material:

a) In general terms, a matter may be judged material if knowledge of it would be likely to

influence the user of the financial statements or the audit report.

b) Materiality is often considered in terms of value but the inherent nature or characteristics
of an item or group of item may also render a matter material for example, where law or
regulation requires if to be disclosed separately regardless of the amount involved.

3.6 Verification that expenditures correspond to the budgets as approved by the

authorities. Briefly analyse the deviations between budgeted and effective expenses.

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 3.7 Verification of the respect of purchasing procedures and also that goods

purchased are utilized within the foreseen objectives and are still available or have been

ceded/sold in conformity with the methods defined in audited entitys rules and

regulations.

3.8 Verification of the transactions under the following aspects:

a) Conformity of expenditure authorizations and validity of the supporting documents;

b) Arithmetic accuracy of accounts, supporting documents and financial statements;

c) Accuracy of the bookkeeping entries;

d) Allocation of expenditures in conformity with budgets;

e) Verification that contracts are in conformity with prevailing laws and regulation;

f) Verification that receipts are exhaustively and regularly accounted for;

g) Control of advances, accrued or in abeyance, justification for amounts overdue or

outstanding for long.

3.9 Verification that the accounting systems in use responds to the needs of

managements, particularly as concerns cost analysis.

3.10 Verification that all corrections required from previous audit have been carried

out.

Planning

5.1.1 The auditor should plan the audit in a manner which ensures that an audit of high

quality is carried out in an economic, efficient and effective way and in a timely manner

5.1.2 In planning the audit, the auditor should:

a) Identify important aspects of the environment in which the audited entity operates;

b) Develop an understanding of the accountability relationships;

c) Consider the form, content and users of audit opinions, conclusions or reports;

d) Specify the audit objectives and the tests necessary to meet them;
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e) Identify key management systems and controls and carry out a preliminary assessment to
identify both their strengths and weaknesses;

f) Determine the materiality of matters to be considered;

g) Review the internal audit of the audited entity and its work program;

h) Assess the extent of reliance that might be placed on other auditors, for example, internal
audit;

i) Determine the most efficient and effective audit approach;

j) Provide for a review to determine whether appropriate action has been taken on previously
reported audit findings and recommendations; and

k) Provide for appropriate documentation of the audit plan and for the proposed fieldwork.

The following planning steps are normally included in an audit:

a) Collect information about the audited entity and its organization in order to assess risk and to
determine materiality;

b) Define the objective and scope of the audit;

c) Undertake preliminary analysis to determine the approach to be adopted and the nature and
extent of enquiries to be made later;

d) Highlight special problems foreseen when planning the audit;

e) Prepare a budget and a schedule for the audit;

f) Identify staff requirements and a team for the audit; and

g) Familiarize the audited entity about the scope, objectives and the assessment criteria of the
audit and discuss with them as necessary.

Management Representation letters

Basic Elements of a Management Representation Letter

15. When requesting a management representation letter, the auditor would request that it be
addressed to the auditor, contain specified information and be appropriately dated and
signed.

16. A management representation letter would ordinarily be dated the same date as the
auditor’s report. However, in certain circumstances, a separate representation letter
regarding specific transactions or other events may also be obtained during the course of
the audit or at a date after the date of the auditor’s report, for example, on the date of a
public offering.

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17. A management representation letter would ordinarily be signed by the members of
management who have primary responsibility for the entity and its financial aspects
(ordinarily the senior executive officer and the senior financial officer) based on the best
of their knowledge and belief. In certain circumstances, the auditor may wish to obtain
representation letters from other members of management. For example, the auditor may
wish to obtain a written representation about the completeness of all minutes of the
meetings of shareholders, the board of directors and important committees from the
individual responsible for keeping such minutes.

If management refuses to provide a representation that the auditor considers necessary,

this constitutes a scope limitation and the auditor should express a qualified opinion or a
disclaimer of opinion. In such circumstances, the auditor would evaluate any reliance placed
on other representations made by management during the course of the audit and consider if the
other implications of the refusal may have any additional effect on the auditor’s report.

The auditor should obtain written representations from management on matters material
to the financial statements when other sufficient appropriate audit evidence cannot
reasonably be expected to exist. The possibility of misunderstandings between the
auditor and management is reduced when oral representations are confirmed by
management in writing. Matters which might be included in a letter from management or
in a confirmatory letter to management are contained in the example of a management
representation letter in the Appendix to this NSA.

8. Written representations requested from management may be limited to matters that are
considered either individually or collectively material to the financial statements.
Regarding certain items it may be necessary to inform management of the auditor’s
understanding of materiality.

9. During the course of an audit, management makes many representations to the auditor,
either unsolicited or in response to specific inquiries. When such representations relate to
matters which are material to the financial statements, the auditor will need to:

(a) seek corroborative audit evidence from sources inside or outside the entity;

(b) evaluate whether the representations made by management appear reasonable and
consistent with other audit evidence obtained, including other representations;
and
AUDITING
(c) consider whether the individuals making the representations can be expected to
be well informed on the particular matters.

