CA Final Audit June Edition

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EDU91

CA Final Audit

Neeraj Arora
सीखना शुरू तो जीतना शुरू
Applicability- For Nov 2023 Exams

Teacher- Neeraj Arora

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Index

Index
Chapter No. Chapter Name Page No.

1 Basics of Auditing 1.1 - 1.12

2 Standards on Auditing 2.1 - 2.186

3 Professional Ethics 3.1 - 3.72

4 Due Diligence, Investigation & Forensic Audit 4.1 - 4.29

5 Company Audit 5.1 - 5.60

6 Audit of Banks 6.1 - 6.28

7 Peer Review and Quality Review 7.1 - 7.24

8 Internal Audit, Management Audit, Operational Audit 8.1 - 8.15

9 Audit Committee and Corporate Governance 9.1 - 9.23

10 Audit of Consolidated Financial Statements 10.1 - 10.8

11 Audit of Public Sector Undertaking 11.1 - 11.14

12 Audit of Non-Banking Financial Companies 12.1 - 12.11

13 Audit of Insurance Companies 13.1 - 13.24

14 Audit Under Fiscal Laws 14.1 - 14.36

15 Special Aspects of Auditing in an Automated Environment 15.1 - 15.10

16 Liabilities of Auditor 16.1 - 16.9

17 CARO - COMPANIES (AUDITOR'S REPORT) ORDER, 2020 17.1- 17.13

18 Miscellaneous 18.1- 18.3

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as possible. All the best.
~ Neeraj Arora

Neeraj Arora | www.edu91.org


Index

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Basics of Auditing

Chapter 1 - Basics of Auditing

What is an assurance engagement?


● Assurance engagement is a kind of service engagement (arrangement) in which a person gives his opinion on
specific information.
● The person giving an opinion is called a practitioner.
● The practitioner is usually appointed by the intended user, who is the person who will be using the
information.
● The “Specific Information” is prepared by another party known as responsible party.
● For expressing an opinion on “specific information” practitioner will examine and will obtain sufficient and
appropriate evidence
● The practitioner evaluate the specific information against a standard benchmark or a suitable criteria and
will obtain sufficient and appropriateevidence and then give his opinion whether the specific information is
as per the suitable criteria or not.

What is Auditing?
Auditing is an assurance service, in which auditor (The person who conducts audit) gives an opinion on financial
information.

In auditing
● Auditor is the practitioner
● Financial information is the “Specific information” or the “Subject Matter” on which auditor gives his
opinion.
● The Persons running the entity whose audit is being conducted are responsible for preparing financial
information are known as responsible party.
● The users of the financial statements, for example in case of a company the shareholders of the company, are
the intended users.
● The auditor will examine the financial information against the financial reporting framework and will obtain
sufficient and appropriate audit evidence and will express his opinion on the basis of sufficient and
appropriate audit evidence that whether the financial information is prepared as per the financial reporting
framework.

How audit takes Place?


● Auditor is appointed.
● Planning, Risk Assesment Procedures, Materiality
● Further audit Procedures
○ Test of Control
○ Substantive Procedures
■ Test of Details
■ Substantive Analytical Procedures
● Audit Evidence, Conclusions, Opinion.
● Reporting

Auditor has to check whether financial statements are prepared in accordance with rules, regulation etc specified for
preparation of financial statements.

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Basics of Auditing

For this auditor will first understand the entity and it’s environment internal control of the entity basically he will
assess how much risk of material misstatement is there in the financial statement of the entity.

After assessing the risk of material misstatement he will decide how much and what kind of audit evidence he need.

The he will obtain the required audit evidence and form his opinion on the basis of such evidence.

ICAI has issued Standards on Auditing and other guiding material to bring uniformity and maintain quality in the
audits conducted by the members of the ICAI. An auditor has to follow the Standards as well as applicable laws and
regulations while conducting the audit.

Meaning of Audit
An Audit is
● independent examination of
● Financial information of
● any entity, whether profit oriented or not , and irrespective of its size or legal form, when such an
examination is conducted
● with a view to expressing an opinion thereon.

Overall Objectives of Auditor


In conducting an audit of financial statements, the overall objectives of the auditor are
● To obtain reasonable assurance about
○ whether the financial statements as a whole
○ are free from material misstatement,
■ whether due to fraud or error,
○ thereby enabling the auditor to express an opinion on
■ whether the financial statements are prepared,
■ in all material respects,
■ in accordance with an applicable financial reporting framework; and
● To report on the financial statements, and communicate as required by the SAs, in accordance with the
auditor’s findings.

Reasonable Assurance
● A high, but not absolute, level of assurance.

Misstatement
A difference between
● the amount, classification, presentation, or disclosure
○ of a reported financial statement item
● and the amount, classification, presentation, or disclosure
○ that is required for the item to be in accordance with the applicable financial reporting framework.
Misstatements can arise from error or fraud.
● 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.
● Fraud’ deals with intentional misrepresentation but, ‘error’, on the other hand, refers to unintentional
mistakes in financial information.

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Basics of Auditing

Material
Misstatements, including omissions, are considered to be material
● if they, individually or in the aggregate,
● could reasonably be expected to influence the economic decisions of users taken on the basis of the financial
statements;

Types of Opinion
● Clean Opinion
● Modified Opinion
○ Qualified Opinion
○ Adverse
○ Disclaimer of Opinion

Meaning of Pervasive
The term pervasive is used to describe the effect of misstatements on the financial statement.

Whether the effect of material misstatement is pervasive or not it depends on auditors judgement.

While deciding that the effect is pervasive or not auditor must keep the following things in mind

● Effect is pervasive when it is not confined to a specific element


● Even if it is confined to a specific element the effect can be considered as pervasive if it represent a
substantial proportion of financial statements
● In relation to disclosures, The effect can be considered as pervasive if It is fundamental to users
understanding of the financial statements.

Those charged with governance


Those charged with governance – The person(s) or organisation(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 overseeing the financial reporting process. In some cases those charged with governance may include
management personnel.

Management
The person(s) with executive responsibility for conduct of entity's operation

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Basics of Auditing

Internal Control
The Process designed, implemented and maintained by
➔ Those charged with governance
➔ Management
➔ Other personnel
To Provide Reasonable Assurance with regard to
● Reliability of financial reporting
● Effectiveness & Efficiency of operations
● Safeguarding of assets
● Compliance with applicable law & regulations

Audit Procedures
Procedures to conduct audit
➔ Risk assessment procedures; and
➔ Further audit procedures, which comprise:
◆ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
◆ Substantive procedures, including tests of details and substantive analytical procedures.

Risk Assessment and Risk Assessment Procedures


● Risk assessment is done to assess the risk of material misstatement. (ROMM)
● Risk of material misstatement is defined as ‘the risk that the financial statements are materially misstated
prior to audit
● Risk assessment procedures are
○ used to
■ obtain an understanding of the entity and its environment,
■ including its internal control
○ in order to
■ assess the risk of material misstatement and
■ determine the nature, extent and timing of further audit procedures.

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Basics of Auditing

● After RAP, the Auditor can assess the level of ROMM.


● Once the ROMM is assessed, we can decide NET of FAPs
○ Nature - (Compliance or Substantive)
○ Extent - (Sample size, Less work or more work)
○ Timing - Interim period and some transaction at the year end OR all year end in detail - For example
it may be appropriate to perform substantive procedures at or near the date of the financial
statements when the risk of material misstatement is assessed as higher.
● Risk assessment procedures alone do not provide audit evidence sufficient to support audit opinion.
● They are required in all financial statement audits.

Further Audit Procedures


Compliance Procedure
● Auditor test internal control in order to
○ to decide whether to rely on them or not .
● We will (For testing IC)
○ Check design (SoD, Approvals, Reconciliations etc)
■ No - Leave it go for SP
■ Yes test efficiency (Operation and Continuity)
○ If because of efficiency of internal control we decided to rely on internal control then we will do
more compliance procedures and less substantive procedures.

Substantive Procedure
Auditor will check transactions, account balance presentation and disclosure
○ Test of Details (Vouching and Verification) - To verify individual transactions and balances.
○ Substantive Analytical Procedures - involve analysing relationships between information to identify
unusual fluctuations which may indicate possible misstatement.

Audit evidence
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.

Information contained in the accounting records


Accounting records include
● the records of initial accounting entries and supporting records such records of fund transfer
● Invoices;
● Contracts
● the ledgers, journal entries and other adjustments to the financial statements.
● records such as worksheets and spreadsheets supporting cost allocations, computations, reconciliations and
disclosures.

Other information
Other information that authenticates the accounting records and also supports the auditor’s rationale behind the
true and fair presentation of the financial statements:

Other information which the auditor may use as audit evidence includes, for example
● minutes of the meetings,

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Basics of Auditing

● written confirmations from trade receivables and trade payables,


● manuals containing details of internal control etc.

Audit Procedures to obtain audit evidence


1. Inspection - Examining the documents
2. Observation - Witnessing a process being conducted by others
3. External Confirmation - direct written response to the auditor from a third party
4. Recalculation - Checking the mathematical accuracy
5. Reperformance - auditor’s independent execution of procedures or controls
6. Analytical Procedure - studying significant ratios and trends and investigating unusual fluctuations.
7. Enquiry - Seeking information from knowledgeable persons both financial and non-financial within the
entity or outside the entity.

A Analytical Procedures

E Enquiry

I Inspection

O Observation

U RecalcUlation

Reperformance

External Confirmation

Audit Risk
The risk that the auditor expresses an inappropriate opinion when the financial statements are materially
misstated.
Audit risk can be divided into two part
● Risk of material misstatement.
○ Inherent risk
○ Control risk
● Detction Risk

What is not included in Audit Risk ?


Risk that the auditor might express an opinion that the financial statements are materially misstated when they are
not.

Audit risk is a technical term related to the process of auditing it does not refer to the auditor's business risks such as
loss from litigation, adverse publicity, or other events arising in connection with the audit of financial statements.

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Basics of Auditing

Components

Example of Audit Risk - Issuing Unmodified Opinion when FS are materially misstated.

AR = ROMM DR

Should be low IR X CR Depends on ROMM

Assessed by Auditor Controlled by Auditor

How Accurate is the client's system? How Effective is How much work do we
the IC of a client ? have to do?

Exist independent of FS Audit

● Weak System is not equal to wrong financials.


● Weak system = more work
● How to Assess ROMM
○ RAP
● Greater risk requires
○ more persuasive evidence , (NATURE from control/compliance to Substantive)
○ a large sample size, and (Extent)
○ shift from interim to year end testing (Timing)

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Basics of Auditing

● There is a direct relationship between risk of material misstatement and the Assurance required from
substantive procedures. More the risk of material misstatement, the more the assurance required from
substantive procedures.
● The assessment of risks is a matter of professional judgment, rather than a matter capable of precise
measurement.

Inherent Risk
(एक Assertion में misstatement होने के chances because of its nature)

An auditor assesses inherent risk as high if assertion is more likely to contain a material misstatement.

Assertions involving the following factors generally have a high inherent risk.
● high volume transactions
● Complex calculations
● amounts derived from estimates
● Cash

Control risk arises when Client IC does not catch (prevent, detect or correct) it (Risk). It is the function of
effectiveness of the design and operation or internal control.
● Some amount of CR will always be there because of Inherent limitations of IC.
● Detection risk is the function of effectiveness of audit procedures and of the manner in which they are
applied.

Detection Risk
Some amount of detection risk will always exist because the auditor does not examine 100% of an account balance
for transactions . Another reason for some amount of detection risk is the mistake in applying audit procedures or
interpreting the results.
● Detection risk can be subdivided into tests of details risk and substantive analytical procedures risk.
● Analytical procedures are used for assessment of risk of material misstatement (RAP) as well as
substantive procedures.