10. Representations by management cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. For example, a representation by
management as to the cost of an asset is not a substitute for the audit evidence of such
cost that an auditor would ordinarily expect to obtain. If the auditor is unable to obtain
sufficient appropriate audit evidence regarding a matter which has, or may have, a
material effect on the financial statements and such evidence is expected to be available,
this will constitute a limitation in the scope of the audit, even if a representation from
management has been received on the matter.

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Fair value accounting

Under GAAP, the fair value of an asset is the amount at which that asset could be bought or sold in a
current transaction between willing parties, other than in a liquidation. On the other side of the balance
sheet, the fair value of a liability is the amount at which that liability could be incurred or settled in a
current transaction between willing parties, other than in a liquidation.
If available, a quoted market price in an active market is the best evidence of fair value and should be
used as the basis for the measurement. If a quoted market price is not available, preparers should make
an estimate of fair value using the best information available in the circumstances. In many
circumstances, quoted market prices are unavailable. As a result, difficulties occur when making estimates
of fair value.

Qualitative characteristics of financial statements

24. Qualitative characteristics are the attributes that make the information provided in financial
statements useful to users. The four principal qualitative characteristics are understandability,
relevance, reliability and comparability.
Understandability
25. An essential quality of the information provided in financial statements is that it is readily
understandable by users. For this purpose, users are assumed to have a reasonable knowledge
of business and economic activities and accounting and a willingness to study the information
with reasonable diligence. However, information about complex matters that should be
included in the financial statements because of its relevance to the economic decision-making
needs of users should not be excluded merely on the grounds that it may be too difficult for
certain users to understand.
Relevance
26. To be useful, information must be relevant to the decision-making needs of users.
Information has the quality of relevance when it influences the economic decisions of users
by helping them evaluate past, present or future events or confirming, or correcting, their past
evaluations.
27. The predictive and confirmatory roles of information are interrelated. For example,
information about the current level and structure of asset holdings has value to users when
they endeavor to predict the ability of the entity to take advantage of opportunities and its
ability to react to adverse situations. The same information plays a confirmatory role in
respect of past predictions about, for example, the way in which the entity would be
structured or the outcome of planned operations. 28. Information about financial position and
past performance is frequently used as the basis for predicting future financial position and
performance and other matters in which users are directly interested, such as dividend and
wage payments, security price movements and the ability of the entity to meet its
commitments as they fall due. To have predictive value, information need not be in the form
of an explicit forecast. The ability to make predictions from financial statements is enhanced,
however, by the manner in which information on past transactions and events is displayed.
For example, the predictive value of the income statement is enhanced if unusual, abnormal
and infrequent items of income or expense are separately disclosed.
Materiality
29. The relevance of information is affected by its nature and materiality. In some cases, the
nature of information alone is sufficient to determine its relevance. For example, the
reporting of a new segment may affect the assessment of the risks and opportunities facing
the entity irrespective of the materiality of the results achieved by the new segment in the
reporting period. In other cases, both the nature and materiality are important, for example,
the amounts of inventories held in each of the main categories that are appropriate to the
business.
30. Information is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial statements. Materiality depends on the size of the
item or error judged in the particular circumstances of its omission or misstatement. Thus,
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materiality provides a threshold or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.
Reliability
31. To be useful, information must also be reliable. Information has the quality of reliability
when it is free from material error and bias and can be depended upon by users to represent
faithfully that which it either purports to represent or could reasonably be expected to
represent.
32. Information may be relevant but so unreliable in nature or representation that its recognition
may be potentially misleading. For example, if the validity and amount of a claim for
damages under a legal action are disputed, it may be inappropriate for the entity to recognise
the full amount of the claim in the balance sheet, although it may be appropriate to disclose
the amount and circumstances of the claim.
Faithful representation
33. To be reliable, information must represent faithfully the transactions and other events it either
purports to represent or could reasonably be expected to represent. Thus, for example, a
balance sheet should represent faithfully the transactions and other events that result in assets,
liabilities and equity of the entity at the reporting date which meet the recognition criteria.
34. Most financial information is subject to some risk of being less than a faithful representation
of that which it purports to portray. This is not due to bias, but rather to inherent difficulties
either in identifying the transactions and other events to be measured or in devising and
applying measurement and presentation techniques that can convey messages that correspond
with those transactions and events. In certain cases, the measurement of the financial effects
of items could be so uncertain that entities generally would not recognise them in the
financial statements; for example, although most entities generate goodwill internally over
time, it is usually difficult to identify or measure that goodwill reliably. In other cases,
however, it may be relevant to recognise items and to disclose the risk of error surrounding
their recognition and measurement.
Substance over form
35. If information is to represent faithfully the transactions and other events that it purports to
represent, it is necessary that they are accounted for and presented in accordance with their
substance and economic reality and not merely their legal form. The substance of transactions
or other events is not always consistent with that which is apparent from their legal or
contrived form. For example, an entity may dispose of an asset to another party in such a way
that the documentation purports to pass legal ownership to that party; nevertheless,
agreements may exist that ensure that the entity continues to enjoy the future economic
benefits embodied in the asset. In such circumstances, the reporting of a sale would not
represent faithfully the transaction entered into (if indeed there was a transaction).
Neutrality
36. To be reliable, the information contained in financial statements must be neutral, that is, free
from bias. Financial statements are not neutral if, by the selection or presentation of
information, they influence the making of a decision or judgement in order to achieve a
predetermined result or outcome.
Prudence
37. The preparers of financial statements do, however, have to contend with the uncertainties that
inevitably surround many events and circumstances, such as the collectability of doubtful
receivables, the probable useful life of plant and equipment and the number of warranty
claims that may occur. Such uncertainties are recognized by the disclosure of their nature and
extent and by the exercise of prudence in the preparation of the financial statements.
Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in
making the estimates required under conditions of uncertainty, such that assets or income are
not overstated and liabilities or expenses are not understated. However, the exercise of
prudence does not allow, for example, the creation of hidden reserves or excessive
provisions, the deliberate understatement of assets or income, or the deliberate over statement
of liabilities or expenses, because the financial statements would not be neutral and,
therefore, not have the quality of reliability.
Completeness