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Basics of Auditing

Assertions
Assertions refer to representations by management, explicit or otherwise, that are embodied in the financial
statements.

By stating that the financial statements are in compliance with the relevant financial reporting framework,
management is making certain assertions about the proper recognition, measurement, presentation, and disclosure
of the various components of the financial statements and any accompanying disclosures.

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Basics of Auditing

Auditor will check those claims (assertions).

The assertions used by the auditor to identify potential errors or inaccuracies in financial statements can be divided
into three categories and may take the following forms.

Transactions Account balance Presentation and Disclosure

Occurence Existence Occurence and rights and obligations

Completeness Rights and obligations Completeness

Accuracy Completeness Classification and understandability

Cut-off Valuation and allocation Accuracy and valuation

Classification

Assertions related to transactions

Occurence
Transactions that are recognized in the financial records as having occurred, i.e., did it really happen? and such
transactions and events pertain to the entity.

Completeness
All transactions and events that should have been recorded have been recorded.

Accuracy
Amounts and other data relating to recorded transactions and events have been recorded appropriately.

Cut-off
Transactions and events have been recorded in the correct accounting period.

Classification
Transactions and events have been recorded in the proper accounts.

Assertions related to Account Balance

Existence
Assets, liabilities, and equity interests exist.

Rights and obligation


the entity holds or controls the rights to assets, and liabilities are the obligations of the entity.

Completeness
All assets, liabilities and equity interests that should have been recorded have been recorded.

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Basics of Auditing

Valuation and allocation


Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any
resulting valuation or allocation adjustments are appropriately recorded.

Assertions related to Presentation and Disclosure

Occurrence and rights and obligations


Disclosed events, transactions, and other matters have occurred and pertain to the entity.

Completeness
All disclosures that should have been included in the financial statements have been included.

Classification and understandability


Financial information is appropriately presented and described, and disclosures are clearly expressed.

Accuracy and valuation


Financial and other information are disclosed fairly and at appropriate amounts.

Inherent Limitations of Audit


Limitations of Audit: As per SA 200 "Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing", the objectives of an audit, is to enable an auditor to express an opinion on
such financial statements.

The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance
that the financial statements are free from material misstatement due to fraud or error.

This is because there are inherent limitations of an audit, which result in most of the audit evidence on which the
auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive.

The process of auditing, however, is such that it suffers from certain limitations, i.e. the limitation which cannot be
overcome irrespective of the nature and extent of audit procedures. The limitations of an audit arise from

The Nature of Financial Reporting


● The preparation of financial statements involves judgment by management.
● In addition, many financial statement items involve subjective decisions or assessments or a degree
of uncertainty.
● Consequently, some financial statement items are subject to an inherent level of variability which
cannot be eliminated by the application of additional auditing procedures.

The Nature of Audit Procedures


There are practical and legal limitations on the auditor's ability to obtain audit evidence. For example:
● There is the possibility that management or others may not provide, intentionally or unintentionally, the
complete information that is relevant to the preparation and presentation of the financial statements or that
has been requested by the auditor.
● Fraud may involve sophisticated and carefully organized schemes designed to conceal it. The auditor is
neither trained as nor expected to be an expert in the authentication of documents.

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Basics of Auditing

● An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given
specific legal powers, such as the power of search, which may be necessary for such an investigation.

Timeliness of Financial Reporting and the Balance between Benefit and Cost
● The relevance of information, and thereby its value, tends to diminish overtime,
● and there is a balance to be struck between the reliability of information and its cost.
● There is an expectation by users of financial statements that the auditor will form an opinion on the
financial statements within a reasonable period of time and at a reasonable cost

Other Matters that Affect the Limitations of an Audit


In the case of certain assertions or subject matters, the potential effects of the limitations on the auditor's ability to
detect material misstatements are particularly significant. Such assertions or subject matters include:
○ Fraud, particularly fraud involving senior management or collusion.
○ The existence and completeness of related party relationships and transactions.
○ The occurrence of non-compliance with laws and regulations.
○ Future events or conditions that may cause an entity to cease to continue as a going concern.
Because of the 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 SAs.
However, the inherent limitations of an audit are not a justification for the auditor to be satisfied with less-than
persuasive audit evidence.

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Standards on Auditing

Chapter 2 - Standards on Auditing

Basics
Standards collectively known as the Engagements Standards issued by AASB under the authority of the council
of ICAI.

The following Standards issued by the Auditing and Assurance Standards Board under the authority of the
Council are collectively known as the Engagement Standards:
● Standards on Auditing (SAs), to be applied in the audit of historical financial information.
● Standards on Review Engagement (SREs), to be applied in the review of historical financial information.
● Standards on Assurance Engagements (SAEs), to be applied in assurance engagements, dealing with
subject-matters other than historical financial information.
● Standards on Related Services (SRSs), to be applied to engagements involving application of agreed
upon procedures to information, compilation engagements, and other related services engagements as
may be specified by the ICAI.
● Standards on Quality Control (SQCs) issued by the AASB under the authority of the Council, are to be
applied for all services covered by the Engagement Standards as described above.

It is to be understood that Standards on Auditing (SAs) apply in “audit of historical financial information”
whereas Standards on Review Engagements (SREs) apply in “review of historical financial information”.
Remember that Standards on auditing apply in “audit” of historical financial information which is a reasonable
assurance engagement whereas Standards on Review Engagements apply in “review” of historical financial
information which is a limited assurance engagement only.

There is another set of standards which apply in assurance engagements dealing with subject matters other
than historical financial information. Such assurance engagements do not include “audit” or “review” of
historical financial information. These standards are known as Standards on Assurance Engagements.

For example, an assurance engagement relating to examination of Internal Control of The Entity.

Standards on related services


These standards apply in engagements to perform agreed-upon procedures regarding financial information. 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.

Standards on Quality Control


Standards on Quality Control (SQCs) are to be applied for all services covered by Engagement Standards.

What are Standards on Auditing (SAs)?


SAs are Auditing Standards, which prescribe the way the auditing should be conducted. They can also be
termed as performance benchmarks for the auditors.

The main purpose is to bring as much uniformity as possible in work performed by auditors.

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Standards on Auditing

Procedure for issuing SAs


Generally following procedure is followed for issuing the SAs
● Auditing and Assurance Standard Board (AASB) of the Institute of Chartered Accountants of India
(ICAI) determines the specific area in which the SAs need to be formulated.
● In preparation of SAs—
○ AASB is assisted by study groups constituted to consider specific subjects.
○ An exposure draft of the proposed SA is finalized by the AASB' of ICAI on the basis of work of
the study group.
○ The exposure draft of the proposed SA is published for comments by the members of the
Institute (ICAI).
○ AASB finalizes the draft of the proposed SA after considering the comments received and
submit to the Council of the Institute (ICAI).
○ The Council considers the draft of the proposed SA and if necessary, modifies the same in
consultation with AASB. The SA is then issued under the authority of the Council of the
Institute of Chartered Accountants of India.
○ AASB of ICAI tries to integrate/harmonize the SAs to the extent possible in the light of the
condition and practices prevailing in India with ISAs (International Standards For Auditing)
issued by IAASB (International Auditing and Assurance Standards Board) of IFAC.

ICAI re-classified the existing auditing and assurance standards in 2008. The objective of re-classification is to
converge our existing auditing and assurance standards with the International Standard on Auditing (ISA)
issued by the International Federation of Accountants (IFAC).

Numbering of Standards
Standard on Quality Control (SQC) 01-99

Standard on Auditing (SA) 100-999

Standard on Review Engagement (SRE) 2000-2699

Standard on Assurance Engagement (SAE) 3000-3699

Related Services (SRS) 4000-4699

Classification of SAs
Introductory matters 100-199

General Principles and Responsibilities 200-299

Risk Assessment and Response to Assessed Risk 300-499

Audit Evidence 500-599

Using work of Others 600-699

Audit conclusions and Reporting 700-799

Specialised Areas 800-899

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Standards on Auditing

List of Standards
General Principles and Responsibilities

1 SA200 (Revised) Overall objectives of the Independent Auditor and the conduct of the
Audit in Accordance with Standard on Auditing

2 SA210 (Revised) Agreeing the Terms of Audit Engagements

3 SA 220 (Revised) Quality Control for an Audit of financial statements

4 SA 230 (Revised) Audit Documentation

5 SA 240 (Revised) The Auditor’s Responsibilities Relating to Fraud in an Audit of


Financial Statements.

6 SA250 Consideration of Laws and Regulations in an Audit of Financial


Statements

7 SA 260 Communication with those Charged with Governance

8 SA265 Communicating Deficiencies in Internal control to those Charged


with Governance and Management

9 SA299 (Revised) Joint Audit of financial statements

Risk Assessment and Responses to Assessed Risks

10 SA300 Planning an Audit of Financial Statements

11 SA315 Identifying and Assessing the Risk of material Misstatements


through understating the Entity and Its Environment

12 SA 320 Materiality in Planning and Performing an Audit

13 SA330 Response to Assessed Risks

14 SA 402 Audit consideration Relating to an Entity using a Service


Organisation

15 SA450 Evaluation of Misstatements Identified during the Audit

Audit Evidence

16 SA500 (Revised) Audit Evidence

17 SA 501 (Revised) Audit Evidence-Specific Consideration for selected Items

18 SA 505 (Revised) External Confirmations

19 SA 510 (Revised) Initial Audit Engagement - Opening balances

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Standards on Auditing

20 SA 520 (Revised) Analytical Procedures

21 SA 530 (Revised) Audit Sampling

22 SA 540 (Revised) Auditing Accounting Estimates, Including fair value Accounting


Estimates and Related Disclosures

23 SA 550 (Revised) Related Parties

24 SA 560 (Revised) Subsequent Events

25 SA 570 (Revised) Going Concern

26 SA 580 (Revised) Written Representation

Using Work of Others

27 SA 600 Using the work of Other Auditors

28 SA 610 (Revised) Using the Work of Internal Auditors

29 SA 620 (Revised) Using the Work of an Auditor’s Expert

Audit Conclusions and Reporting

30 SA700 (Revised) Forming an Opinion and Reporting on Financial Statements

31 SA 701 Communicating key Audit Matters in the independent Auditor’s


Report

32 SA 705 (Revised) Modifications to the opinion in the independent Auditor’s Report

33 SA 706 (Revised) Emphasis of Matter Paragraphs and other Matter Paragraphs in the
Independent Auditor’s Report

34 SA 710 (Revised) Comparative Information -Corresponding Figures and Comparative


Financial Statements

35 SA 720 (Revised) The Auditor’s responsibilities relating to Other Information

Standards on Quality Control

36 SQC 1 “Quality Control for Firms that Perform Audit and Reviews of
Historical Financial Information, and other Assurance and Related
Services Engagements”

Standards on Review Engagements (SREs)

37 SRE 2400 Engagements to Review Historical Financial Statements

Neeraj Arora | www.edu91.org 2.4


Standards on Auditing

38 SRE 2410 "Review of Interim Financial Information Performed by the Independent


Auditor of the Entity"

Standards on Assurance Engagements (SAEs)

39 SAE 3400 The Examination of Prospective Financial Information

40 SAE 3402 Assurance Reports on Controls At a Service Organisation

41 SAE 3420 Assurance Engagements to Report on the Compilation of Pro Forma


Financial Information Included in a Prospectus

Standards on Related Services (SRSs)

42 SRS 4400 Engagements to Perform Agreed-upon Procedures Regarding


Financial Information.

43 SRS 4410 Compilation Engagements

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Standards on Auditing

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

↗️ Introduction
Every CA Firm must Have system of quality control for audits and reviews of historical financial information,
and for other assurance and related services engagements.

The firm should establish a system of quality control designed to provide it with reasonable assurance that
● the firm and its personnel comply with professional standards and regulatory and legal requirements,
and
● that reports issued by the firm or engagement partner(s) are appropriate in the circumstances.

A system of quality control consists of


● policies
○ designed to achieve the objectives set out above and
● procedures
○ necessary to implement and monitor compliance with those policies.

⛓️ Elements of a System of Quality Control


The firm’s system of quality control should include policies and procedures addressing each of the following
elements:
a. 🙋Leadership responsibilities for quality within the firm.
b. ✊Ethical requirements.
c. 🤝Acceptance and continuance of client relationships and specific engagements.
d. 🧑🏻‍🤝‍🧑🏻Human resources.
e. 🔥Engagement performance.
f. 🔍Monitoring.
➔ ​The quality control policies and procedures should be
◆ documented📚 and
◆ communicated 📢 to the firm’s personnel.
➔ Such communication
◆ describes the quality control policies and procedures and (What are the Policies &
Procedures)
◆ the objectives they are designed to achieve, and (What objectives will be achieved)
◆ includes the message
● that each individual has a personal responsibility for quality and
● is expected to comply with these policies and procedures. (Quality is personal
responsibility and compliance is expected)
➔ The firm should encourages its personnel to communicate their feedback on quality control matters
and consider feedback as an integral part of system of quality control.

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Standards on Auditing

🙋Leadership responsibilities for quality within the firm.


● The firm’ policies and procedures must be designed to create an internal culture which promotes
quality as essential in performing engagements to achieve the following objectives
○ Perform work that complies with professional standards and regulatory and legal requirements;
and
○ Issue reports that are appropriate in the circumstances.
● Such policies and procedures should require the firm’s chief executive officer (or equivalent) or, if
appropriate, the firm’s managing partners (or equivalent), to assume ultimate responsibility for the
firm’s system of quality control.
● Any person or persons assigned operational responsibility for the firm’s quality control system by the
firm’s chief executive officer or managing board of partners should have sufficient and appropriate
experience and ability, and the necessary authority, to assume that responsibility.

✊ Ethical Requirements
The firm should establish policies and procedures designed to provide it with reasonable assurance that the
firm and its personnel comply with relevant ethical requirements.

Ethical requirements relating to audits and reviews of historical financial information, and other assurance and
related services engagements are contained in the Code. The Code establishes the fundamental principles of
professional ethics, which include:
a. Integrity;
b. Objectivity;
c. Professional competence and due care;
d. Confidentiality; and
e. Professional behavior.

Independence
Establish policies and procedures
The firm should establish policies and procedures designed to provide it with reasonable assurance that the
firm and its personnel (including experts contracted by the firm and network firm personnel), maintain
independence where required by the Code.

Role of Such policies and procedures


Such policies and procedures should enable the firm to:
a. Communicate its independence requirements to its personnel and (Independence Requirement)
b. Identify and evaluate circumstances and relationships that create threats to independence,
(Identification and evaluation of threat)
c. Take appropriate action to eliminate those threats or reduce them to an acceptable level by applying
safeguards, or, if considered appropriate, to withdraw from the engagement.(Action to eliminate and
reduce)

Role of Such policies and procedures w.r.t breaches


The firm should establish policies and procedures designed to provide it with reasonable assurance that it is
notified of breaches of independence requirements, and to enable it to take appropriate actions to resolve
such situations.

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Standards on Auditing

The policies and procedures should include requirements for:


a. All who are subject to independence requirements to promptly notify the firm of independence
breaches of which they become aware;
(All to firm - Breaches)
b. The firm to promptly communicate identified breaches of these policies and procedures to:
i. The engagement partner
ii. Other relevant personnel who need to take appropriate action; and
(Identified breaches - FIRM to EP and ORP)
c. Prompt communication to the firm, if necessary, by the engagement partner and the other individuals
of the actions taken to resolve the matter, so that the firm can determine whether it should take further
action.
(EP and ORP to Firm - Actions)

At least annually, the firm should obtain written confirmation of compliance with its policies and procedures
on independence from all firm personnel required to be independent in terms of the requirements of the Code.

The familiarity threat is particularly relevant in the context of financial statement audits of listed entities. For
these audits, the engagement partner should be rotated after a pre-defined period, normally not more than
seven years.

🤝 Acceptance and Continuance of Client Relationships and Specific


Engagements
The firm should establish policies and procedures for the acceptance and continuance of client relationships
and specific engagements, designed to provide it with reasonable assurance that it will undertake or continue
relationships and engagements only where it:
a. Has considered the integrity of the client and
➢ does not have information that would lead it to conclude that the client lacks integrity;
b. Is
➢ competent to perform the engagement and
➢ has the capabilities, time and
➢ resources to do so; and
c. Can comply with the ethical requirements.
Where issues have been identified, and the firm decides to accept or continue the client relationship or a
specific engagement, it should document how the issues were resolved.

Matters to be considered with regard to integrity of the client


With regard to the integrity of a client, matters that the firm considers include, for example
● The identity and business reputation of the client's principal owners, key management, related parties
and those charged with its governance.
● Information concerning the attitude of the client's principal owners, key management and those
charged with its governance towards such matters as aggressive interpretation of accounting standards
and the internal control environment.
● The nature of the client's operations, including its business practices.
● Whether the client is aggressively concerned with maintaining the firm's fees as low as possible.
Indications of an inappropriate limitation in the scope of work.
● Indications that the client might be involved in money laundering or other criminal activities.

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Standards on Auditing

● The reasons for the proposed appointment of the firm and non-reappointment of the previous firm.

The extent of knowledge a firm will have regarding the integrity of a client will generally grow within the
context of an ongoing relationship with that client.

Information on such matters that the firm obtains may come from, for example
● Communications with existing or previous providers of professional accountancy services to the client
in accordance with the Code, and discussions with other third parties.
● Inquiry of other firm personnel or third parties such as bankers, legal counsel and industry peers.
● Background searches of relevant databases.

Matters the firm considers while evaluating capabilities, competence, time and resources to undertake a new
engagement from a new or an existing client.
Firm personnel have knowledge of relevant industries or subject matters;
● Firm personnel have experience with relevant regulatory or reporting requirements, or the ability to
gain the necessary skills and knowledge effectively;
● The firm has sufficient personnel with the necessary capabilities and competence;
● Experts are available, if needed;
● Individuals meeting the criteria and eligibility requirements to perform engagement quality control
review are available, where applicable; and
● The firm would be able to complete the engagement within the reporting deadline.

Obtains information that would have caused it to decline an engagement


Where the firm obtains information that would have caused it to decline an engagement if that information had
been available earlier, policies and procedures should include consideration of:
a. The professional and legal responsibilities that apply to the circumstances, including whether there is
a requirement for the firm to report to the person or persons who made the appointment or, in some
cases, to regulatory authorities; and
b. The possibility of withdrawing from the engagement or from both the engagement and the client
relationship.

🧑🏻‍Human Resources
The firm should establish policies and procedures designed to provide it with reasonable assurance that it has
sufficient personnel with the capabilities, competence, and commitment to ethical principles necessary to
perform its engagements in accordance with professional standards and regulatory and legal requirements, and
to enable the firm or engagement partners to issue reports that are appropriate in the circumstances

Such policies and procedures address the following personnel issues:


(a) Recruitment;
(b) Performance evaluation;
(c) Capabilities;
(d) Competence;
(e) Career development;
(f) Promotion;
(g) Compensation; and
(h) Estimation of personnel needs.

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Standards on Auditing

Addressing these issues enables the firm to ascertain the number and characteristics of the individuals
required for the firm’s engagements. The firm’s recruitment processes include procedures that help the firm
select individuals of integrity as well as the capacity to develop the capabilities and competence necessary to
perform the firm’s work.

Assignment of Engagement Teams


The firm should assign responsibility for each engagement to an engagement partner. The firm should
establish policies and procedures requiring that
a. The identity and role of the engagement partner are communicated to key members of the client’s
management and those charged with governance;
b. The engagement partner has the appropriate capabilities, competence, authority and time to perform
the role; and
c. The responsibilities of the engagement partner are clearly defined and communicated to that partner.

The firm should also assign appropriate staff with the necessary capabilities, competence and time to perform
engagements in accordance with professional standards and regulatory and legal requirements, and to enable
the firm or engagement partners to issue reports that are appropriate in the circumstances.

🔥 Engagement Performance
The firm should establish policies and procedures designed to provide it with reasonable assurance that
engagements are performed in accordance with professional standards and regulatory and legal requirements,
and that the firm or the engagement partner issues reports that are appropriate in the circumstances.

Through its policies and procedures, the firm seeks to establish consistency in the quality of engagement
performance. This is often accomplished through written or electronic manuals, software tools or other forms
of standardized documentation, and industry or subject matter- specific guidance materials.

Matters to be considered to ensure the achievement of objective of Engagement Performance


Matters addressed include the following
● How engagement teams are briefed on the engagement to obtain an understanding of the objectives of
their work.
● Processes for complying with applicable engagement standards.
● Processes of engagement supervision, staff training and coaching.
● Methods of reviewing the work performed, the significant judgments made and the form of report
being issued.
● Appropriate documentation of the work performed and of the timing and extent of the review.
● Processes to keep all policies and procedures current.

Following things are covered in Engagement Performance


● Supervision
● Review
● Consultation
● Difference of Opinion
● Engagement Quality control review
● Enagagement Documentation

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Standards on Auditing

Supervision
Supervision includes the following:
● Tracking the progress of the engagement
● Considering the capabilities and competence of individual members of the engagement team
● Addressing significant issues arising during the engagement
● Identifying matters for consultation or consideration by more experienced engagement team members
during the engagement.

Review
Review responsibilities are determined on the basis that more experienced engagement team members,
including the engagement partner, review work performed by less experienced team members. Reviewers
consider whether
a. The work has been performed in accordance with professional standards and regulatory and legal
requirements;
b. Significant matters have been raised for further consideration;
c. Appropriate consultations have taken place and the resulting conclusions have been documented and
implemented;
d. There is a need to revise the nature, timing and extent of work performed;
e. The work performed supports the conclusions reached and is appropriately documented;
f. The evidence obtained is sufficient and appropriate to support the report; and
g. The objectives of the engagement procedures have been achieved.

Consultation
The firm should establish policies and procedures designed to provide it with reasonable assurance that:
a. Appropriate consultation takes place on difficult or contentious matters;
b. Sufficient resources are available to enable appropriate consultation to take place;
c. The nature and scope of such consultations are documented; and
d. Conclusions resulting from consultations are documented and implemented.

Differences of Opinion
The firm should establish policies and procedures for dealing with and resolving differences of opinion
● within the engagement team,
● with those consulted and, where applicable,
● between the engagement partner and the engagement quality control reviewer.
Conclusions reached should be documented and implemented.

Engagement Quality Control Review


The firm should establish policies and procedures requiring, an engagement quality control review that
provides an objective evaluation of the significant judgments made by the engagement team and the
conclusions reached in formulating the report. Such policies and procedures should:
● Require an engagement quality control review for all audits of financial statements of listed entities
● Set out criteria against which all other audits and reviews of historical financial information, and other
assurance and related services engagements should be evaluated to determine whether an engagement
quality control review should be performed.
● Require an engagement quality control review for all engagements meeting the criteria as set-out by
the firm.

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Standards on Auditing

The firm’s policies and procedures should require the completion of the engagement quality control review
before the report is issued.

Nature, Timing and Extent of the Engagement Quality Control Review


An engagement quality control review ordinarily involves
● discussion with the engagement partner,
● a review of the
○ financial statements or other subject matter information and
○ the report, and,
● in particular, consideration of whether the report is appropriate.
● Review of selected working papers relating to the significant judgments that the engagement team
made and the conclusions they reached.