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38. To be reliable, the information in financial statements must be complete within the bounds of
materiality and cost. An omission can cause information to be false or misleading and thus
unreliable and deficient in terms of its relevance.
Comparability
39. Users must be able to compare the financial statements of an entity through time in order to
identify trends in its financial position and performance. Users must also be able to compare
the financial statements of different entities in order to evaluate their relative financial
position, performance and changes in financial position. Hence, the measurement and display
of the financial effect of like transactions and other events must be carried out in a consistent
way throughout an entity and over time for that entity and in a consistent way for different
entities.
40. An important implication of the qualitative characteristic of comparability is that users be
informed of the accounting policies employed in the preparation of the financial statements,
any changes in those policies and the effects of such changes. Users need to be able to
identify differences between the accounting policies for like transactions and other events
used by the same entity from period to period and by different entities. Compliance with
Nepal Accounting Standards, including the disclosure of the accounting policies used by the
entity, helps to achieve comparability.
41. The need for comparability should not be confused with mere uniformity and should not be
allowed to become an impediment to the introduction of improved accounting Standards. It is
not appropriate for an entity to continue accounting in the same manner for a transaction or
other event if the policy adopted is not in keeping with the qualitative characteristics of
relevance and reliability. It is also inappropriate for an entity to leave its accounting policies
unchanged when more relevant and reliable alternatives exist.
42. Because users wish to compare the financial position, performance and changes in financial
position of an entity over time, it is important that the financial statements show
corresponding information for the preceding periods.
Constraints on relevant and reliable information
Timelines
43. If there is undue delay in the reporting of information it may lose its relevance. Management
may need to balance the relative merits of timely reporting and the provision of reliable
information. To provide information on a timely basis it may often be necessary to report
before all aspects of a transaction or other event are known, thus impairing reliability.
Conversely, if reporting is delayed until all aspects are known, the information may be highly
reliable but of little use to users who have had to make decisions in the interim. In achieving
a balance between relevance and reliability, the overriding consideration is how best to
satisfy the economic decision making needs of users.
Balance between benefit and cost
44. The balance between benefit and cost is a pervasive constraint rather than a qualitative
characteristic. The benefits derived from information should exceed the cost of providing it.
The evaluation of benefits and costs is, however, substantially a judgemental process.
Furthermore, the costs do not necessarily fall on those users who enjoy the benefits. Benefits
may also be enjoyed by users other than those for whom the information is prepared; for
example, the provision of further information to lenders may reduce the borrowing costs of
an entity. For these reasons, it is difficult to apply a cost-benefit test in any particular case.
Nevertheless, Standard-setters in particular, as well as the preparers and users of financial
statements, should be aware of this constraint.
Balance between qualitative characteristics
45. In practice a balancing, or trade-off, between qualitative characteristics is often necessary.
Generally the aim is to achieve an appropriate balance among the characteristics in order to
meet the objective of financial statements. The relative importance of the characteristics in
different cases is a matter of professional judgement.
True and fair view/fair presentation
46. F inancial statements are frequently described as showing a true and fair view of, or as
presenting fairly, the financial position, performance and changes in financial position of an
entity. Although this Framework does not deal directly with such concepts, the application of

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the principal qualitative characteristics and of appropriate accounting Standards normally
results in financial statements that convey what is generally understood as a true and fair
view of, or as presenting fairly such information.

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