The extent of the review depends on the complexity of the engagement and the risk that the report might not
be appropriate in the circumstances. The review does not reduce the responsibilities of the engagement
partner.

Considerations in case of EQCR of Listed Entities


An engagement quality control review for audits of financial statements of listed entities includes considering
the following:
1. The engagement team’s evaluation of the firm’s independence in relation to the specific engagement.
2. Significant risks identified during the engagement and the responses to those risks.
3. Judgments made, particularly with respect to materiality and significant risks.
4. Whether appropriate consultation has taken place on matters involving differences of opinion or other
difficult or contentious matters, and the conclusions arising from those consultations.
5. The significance and disposition of corrected and uncorrected misstatements identified during the
engagement.
6. The matters to be communicated to management and those charged with governance and, where
applicable, other parties such as regulatory bodies.
7. Whether working papers selected support the conclusions reached.
8. The appropriateness of the report to be issued.

Where the engagement quality control reviewer makes recommendations that the engagement partner does
not accept and the matter is not resolved to the reviewer’s satisfaction, the report is not issued until the matter
is resolved by following the firm’s procedures for dealing with differences of opinion.

Objectivity of the engagement quality control reviewer


The firm’s policies and procedures are designed to maintain the objectivity of the engagement quality control
reviewer. For example, the engagement quality control reviewer:
a. Is not selected by the engagement partner;
b. Does not otherwise participate in the engagement during the period of review;
c. Does not make decisions for the engagement team; and
d. Is not subject to other considerations that would threaten the reviewer’s objectivity.

The engagement partner may consult the engagement quality control reviewer during the engagement. Such
consultation need not compromise the engagement quality control reviewer’s eligibility to perform the role.

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Standards on Auditing

Engagement Documentation
● The firm should establish policies and procedures for engagement teams to complete the assembly of
final engagement files on a timely basis after the engagement reports have been finalized.
● The firm should establish policies and procedures designed to maintain the confidentiality, safe
custody, integrity, accessibility and retrievability of engagement documentation.
● The firm should establish policies and procedures for the retention of engagement documentation for a
period sufficient to meet the needs of the firm or as required by law or regulation.
● In the specific case of audit engagements, the retention period ordinarily is no shorter than 7 years
from the date of the auditor's report, or, if later, the date of the group auditor's report.
● Unless otherwise specified by law or regulation, engagement documentation is the property of the
firm.
● The firm may, at its discretion, make portions of, or extracts from, engagement 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 firm or its personnel.

🔍 Monitoring
The firm should establish policies and procedures designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, operating effectively
and complied with in practice.

The purpose of monitoring compliance with quality control policies and procedures is to provide an evaluation
of:
● Adherence to professional standards and regulatory and legal requirements;
● Whether the quality control system has been appropriately designed and effectively implemented;
● Whether the firm’s quality control policies and procedures have been appropriately applied, so that
reports that are issued by the firm or engagement partners are appropriate in the circumstances.
● Follow-up by appropriate firm personnel so that necessary modifications are promptly made to the
quality control policies and procedures.

Complaints and Allegations


As per 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”,
1. The firm should establish policies and procedures designed to provide it with reasonable assurance that
it deals appropriately with
➢ Complaints and allegations that the work performed by the firm fails to comply with
professional standards and regulatory and legal requirements; and
➢ Allegations of non-compliance with the firm’s system of quality control.
(PP-DP-RA-DA-CA-AC)
2. Complaints and allegations (which do not include those that are clearly frivolous) may originate from
within or outside the firm. They may be received by engagement team members or other firm
personnel. (ORIGINATE FROM AND RECEIVED BY)
3. As part of this process, the firm establishes clearly defined channels for firm personnel to raise any
concerns in a manner that enables them to come forward without fear of reprisals. (CHANNELS)
4. INVESTIGATION
➢ The firm investigates such complaints and allegations in accordance with established policies
and procedures.

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Standards on Auditing

➢ The investigation is
○ supervised by a partner
■ with sufficient and appropriate experience and authority within the firm
■ but who is not otherwise involved in the engagement,
○ and includes involving legal counsel as necessary.
➢ Small firms and sole practitioners may use the services of a suitably qualified external person or
another firm to carry out the investigation.
5. Where the results of the investigations indicate deficiencies in the design or operation of the firm’s
quality control policies and procedures, or non-compliance with the firm’s system of quality control by
an individual or individuals, the firm takes appropriate action. (ACTION)

MB & Associates is a partnership firm of Chartered Accountants which was established seven years back. The firm is
getting new clients and has also, been offered new engagement services with existing clients. The firm is concerned
about obtaining such information as it considers necessary in the circumstances before accepting an engagement with a
new client and acceptance of a new engagement with an existing client. The firm is looking to work with only select
clients to adhere to the Quality Control Standards. Guide MB & Associates about the matters to be considered with
regard to the integrity of a client, as per the requirements of SQC 1.
(SA, Nov 2019, 4 Marks) (Study Material)

M/s NK & Co., Chartered Accountants were appointed as Statutory Auditors of Fresh Juice Limited for the F.Y
2022-2023. The previous year's audit was conducted by M/s. LP & Associates. After the audit was completed and report
submitted, it was found that closing balances of last financial year i.e., 2018-19 were incorrectly brought forward. It was
found that M/s NK & Co. did not apply any audit procedures to ensure that correct opening balances have been brought
forward to the current period.
Accordingly, a complaint was filed against NK & Co. in relation to this matter.
You are required to inform what policies are required to be implemented by NK & Co. for dealing with such complaints
and allegations as required by Standard on Quality Control (SQC).
(SA, Jan 2021, 5 Marks) (MTP1, May 2019, 5 Marks)

J.A.C.K. & Co., a Chartered Accountant firm was appointed as the statutory auditor of Falcon Ltd. after ensuring the
compliance with relevant provisions of the Companies Act, 2013. Mr. Jay was the engagement partner for the aforesaid
audit and prior to commencement of the audit, Mr. Jay had called for a meeting of the engagement team in order to
direct them and assign them their responsibilities. At the end of meeting, Mr. Jay assigned review responsibilities to two
of the engagement team members who were the most experienced amongst all, for reviewing the work performed by the
less experienced team members. While reviewing the work performed by the less experienced members of the
engagement team, what shall be the considerations of the reviewer?
(MTP 1, May 2021, 5 Marks)

HK & Co. Chartered Accountants have been auditors of SAT Ltd (a listed entity) for the last 8 financial years. CA. H,
partner of the firm, has been handling the audit assignment very well since the appointment. The audit work of CA. H
and her team is reviewed by a senior partner CA. K to assure that audit is performed in accordance with professional
standards and regulatory and legal requirements. CA. K was out of India for some personal reasons, so this year CA. G
has been asked to review the audit work. In your opinion, what areas CA. G should consider at the time of review. List
any four areas and also comment whether firm is complying with Standard on Quality Control or not.
(SA, July 2021, 5 Marks) (MTP2, Nov 2022, 5 Marks)

PQR & Associates, Chartered Accountants, is a partnership firm having 3 partners CA P, CA Q and CA R. PQR &
Associates are appointed as Statutory Auditors of ABC Limited, a listed entity for the financial year 2021-22 and CA P is
appointed as Engagement Partner for the audit of ABC Limited. Before issuing the Audit Report of ABC Limited, CA P
asked CA R to perform Engagement Quality Control Review and is of the view that his responsibility will be reduced

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Standards on Auditing

after review by CA R. Whether the contention of CA P is correct? What are the aspects that need to be considered by CA
R while performing Engagement Quality Control Review for audit of financial statements of ABC Limited?
(SA, May 2022, 5 Marks)

SA 200 Overall Objectives of the Independent Auditor and the


Conduct of an Audit in Accordance with Standards on Auditing

Topics to be covered
● Overall Objectives of the auditor - Already Covered in Basics
● Inherent limitations of Auditing
● Historical financial information.
● Financial Statements.
● Financial reporting framework.
● Applicable financial reporting framework.
● Ethical Requirements Relating to an Audit of Financial Statements.
● Professional Skepticism.
● Professional Judgement
● Scope of the Audit
● Premise on which audit is conducted.
● Conduct of an audit in accordance with SAs

Historical financial information.


Information expressed in financial terms in relation to a particular entity, derived primarily from that entity’s
accounting system, about economic events occurring in past time periods or about economic conditions or
circumstances at points in time in the past.

Financial statements
A structured representation of historical financial information, including related notes, intended to
communicate an entity’s economic resources or obligations at a point in time or the changes therein for a
period of time in accordance with a financial reporting framework. The related notes ordinarily comprise a
summary of significant accounting policies and other explanatory information.

The term “financial statements” ordinarily refers to a complete set of financial statements as determined by the
requirements of the applicable financial reporting framework, but can also refer to a single financial statement.

Financial reporting framework


The term financial reporting framework is defined as a set of criteria used to determine measurement,
recognition, presentation, and disclosure of all material items appearing in the financial statements

Generally it includes financial reporting standards established by an authorised or recognised standards setting
organisation, or legislative or regulatory requirements.

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Standards on Auditing

In some cases, the financial reporting framework may encompass both financial reporting standards
established by an authorised or recognised standards setting organisation and legislative or regulatory
requirements.

Applicable financial reporting framework


The financial reporting framework adopted by management and, where appropriate, those charged with
governance in the preparation and presentation of the financial statements that is acceptable in view of the
nature of the entity and the objective of the financial statements, or that is required by law or regulation.

Ethical Requirements Relating to an Audit of Financial Statements


The auditor is subject to relevant ethical requirements, including those pertaining to independence, relating to
financial statement audit engagements.

Relevant ethical requirements ordinarily comprise the Code of Ethics issued by the Institute of Chartered
Accountants of India.

The Code establishes the following as the fundamental principles of professional ethics relevant to the auditor
when conducting an audit of financial statements and provides a conceptual framework for applying those
principles;
(a) Integrity;
(b) Objectivity;
(c) Professional competence and due care;
(d) Confidentiality; and
(e) Professional behavior.

Professional Skepticism
Professional skepticism refers to an attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

It also includes consideration of the sufficiency and appropriateness of audit evidence obtained in the light of
the circumstances.

Examples of professional skepticism:


The auditor shall plan and perform an audit with professional skepticism recognising that circumstances may
exist that cause the financial statements to be materially misstated.
Professional skepticism includes being alert to, for example:
● Audit evidence that contradicts other audit evidence obtained.
● Information that brings into question the reliability of documents and responses to inquiries to be used
as audit evidence.
● Conditions that may indicate possible fraud.
● Circumstances that suggest the need for audit procedures in addition to those required by the SAs.

Maintaining professional skepticism throughout the audit is necessary if the auditor is to reduce the risks of:
➢ Overlooking unusual circumstances.
➢ Over generalizing when drawing conclusions from audit observations.

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Standards on Auditing

➢ Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.

The auditor cannot be expected to disregard past experience of the honesty and integrity of the entity’s
management and those charged with governance. Nevertheless, a belief that management and those charged
with governance are honest and have integrity does not relieve the auditor of the need to maintain professional
skepticism or allow the auditor to be satisfied with less-than-persuasive audit evidence when obtaining
reasonable assurance.

Professional Judgement
The application of relevant
➔ training, knowledge & experience, (TKE)
➔ in making informed decisions
➔ about the courses of action that are appropriate in the circumstances of the audit engagement.
Professional judgment is essential to the proper conduct of an audit.

Professional judgment is necessary in particular regarding decisions about:


● Materiality and audit risk.
● The nature, timing, and extent of audit procedures used to meet the requirements of the SAs and gather
audit evidence.
● Evaluating whether sufficient appropriate audit evidence has been obtained, and whether more needs to
be done to achieve the objectives of the SAs and thereby, the overall objectives of the auditor.
● The evaluation of management’s judgments in applying the entity’s applicable financial reporting
framework.
● The drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.

Scope of the Audit


The auditor’s opinion on the financial statements deals with whether the financial statements are prepared, in
all material respects, in accordance with the applicable financial reporting framework. Such an opinion is
common to all audits of financial statements.

The auditor’s opinion therefore does not assure, for example, the future viability of the entity nor the efficiency
or effectiveness with which management has conducted the affairs of the entity.

In some cases, however, the applicable laws and regulations may require auditors to provide opinions on other
specific matters, such as the effectiveness of internal control, or the consistency of a separate management
report with the financial statements.

Premise on which audit is conducted.


An audit in accordance with SAs is conducted on the premise that management and, where appropriate, those
charged with governance have responsibility
a. For the preparation and presentation of the financial statements in accordance with the applicable
financial reporting framework; this includes the design, implementation and maintenance of internal
control relevant to the preparation and presentation of financial statements that are free from material
misstatement, whether due to fraud or error; and

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Standards on Auditing

b. To provide the auditor with:


i. All information, such as records and documentation, and other matters that are relevant to the
preparation and presentation of the financial statements;
ii. Any additional information that the auditor may request from management and, where
appropriate, those charged with governance; and
iii. Unrestricted access to those within the entity from whom the auditor determines it necessary to
obtain audit evidence.

Conduct of an audit in accordance with SAs

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M/s SG & Co. Chartered Accountants were appointed as Statutory Auditors of XYZ Limited for the F.Y
2022-2023. The Company implemented internal controls for prevention and early detection of any fraudulent
activity. Auditors carried out test of controls and found out no major observations. After the completion of
audit, audit report was submitted by the auditors and audited results were issued. Fraud pertaining to the
area of inventory came to light subsequently for the period covered by audit and auditors were asked to make
submission as to why audit failed to identify such fraud. Auditors submitted that because of inherent
limitations of audit, it is not possible to get persuasive evidence of certain matters like fraud. Do you think
auditor made correct statement? Also discuss certain subject matters or assertions where it is difficult to
detect material misstatements due to potential effects of inherent limitations.
(SA, July 2021, 5 Marks)

Yupee (P) Ltd. got incorporated on 15th May 2022 and Mr. Harsh, the director of Yupee (P) Ltd. proposed to
Kamal & Co. on 24th May 2022, for being appointed as its statutory auditor. Mr. Kamal, the sole proprietor of
Kamal & Co., after checking the compliance with all the statutory requirements, accepted the said offer and
issued an audit engagement letter vide email to Yupee (P) Ltd. Mr. Harsh found all terms of audit engagement
to be proper but in the paragraph relating to auditor’s responsibly in the engagement letter, as produced
below:-
“We will conduct our audit in accordance with Standards on Auditing (SAs), issued by the Institute of
Chartered Accountants of India (ICAI). Those Standards require that we comply with ethical requirements
and plan and perform the audit to obtain reasonable assurance about whether the financial statements are
free from material misstatement.”
Certain queries raised in his mind that what does reasonable assurance meant? Which Standard on Auditing
requires the auditor to obtain such reasonable assurance? Is it possible to give absolute assurance on such
financial statements?
Assuming that you are Mr. Kamal, the newly appointed statutory auditor of Yupee (P) Ltd. Please address to
the queries of Mr. Harsh as stated above.
(MTP2, May 2022, 5 Marks)

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Standards on Auditing

SA 210 - Agreeing the terms of Audit Engagement


Basics

Pre- Conditions for an audit


In order to establish whether the preconditions for an audit are present, the auditor shall:
● Determine whether the financial reporting framework is acceptable; and
● Obtain the agreement of management that it acknowledges (मानती है ) and understands (जानती है ) its
responsibility:
○ For the preparation of the financial statements​in accordance with the applicable financial
reporting framework;
○ For the internal control​as management considers necessary; and
○ To provide the auditor with:
■ Access to all information such as records, documentation and other matters;
■ Additional information that the auditor may request from management for the purpose
of the audit; and

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Standards on Auditing

■ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.

Agreement on Audit Engagement Terms


The auditor shall agree the terms of the audit engagement with management or those charged with governance,
as appropriate.

It is in the interests of both the entity and the auditor that the auditor sends an audit engagement letter before
the commencement of the audit to help avoid misunderstandings with respect to the audit.

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

1. The objective and scope of the audit of the financial statements;


2. The responsibilities of the auditor;
3. The responsibilities of management;
4. Identification of the applicable financial reporting framework for the preparation of the financial
statements; and
5. 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.

If law or regulation prescribes in sufficient detail the terms of the audit engagement referred above, the auditor
need not record them in a written agreement, except for the fact that such law or regulation applies and that
management acknowledges and understands its responsibilities.

Recurring Audits
On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement
to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement.

The auditor may decide not to send a new audit engagement letter or other written agreement each period.
However, in the following situations it is appropriate to revise the terms of the audit engagement or to remind
the entity of existing terms

The auditor may decide not to send a new audit engagement letter or other written agreement each period.
However, the following factors may make it appropriate to revise the terms of the audit engagement or to
remind the entity of existing terms:
● Any indication that the entity misunderstands the objective and scope of the audit.
● Any revised or special terms of the audit engagement.
● A recent change of senior management.
● A significant change in ownership.
● A significant change in nature or size of the entity’s business.
● A change in legal or regulatory requirements.
● A change in the financial reporting framework adopted in the preparation of the financial statements.
● A change in other reporting requirements.

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Standards on Auditing

Limitation on Scope Prior to Audit Engagement Acceptance


● If
○ management or those charged with governance
○ impose a limitation on the scope of the auditor’s work
○ in the terms of a proposed audit engagement
○ such that the auditor believes the limitation will result in the auditor disclaiming an opinion on
the financial statements,
■ the auditor
■ shall not accept such a limited engagement as an audit engagement,
■ unless required by law or regulation to do so.

Acceptance of a change in engagement


If, prior to completing the audit engagement,
● the auditor is requested to change the audit engagement
● to an engagement that conveys a lower level of assurance,
● the auditor shall determine whether there is
● Reasonable justification for doing so.

If auditor concludes that there is reasonable justification for changing the terms of audit engagement then
auditor must do his work as per the new terms of engagement and must issue a report in accordance with the
new terms of engagement

The report would not include reference to


● the original engagement; or
● any procedures that may have been performed in the original engagement.

If the terms of the audit engagement are changed, the auditor and management shall agree on and record the
new terms of the engagement in an engagement letter or other suitable form of written agreement.

The auditor should not agree to a change of engagement where there is no reasonable justification for doing so.

If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by
management to continue the original audit engagement, the auditor shall:
➔ Withdraw from the audit engagement where possible under applicable law or regulation; and
➔ Determine whether there is any obligation, either contractual or otherwise, to report the circumstances
to other parties, such as those charged with governance, owners or regulators.
A request from the client for the auditor to change the engagement may result from-
● a change in circumstances affecting the need for the service,
● a misunderstanding as to the nature of an audit or related service originally requested.
● a restriction on the scope of the engagement, whether imposed by management or caused by
circumstances.

Mr. Ram Kapoor, Chartered Accountant, has been appointed as the statutory auditor by XYZ Private Limited
for the audit of their financial statements for the year 2022-23. The company has mentioned in the audit
terms that they will not be able to provide internal audit reports to Mr. Ram during the course of audit.
Further, company also imposed some limitation on scope of Mr. Ram.

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Standards on Auditing

What are the preconditions Mr. Ram should ensure before accepting/ refusing the proposal? Also advise,
whether Mr. Ram should accept the proposed audit engagement?
(RTP, Nov 2019, NA)

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 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?
(MTP2, May 2019, 4 Marks)

T & Co., a firm of chartered accountants has not revised the terms of engagements and obtained confirmation
from the clients for last 5 years despite changes in business and professional environment. Please elucidate
the circumstances that may warrant the revision in terms of engagement.
(SA, May 2013, 4 Marks) (SA, Nov 2020 (Old), 4 Marks)

MEA Limited is a listed company having its operations across India. MEA Limited appointed Mr. X, Mr. Y
and Mr. Z, as its joint auditors for the year 2022-23. After making sure that all of them are qualified to be
appointed as statutory auditor, MEA Limited issued engagement letter to all of them. But Mr. X was not clear
on some points, so he requested MEA Limited to slightly change the terms of his engagement. This change
will not impact the ultimate opinion on the financial statement. The engagement letter contains the details
on objective and scope of audit, responsibilities of auditor and identification of framework applicable. It also
contains the reference to expected form and content of report from all three joint auditors. In your opinion,
what was the discrepancy in the Audit engagement letter issued by MEA Limited?
(RTP, Nov 2020, NA) (MTP2, Nov 2021, 4 Marks) (MTP1, Nov 2022, 4 Marks)

SA 220 - Quality Control For An Audit Of Financial Statements

A discussion on SQC-1 - Refer Videos


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.

The firm should establish a system of quality control designed to provide it with reasonable assurance
● that the firm and its personnel comply with
○ professional standards and
○ regulatory and legal requirements, and

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Standards on Auditing

● that reports issued by the firm or engagement partner(s) are appropriate in the circumstances.

Elements of a System of Quality Control

1. Leadership responsibilities for quality within the firm.


2. Ethical requirements.
3. Acceptance and continuance of client relationships and specific engagements.
4. Human resources.
5. Engagement performance.
6. Monitoring

Now Let Us Start SA 220

Basics
This Standard on Auditing (SA) deals with the specific responsibilities of the auditor regarding quality control
procedures for an audit of financial statements.

It also addresses, where applicable, the responsibilities of the engagement quality control reviewer. This SA is
to be read in conjunction with relevant ethical requirements

Quality control systems, policies and procedures are the responsibility of the audit firm.

Leadership Responsibilities for Quality on Audits


As per SA 220 “Quality Control for an Audit of Financial Statements”, the engagement partner shall take
responsibility for the overall quality on each audit engagement to which that partner is assigned.

The actions of the engagement partner and his communication with the members of the engagement team
should emphasis on

1. The importance of the following in audit quality


a. Performing work that complies regulatory and legal requirements; with professional standards
and
b. Complying with the firm’s quality control policies and procedures as applicable;
c. Issuing auditor’s reports that are appropriate in the circumstances; and
d. The engagement team’s ability to raise concerns without fear of reprisals; and
2. The fact that quality is essential in performing audit engagements.

Relevant Ethical Requirements


It is the responsibility of the Engagement Partner to keep vigilant for any indications of non-compliance with
relevant ethical requirements by the Engagement Team, which can be detected through inquiry and
observation.

If the Engagement Partner discovers any evidence of non-compliance with relevant ethical requirements, they
should consult with others in the firm and determine the appropriate action to take.

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Standards on Auditing

Independence
The engagement partner shall form a conclusion on compliance with independence requirements that apply to
the audit engagement. In doing so, the engagement partner shall:
a. Obtain relevant information from the firm to identify and evaluate circumstances and relationships that
create threats to independence;
b. Evaluate information on identified breaches to determine whether they create a threat to independence
for the audit engagement; and
c. 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.

Acceptance and Continuance of Client Relationships and Audit Engagements


SA 220 requires the firm to obtain information before accepting an engagement. Information such as the
following assists the engagement partner in determining whether the decisions regarding the acceptance and
continuance of audit engagements are appropriate

1. The integrity of the principal owners, key management and those charged with governance of the entity.
2. Whether the engagement team is competent to perform the audit engagement and has the necessary
capabilities, including time and resources;
3. Whether the firm and the engagement team can comply with relevant ethical requirements; and
4. Significant matters that have arisen during the current or previous audit engagement, and their
implications for continuing the relationship.

If the engagement partner obtains information that would have caused the firm to decline the audit
engagement had that information been available earlier, the engagement partner shall communicate that
information promptly to the firm, so that the firm and the engagement partner can take the necessary action.

Assignment of Engagement Teams


The engagement partner shall be satisfied that the engagement team, and any auditor’s experts who are not part
of the engagement team, collectively have the appropriate competence and capabilities to:
a. Perform the audit engagement in accordance with professional standards and regulatory and legal
requirements; and
b. Enable an auditor’s report that is appropriate in the circumstances to be issued.

Human Resource (SQC -1 Text)


The firm should establish policies and procedures designed to provide it with reasonable assurance that it has
sufficient personnel with the capabilities, competence, and commitment to ethical principles necessary to
perform its engagements in accordance with professional standards and regulatory and legal requirements, and
to enable the firm or engagement partners to issue reports that are appropriate in the circumstances

Such policies and procedures address the following personnel issues:


(a) Recruitment;
(b) Performance evaluation;

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Standards on Auditing

(c) Capabilities;
(d) Competence;
(e) Career development;
(f) Promotion;
(g) Compensation; and
(h) Estimation of personnel needs.

Addressing these issues enables the firm to ascertain the number and characteristics of the individuals required
for the firm’s engagements.

The firm’s recruitment processes include procedures that help the firm select individuals of integrity as well as
the capacity to develop the capabilities and competence necessary to perform the firm’s work.

Engagement Performance
Topics to covered
● Direction, Supervision and Performance
● Revviews
● Engagement Quality Control Review
● Consultation
● Differences of Opinion

Direction, Supervision and Performance


The engagement partner shall take responsibility for:
● The direction, supervision and performance of the audit engagement in compliance with professional
standards and regulatory and legal requirements; and
● The auditor’s report being appropriate in the circumstances.

Reviews
The engagement partner shall take responsibility for reviews being performed in accordance with the firm’s
review policies and procedures.

On or before the date of the auditor’s report, the engagement partner shall, through a review of the audit
documentation and discussion with the engagement team, be satisfied that sufficient appropriate audit
evidence has been obtained to support the conclusions reached and for the auditor’s report to be issued.

Consultation
The engagement partner shall:

a. Take responsibility for the engagement team undertaking appropriate consultation on difficult or
contentious matters;
b. Be satisfied that members of the engagement team have undertaken appropriate consultation during
the course of the engagement, both within the engagement team and between the engagement team and
others at the appropriate level within or outside the firm;
c. Be satisfied that the nature and scope of, and conclusions resulting from, such consultations are agreed
with the party consulted; and
d. Determine that conclusions resulting from such consultations have been implemented.

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Standards on Auditing

Engagement Quality Control Review


For audits of financial statements of listed entities and those other audit engagements, if any, for which the
firm has determined that an engagement quality control review is required, the engagement partner shall:
● Determine that an engagement quality control reviewer has been appointed;
● Discuss significant matters arising during the audit engagement, including those identified during the
engagement quality control review, with the engagement quality control reviewer; and
● Not date the auditor’s report until the completion of the engagement quality control review.

Matters to be evaluated by EQC Reviewer.


The engagement quality control reviewer shall perform an objective evaluation of the significant judgments
made by the engagement team, and the conclusions reached in formulating the auditor’s report.
This evaluation shall involve:
● Discussion of significant matters with the engagement partner;
● Review of the financial statements and the proposed auditor’s report;
● Review of selected audit documentation relating to the significant judgments the engagement team
made and the conclusions it reached; and
● Evaluation of the conclusions reached in formulating the auditor’s report and consideration of whether
the proposed auditor’s report is appropriate.

Differences of Opinion
If differences of opinion arise within the engagement team, with those consulted or, where applicable, between
the engagement partner and the engagement quality control reviewer, the engagement team shall follow the
firm’s policies and procedures for dealing with and resolving differences of opinion.

Monitoring
The firm should establish policies and procedures designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, operating effectively
and complied with in practice.

The purpose of monitoring compliance with quality control policies and procedures is to provide an evaluation
of:
● Adherence to professional standards and regulatory and legal requirements;
● Whether the quality control system has been appropriately designed and effectively implemented;
● Whether the firm’s quality control policies and procedures have been appropriately applied, so that
reports that are issued by the firm or engagement partners are appropriate in the circumstances.
● Follow-up by appropriate firm personnel so that necessary modifications are promptly made to the
quality control policies and procedures.

Documentation
The auditor shall document:
● Issues identified with respect to compliance with relevant ethical requirements and how they were
resolved.
● Conclusions on compliance with independence requirements that apply to the audit engagement, and
any relevant discussions with the firm that support these conclusions.
● Conclusions reached regarding the acceptance and continuance of client relationships and audit
engagements.

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Standards on Auditing

● The nature and scope of, and conclusions resulting from, consultations undertaken during the course of
the audit engagement.

The engagement quality control reviewer shall document, for the audit engagement reviewed, that:
● The procedures required by the firm’s policies on engagement quality control review have been
performed;
● The engagement quality control review has been completed on or before the date of the auditor’s report;
and
● The reviewer is not aware of any unresolved matters that would cause the reviewer to believe that the
significant judgments the engagement team made and the conclusions they reached were not
appropriate.

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.
(RTP, Nov 2019, NA) (MTP1, Nov 19, 4 Marks)

Rishikumar & Co. has been appointed as an auditor of PK Ltd. for the financial year 2022 - 23. CA. Kumar,
one of the partners of M/s Rishikumar & Co., completed entire routine audit work by 29th May, 2022.
Unfortunately, on the very next morning, while roving towards office of PK Ltd. to sign final audit report, he
met with a road accident and died.
CA. Rishi, another partner of M/s Rishikumar & Co., therefore, signed the accounts of PK Ltd., without
reviewing the work performed by CA. Kumar.
Advise, whether CA. Rishi is right in expressing an opinion on financial statements the audit of which is
performed by another auditor.
(MTP2, May 2018, 5 Marks)

OP & Associates are the statutory auditors of BB Ltd. BB Ltd is a listed company and started its operations 5
years back. The field work during the audit of the financial statements of the company for the year ended
March 31, 2022 got completed on July 1, 2022. The auditor’s report was dated July 12, 2022. During the
documentation review of the engagement, it was observed that the engagement quality control review was
completed on July 15, 2022. Engagement partner had completed his reviews in entirety by July 10, 2022.
Comment.
(MTP2, May 2018, 5 Marks) (MTP1, May 2019, 5 Marks)

Ace Limited (manufacturer of textile goods) got an order of manufacturing of PPE Kits in December 2022.
But there was shortage of machinery and manpower to accomplish the ordered requirement of PPE kits. Ace
Ltd. approached another manufacturing unit Jack Limited for purchase of the unit. Jack Limited was
interested in the sale of the unit, so the deal went through and Ace Limited acquired ninety five percent
shares of Jack Limited. The new management of Jack Limited proposed and appointed NKB Associates,
Chartered Accountants (already auditors of Ace Limited) as new auditors of Jack Limited. NKB Associates
accepted the assignment without considering information whether the conclusions reached regarding the

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Standards on Auditing

acceptance and continuance of client relationships and audit engagements are appropriate. Comment with
respect to appropriate Standard of Auditing what type of engagement assists the engagement partner in
determining whether the conclusions reached regarding the acceptance and continuance of client
relationships and audit engagements are appropriate or not?
(SA, Dec 2021 (Old), 5 Marks) (MTP1, Nov 2022, 5 Marks)

SA 230 Audit Documentation

Audit documentation
The record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor
reached

The standard does not in any way limit the specific documentation requirements of other SA’s. In other words,
if other SAs prescribe more documentation requirements, those documentations are also to be maintained.

Purposes of Audit Documentation


Audit documentation that meets the requirements of this SA and the specific documentation requirements of
other relevant SAs provides:
a. Evidence of the achievement of the overall objectives of the auditor; and
b. Evidence that the audit was planned and performed in accordance with SAs and applicable legal and
regulatory requirements.
Audit documentation serves a number of additional purposes, including the following:
1. Assisting the engagement team to plan and perform the audit.
2. Assisting members of the engagement team responsible for supervision to direct and supervise the
audit work, and to discharge their review responsibilities.
3. Enabling the engagement team to be accountable for its work.
4. Retaining a record of matters of continuing significance to future audits.
5. Enabling the conduct of quality control reviews and inspections.
6. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other
requirements.

Form ,Content and Extent of Audit Documentation


The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor to
understand.
a) The nature, timing and extent of the audit procedures:
b) The results of the audit procedures performed, and the audit evidence obtained; and
c) Significant matters arising during the audit and the conclusions reached thereon,significant
professional judgements made in reaching those conclusions
In documenting the nature, timing and extent of audit procedures performed, the auditor of shall record:
● The identifying characteristics of the specific items or matters tested. (Assertions tested) - क्या
● Who performed the audit work and the date such work was completed; and किसने check किया और कब
● Who reviewed the audit work performed and the date and extent of such review. किसने review किया कब
और कितना

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Standards on Auditing

The auditor shall 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.

If the auditor identified information that is inconsistent with the auditor's final conclusion regarding a
significant matter, the auditor shall document how the auditor addressed the inconsistency

Experience Auditor
An individual (whether internal or external to the firm) who has practical audit experience, and a reasonable
understanding of:
● Audit processes;
● SAs and applicable legal and regulatory requirements;
● The business environment in which the entity operates; and
● Auditing and financial reporting issues relevant to the entity’s industry.

Factors effecting Form, content and extent of audit documentation


The form, content and extent of audit documentation depend on factors such as:
● The size and complexity of the entity.
● The nature of the audit procedures to be performed.
● The identified risks of material misstatement.
● The significance of the audit evidence obtained.
● The nature and extent of exceptions identified.
● The need to document a conclusion or the basis for a conclusion not readily determinable* from the
documentation of the work performed or audit evidence obtained.
● The audit methodology and tools used.

*for example auditor’s assessment of risk of material misstatement is a matter of professional judgement and
the basis of this assessment of it is not readily determinable)

Ownership of Audit Documentation


Standard on Quality Control (SQC) 1 provides that,
● unless otherwise specified by law or regulation,
● Audit documentation is the property of the auditor.

The auditor should adopt reasonable procedures for custody and confidentiality of his working papers.

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.

In the case of a company, the main auditor has to consider the report of the branch auditor and has a right to
seek clarification and to visit the branch but cannot ask for the copy of working paper and therefore, the
branch auditor is under no compulsion to give photocopies of his working paper to the principal auditor.

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Standards on Auditing

Statutory auditor of the Holding company / Head office cannot have complete access to audit working papers
of the subsidiary company’s auditor or the auditor of the branch.

Auditors of the holding company can ask questions related to the audit procedures etc which was used to
conduct the audit of the subsidiary company.

With respect to audit or branch we need to study SA 600.

Preparation of Audit Documentation


● Preparing sufficient and appropriate audit documentation on a timely basis helps to
○ enhance the quality of the audit and
○ facilitates the effective review and evaluation of the audit evidence obtained and conclusions
reached before the auditor’s report is finalised.
● Documentation prepared after the audit work has been performed is likely to be less accurate than
documentation prepared at the time such work is performed.

Assembly of final audit file


● The auditor’s shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor’s report.
● SQC 1 “Quality Control for Firms that perform Audits and Review of Historical Financial Information,
and other Assurance and related services”, An appropriate time limit within which to complete the
assembly of the final audit file is ordinarily not more than 60 days after the date of the auditor’s report.
● The completion of the assembly of the final audit file after the date of the auditor’s report is an
administrative process that does not involve the performance of new audit procedures or the drawing
of new conclusions.
● Changes may , however be made to the audit documentation during the final assembly process if they
are administrative in nature. Examples of such changes include.
○ Deleting or discarding superseded documentation.
○ Sorting, collating and cross referencing working papers.
○ Signing off on completion checklists relating to the file assembly process.
○ Documenting audit evidence that the auditor has obtained, discussed and agreed with the
relevant members of the engagement team before the date of the auditor’s report.
● After the assembly of the final audit file has been completed, the auditor shall not delete or discard
audit documentation of any nature before the end of its retention period.

Matters Arising after the Date of the Auditor’s Report


As per SA 230 - Audit Documentation If, in exceptional circumstances, the auditor performs new or additional
audit procedures or draws new conclusions after the date of the auditor’s report, the auditor shall document
a. The circumstances encountered;
b. The new or additional audit procedures performed, audit evidence obtained, and conclusions reached,
and their effect on the auditor's report;
c. When and by whom the resulting changes to audit documentation were made and reviewed.

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Standards on Auditing

Retention
SQC 1 requires firms to establish policies and procedures for the retention of engagement documentation. The
retention period for audit engagements ordinarily is no shorter than seven years from the date of the auditor’s
report, or, if later, the date of the group auditor’s report.

Documentation of a Departure from a Relevant Requirement


If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement in a SA,
the auditor shall document
● how the alternative audit procedures performed achieve the aim of that requirement, and
● the reasons for the departure.

Mr. A, a practicing Chartered Accountant, has been appointed as auditor of True Pvt. Ltd. What factors would
influence the amount of working papers required to be maintained for the purpose of his audit?
(SA, Nov 2015, 5 Marks) (RTP, May 2020, NA)

B is the Principal Auditor of ABC Co. Ltd., with 8 branches audited by 8 Branch Auditors. B wanted to ensure
that the works of Branch Auditors were adequate for the purpose of his audit. Hence, he insisted on Branch
Auditors to get familiar with a check list he prepared for branches and, besides, required them to share the
working papers complied by them for his review and return. Is principal auditor within his right in asking for
such sharing of working papers?
(SA, May 2018, 5 Marks)

You are the team leader of 10 members for an audit of a Multinational Company. All the team members are
concerned about audit documentation in order to provide evidence that the audit complies with SAs. Hence,
the team members wish to document every matter concerned. In your opinion it is neither necessary nor
practicable for the auditor to document every matter considered or professional judgement made in an audit.
Further you feel that it is unnecessary for the auditor to document separately compliance with matters for
which compliance is demonstrated by documents included within the audit file. Illustrate by giving examples
with reference to relevant Standard on Auditing.
(SA, May 2022, 5 Marks)

SA 240 - The Auditor’s Responsibility Relating to Fraud In An Audit


Of Financial Statements
This Standard on Auditing (SA) deals with the auditor’s responsibilities relating to fraud in an audit of financial
statements. Specifically, it expands on how SA 315, “Identifying and Assessing the Risks of Material
Misstatement Through Understanding the Entity and Its Environment,” and SA 330, “The Auditor’s Responses
to Assessed Risks,” are to be applied in relation to risks of material misstatement due to fraud.

The objectives of the auditor are:


● To identify and assess the risks of material misstatement in the 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.

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Standards on Auditing

Meaning of Fraud

Auditor’s Concern
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is concerned with fraud that
causes a material misstatement in the financial statements.
Two types of intentional misstatements are relevant to the auditor
● Misstatement resulting from fraudulent financial reporting.
● Misstatements resulting from misappropriation of assets.

Different Ways of Committing Frauds relevant for Auditor


Fraudulent Financial Reporting
Fraudulent financial reporting involves intentional misstatements including omissions of amounts or
disclosures in financial statements to deceive financial statement users.

As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”,
● Fraudulent financial reporting may involve
● Manipulation, falsification or alteration of accounting records or supporting documents from
which financial statements are prepared,
● Misrepresentation in, or intentional omission from, financial statements of events, transactions
or other significant information or
● 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.
○ 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
○ 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.

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Standards on Auditing

○ Omitting, advancing or delaying Recognition in the financial statements of events and


transactions that have occurred during the reporting period.

Misappropriation of Assets
● Misappropriation of assets means 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 capable of concealing
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).

Detection of fraud and error duty of an auditor


Primary responsibility
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”,
● 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 for a
strong emphasis on fraud prevention, detection of Fraud/Error.
● This involves a commitment to creating a culture of honesty and ethical behavior which can be
reinforced by an active oversight by those charged with governance.

Broadly, the general principles laid down in the SA may be noted as under:

Auditor’s Objective
● 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.

Owning to ILA
● As described in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing,”
○ owing to the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements will not be detected,
○ even though the audit is properly planned and performed in accordance with the SAs.

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Standards on Auditing

Risk of not detecting


● 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.

Management Fraud
● 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.

Professional Skepticism
● When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of
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.

Auditor 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:

● 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;
● Consider whether
○ it is appropriate to withdraw from the engagement,
○ where withdrawal is possible under applicable law or regulation; and
● If the auditor withdraws:
○ 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
○ 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.

Auditor’s failure and Negligence


The subsequent discovery of a material misstatement of the financial statements resulting from fraud or error
does not by itself indicate a failure to conduct an audit in accordance with SAs.

“ If there remains a deep laid fraud in the accounts, which in the normal course of examination of accounts may
not come to light,
● It will not be construed as failure of audit​,

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● provided the auditor was not negligent in carrying out his normal work”

Auditor WILL NOT BE considered as negligent


● If he has carried his work in accordance
○ with SA’s and
○ applicable law and regulations.

Whether the auditor has performed an audit in accordance with SAs and law and regulations is determined by
the
● audit procedures performed in the circumstances, the
● sufficiency and appropriateness of the audit evidence obtained as a result thereof
● and the suitability of the auditor’s report based on an evaluation of that evidence in light of the overall
objectives of the auditor.

All this can be checked by AUDIT DOCUMENTATION.

However, the inherent limitations of an audit are not a justification for the auditor to be satisfied with less-than
persuasive audit evidence.

Fraud Risk Factors And The Possibility Of Fraud


Fraud Risk Factors may be defined as
● events or conditions that indicate an
○ incentive or pressure to commit fraud or
○ provide an opportunity to commit fraud.

Fraud, whether 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:

● Incentive or pressure to commit fraudulent financial reporting may exist when management is under
pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic)
earnings target or financial outcome.
● A perceived opportunity to commit fraud may exist when an individual believes internal control can be
overridden, for example, because the individual is in a position of trust or has knowledge of specific
deficiencies in internal control.
● Individuals may be able to rationalize committing a fraudulent act. Some individuals possess an
attitude, character or set of ethical values that allow them knowingly and intentionally to commit a
dishonest act. However, even otherwise honest individuals can commit fraud in an environment that
imposes sufficient pressure on them.

Risk Assessment Procedures and Related Activities


When performing risk assessment procedures and related activities to obtain an understanding of the entity
and its environment, including the entity’s internal control, required by SA 315 , the auditor shall perform the
following activities to obtain information for use in identifying the risks of material misstatement due to fraud.

(Activities to be done by auditor to Identify the risk of material misstatement due to fraud)

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1. Inquiries of management
2. Inquiries of those charged with governance.
3. Unusual or Unexpected Relationships Identified
4. Other Information
5. Evaluation of Fraud Risk Factors

Inquiries of management
The auditor shall make inquiries of management regarding
1. Management’s assessment of the risk that the financial statements may be materially misstated due to
fraud, including the nature, extent and frequency of such assessments.
2. Management’s process for identifying and responding to the risks of fraud in the entity.
3. Management’s communication, if any, to those charged with governance regarding its processes for
identifying and responding to the risks of fraud in the entity
4. Management’s communication, if any, to employees regarding its views on business practices and
ethical behavior.

For those entities that have an internal audit function, the auditor shall make inquiries of internal audit to
determine whether it has knowledge of any actual, suspected or alleged fraud affecting the entity, and to obtain
its views about the risks of fraud.

Inquiries of those charged with governance.


● UNDERSTANDING - Unless all of those charged with governance are involved in managing the entity ,
the auditor shall obtain an understanding of
○ how those charged with governance exercise oversight of
■ management’s processes for identifying and responding to the risks of fraud in the entity
and

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■ the internal control that management has established to mitigate these risks.
● INQUIRIES - The auditor shall make inquiries of those charged with governance to determine whether
they have knowledge of any actual, suspected or alleged fraud affecting the entity.
● WHY? - These inquiries are made in part to corroborate the responses to the inquiries of management.

Unusual or Unexpected Relationships Identified


The auditor shall evaluate whether unusual or unexpected relationships that have been identified in
performing analytical procedures, including those related to revenue accounts, may indicate risks of material
misstatement due to fraud.

Other Information (Consider OI Indicates ROMM-F)


The auditor shall consider whether other information obtained by the auditor indicates risks of material
misstatement due to fraud
Evaluation of Fraud Risk Factors
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.

They may indicate risks of material misstatement due to fraud.

For self study - The auditor shall treat those assessed risks of material misstatement due to fraud as significant
risks and accordingly the auditor shall obtain an understanding of the entity’s related controls, including
control activities, relevant to such risks. (if not done earlier)

Responses to the Assessed Risks of Material Misstatement Due to Fraud


Overall responses to address the assessed risks of material misstatement due to fraud at the
financial statement level
● Assign personnel with required knowledge, skill and ability.
● Evaluate whether the selection and application of accounting policies by the entity, may be indicative of
fraudulent financial reporting resulting from management’s effort to manage earnings.
● Incorporate an element of unpredictability in the selection of the nature, timing and extent of audit
procedures.

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

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.
● Although the level of risk of management override of controls will vary from entity to entity, the risk is
nevertheless 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.

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● he auditor shall determine whether, in order to respond to the identified risks of management override
of controls, the auditor needs to perform other any additional audit procedures.

Management Representations
The auditor shall obtain written representations from management and, where applicable, those charged with
governance that
● They acknowledge their responsibility for the design, implementation and maintenance of internal
control to prevent and detect fraud;
● They have disclosed to the auditor the results of management’s assessment of the risk of material
misstatement in the financial statement because of fraud.
● 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
● 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.

Documentation
● The significant decisions reached during the discussion among the engagement team regarding the
susceptibility of the entity’s financial statements to material misstatement due to fraud.
● The identified and assessed risks of material misstatement due to fraud at the financial statement level
and at the assertion level.
● 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;
● The results of the audit procedures, including those designed to address the risk of management
override of controls.

M/s Innocent Limited has entered into a transaction on 5th March, 2022, near year-end, whereby it has agreed
to pay Rs. 5 lakhs per month to Mr. Yuvraj as annual retainer-ship fee for "engineering consultation". No
amount was actually paid, but Rs. 60 lakhs are provided in books of account as on March 31, 2022. Your inquiry
elicits a response that need-based consultation was obtained round the year, but there is no documentary or
other evidence of receipt of the service. As the auditor of M/s Innocent Limited, what would be your
approach?
(RTP, Nov 2018, NA)

Comment on the following: On 15th March, 2022, the directors of Phony Ltd. instructed their accountant to
enter purchases amounting Rs. 1.02 crores from a company incorporated dated 11th March, 2022. However, no
amount was actually paid and Rs. 1.02 crore was provided in the books of account as purchases for the year
ending on 31st March, 2022. On inspection, no documentary or other evidence of such purchases was found.
As the auditor of Phony Ltd., what would be your approach regarding reporting of such bogus purchases?
(MTP1, May 2020, 5 Marks)

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Standards on Auditing

In the course of audit of Quick Ltd, you suspect that the management has made misstatement in the financial
statements intentionally to deceive the users and to succumb to pressures to meet market expectations.
Elucidate how the fraudulent financial reporting may be accomplished and also discuss the techniques of
committing fraud by management overriding controls.
(SA, Nov 2020, 5 Marks) (MTP1, Nov 2021, 5 Marks)

M/s Kumar & Co., Chartered Accountants were appointed as statutory auditors of PC limited for the financial
year 2022-23. During the course of audit, one of the partners CA Kumar observed that there is
misappropriation of assets in the form of theft of entity's inventory and is perpetrated by employees in
relatively small and immaterial amounts. CA Kumar is concerned with the existence of certain circumstances
for increasing the susceptibility of assets to misappropriation.
Guide CA Kumar with respect to Risk factors related to misstatements arising from misappropriation of assets
with reference to relevant Standard on Auditing.

(SA, Dec 2021, 5 Marks)


Arihant Limited was engaged in the business of owning and managing hotels and resorts, selling tourism
packages and performing airline bookings for corporate and individuals. It appointed Upadhyay & Co. as its
statutory auditor for the financial year 2022-23. While planning the audit, the audit team decided that the risk
of improper revenue recognition from hotel business should not be treated as a fraud risk. This conclusion
was based on the assessment of earlier years, wherein no fraud was identified in revenue recorded from such
business. While testing the internal financial controls over the process of revenue recognition, it was
identified that the controls are not properly designed to mitigate the risk of fraud and risk of improper
revenue recognition. As a result, the audit team decided to perform additional substantive testing. However,
the audit team still were to the conclusion that there is no risk of fraud in revenue recognition. During the
course of substantive testing, it was identified that the management did not account for revenue received from
corporate hotel bookings amounting to Rs 35 crore. These amounts were partially received in the company’s
bank accounts and partially received in the CFO’s personal account. The amounts received in the bank
account of the company were disclosed as advances
received against the future bookings.
In the light of above scenario, kindly guide the statutory auditors with respect to their responsibility relating
to fraud in an audit of a financial statement.
(RTP, Nov 2022, NA)

SA 250 Consideration of Laws and Regulations in an Audit of


Financial Statements

Responsibility of Management for Compliance with Law and Regulation


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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COMPLIANCE Meaning - the act of obeying an order, rule, or request

Policies are Procedures Implemented by Management to assist in the prevention


and detection of non-compliance with laws and regulations
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:
1. Monitoring legal requirements and
○ ensuring that operating procedures are designed to meet these requirements.
2. Instituting and operating appropriate systems of internal control.
3. Developing, publicising and following a code of conduct.
4. Ensuring employees are properly trained and understand the code of conduct.
5. Monitoring compliance with the code of conduct and acting appropriately to discipline employees who
fail to comply with it.
6. Engaging legal advisors to assist in monitoring legal requirements.
7. Maintaining a register of significant laws and regulations with which the entity has to comply within its
particular industry and a record of complaints.

Responsibility of the Auditor


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.
However, the auditor is not responsible for preventing non-compliance and cannot be expected to detect
non-compliance with all laws and regulations.

This SA distinguishes the auditor’s responsibilities in relation to compliance with two different categories of
laws and regulations as follows.
● Provisions of those L&R having a direct effect on determination of material amounts and disclosures in
F.S. such as tax and labour laws; and
● Other laws and regulations that don't have direct effect on determination of amounts and disclosures in
F.S., but compliance with which may be fundamental to operating aspects of business.
● For 1" category, auditor's responsibility is to obtain SAAE about compliance with Laws & Regulations.
● For second category, auditor's responsibility is limited to undertake specified audit procedures to help
identify non-compliance with those L&Rs that may have material effect on F.S.

The Auditor’s Consideration of Compliance with Laws and Regulations


● General Understanding
○ The auditor should obtain a general understanding of
○ The legal and regulatory framework applicable to the entity and the industry or sector in
which the entity operates; and
○ How the entity is complying with that framework.

● SAAE - COMPLIANCE
○ The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the
provisions of those laws and regulations that have

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■ a direct effect on the


★ determination of material amounts and
★ disclosures in the financial statements.

● AUDIT PROCEDURE - IDENTIFY INSTANCES OF NON COMPLIANCE


○ 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
★ Inquiring of management and, where appropriate, those charged with
governance, as to whether the entity is in compliance with such laws and
regulations; and
★ Inspecting correspondence, if any, with the relevant licensing or regulatory
authorities

(Non–compliance with other laws and regulations may result in fines, litigation or other consequences for the
entity, the costs of which may need to be provided for.)

● ALERT
○ 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.

● WRITTEN REPRESENTATIONS for instances of Non-Compliance and Suspected Non


Compliance
○ 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.

Indications of Non-Compliance with Laws and Regulations


1. Investigations by regulatory organisations and government departments or payment of fines or
penalties.
2. Payments for unspecified services or loans to consultants, related parties, employees or government
employees.
3. Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the entity
or in its industry or to the services actually received.
4. Purchasing at prices significantly above or below market price.
5. Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to
numbered bank accounts.
6. Unusual payments towards legal and retainership fees.

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7. Unusual transactions with companies registered in tax havens.


8. Payments for goods or services made other than to the country from which the goods or services
originated.
9. Payments without proper exchange control documentation. (without compliance with laws on foreign
exchange movement)
10. Existence of an information system which fails, whether by design or by accident, to provide an
adequate audit trail or sufficient evidence.
11. Unauthorised transactions or improperly recorded transactions.
12. Adverse media comment.

Audit Procedures When Non-Compliance is Identified or Suspected


1. 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.

Auditor suspects be non-compliance


2. 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.

3. 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. 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.

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Reporting of Identified and suspected non compliance

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As a statutory auditor of a company, comment on the following: While verifying the employee records in a company, it was found
that a major portion of the labour employed was child labour. On questioning the management, the auditor was told that it was
outside his scope of the financial audit to look into the compliance with other laws.
(RTP, May 2018, NA) (MTP 1, May 2020, 5 Marks) (MTP 2, May 2021, 4 Marks)

PQ Limited, a listed entity, is in the business of manufacturing of specialty chemicals. The company has appointed CA Jazz as
CFO of the company. CA Jazz is concerned about compliance with the provisions of laws and regulations that determine the
reported amounts and disclosure in financial statements of PQ Limited. Accordingly CA Jazz wants to implement such policies
and procedures that can assist him in the prevention and detection of non-compliance with laws and regulations. Help CA Jazz
by citing examples of such policies and procedures.
(SA, Nov 2020, 5 Marks)

As an Auditor of TRP Ltd., you are suspicious that there might be non-compliance with laws and regulations to which the

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company is subject to. Indicate the possible areas or aspects where you may have to look out for forming an opinion as to
whether your suspicion has some based to further inquire.
(SA, May 2018, 4 Marks) (MTP 2, Nov 2021, 4 Marks)

During the course of Audit of POP Ltd., you as an auditor while performing the audit procedures become aware of the existence
of certain instances which seem to be an indication of non-compliance with Laws and regulations. List out any five such
instances identified by you as an auditor, suggestive of non-compliance with Laws and regulations.
(SA, Jan 2021 (Old), 5 Marks)

You are appointed as auditor of BHK Ltd, a company engaged in export of agricultural equipment. During the course of audit,
your audit team informed you regarding non deduction of TDS on huge payments made to legal counsel of BHK Ltd. You want to
alert your team on the possibility of non-compliance with Laws and Regulations particularly related to payments made by the
company.
(SA, Dec 2021 (Old), 4 Marks)

CA Abhinanadan is an auditor of KM Private Limited. During the course of audit, CA Abhinanadan becomes aware of
information concerning an instance of non-compliance or suspected non-compliance with laws and regulations. Being a senior
partner of CA. Abhinanadan, guide him regarding audit procedures to be followed when non-compliance is identified or
suspected.
(RTP, May 2022, NA)

SA 260 - Communication With Those Charged With Governance

Scope
This SA deals with Auditor’s Responsibility to communicate with TCWG in an audit of financial statements

Role of Communication
There must be two way communication. This two-way communication is important in assisting ( basically now
we are going to discuss importance of two way communication)

1. Constructive working relationship and understanding the matters related to audit. This relationship is
developed while maintaining auditor's Independence and objectivity.
2. 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.

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3. Those charged with governance in fulfilling their responsibility to oversee the financial reporting
process thereby reducing the risk of material misstatement of the financial statements.

Communication
With whom? IDENTIFY
● The auditor shall determine the appropriate person(s) within the entity’s governance structure with
whom to communicate.

Communication with a Subgroup of Those Charged with Governance


● 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.

When All of Those Charged with Governance Are Involved in Managing the Entity
● In some cases, all of those charged with governance are involved in managing the entity,
● For example, a small business where a single owner manages the entity and no one else has a
governance role. In these cases, if matters required by this SA are communicated with person(s) with
management responsibilities, and those person(s) also have governance responsibilities, the matters
need not be communicated again with those same person(s) in their governance role.
● The auditor shall 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.

Matters to Be Communicated
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:
○ 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
○ The audit of the financial statements does not relieve management or those charged with
governance of their responsibilities.

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.

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.
b. Significant difficulties, if any, encountered during the audit;
c. Significant matters arising during the audit that were discussed, or subject to correspondence, with
management; and
d. Written representations the auditor is requesting;

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e. Circumstances that affect the form and content of the auditor's report, if any; and
f. 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.

Auditor Independence
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
● We have identified and considered all relationships that may have an impact on Independence
including the impact of non audit services.
● The related safeguards that have been applied to eliminate identified threats to independence or reduce
them to an acceptable level.

The Communication Process


Establishing the Communication Process
The auditor shall communicate with those charged with governance the form, timing and expected general
content of communications.

Forms of Communication
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.

Independence
The auditor shall communicate in writing with those charged with governance regarding auditor independence
when required

Timing of Communications
The auditor shall communicate with those charged with governance on a timely basis.

Adequacy of the Communication Process (Adequate, Effect)


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.

Factors affecting form of communication


In addition to the significance of a particular matter, the form of communication (e.g., whether to
communicate orally or in writing, the extent of detail or summarization in the communication, and whether to
communicate in a structured or unstructured manner) may be affected by such factors as
● Whether a discussion of the matter will be included in the auditor’s report. For example, when key audit
matters are communicated in the auditor’s report, the auditor may consider it necessary to
communicate in writing about the matters determined to be key audit matters.
● Whether the matter has been satisfactorily resolved.
● Whether management has previously communicated the matter.
● The size, operating structure, control environment, and legal structure of the entity.
● Legal requirements. In some entities, a written communication with those charged with governance is
required in a prescribed form by local law.

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● The expectations of those charged with governance, including arrangements made for periodic
meetings or communications with the auditor.
● The amount of ongoing contact and dialogue the auditor has with those charged with governance.
● Whether there have been significant changes in the membership of a governing body.

Significant difficulties
Significant difficulties encountered during the audit may include such matters as:
● Significant delays by management, the unavailability of entity personnel, or an unwillingness by
management to provide information necessary for the auditor to perform the auditor's procedures.
● An unreasonably brief time within which to complete the audit.
● Extensive unexpected effort required to obtain sufficient appropriate audit evidence.
● The unavailability of expected information.
● Restrictions imposed on the auditor by management.
● Management‟s unwillingness to make or extend its assessment of the entity's ability to continue as a
going concern when requested.
In some circumstances, such difficulties may constitute a scope limitation that leads to a modification of the
auditor’s opinion.

Significant Matters
Significant matters 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.
Circumstances that Affect the Form and Content of the Auditor’s Report
SA 210 requires the auditor to agree the terms of the audit engagement with management or those charged with
governance, as appropriate.

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.

The communication required 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 (or that affect the Form and Content of the Auditor’s Report)

● The auditor expects to modify the opinion in the auditor's report in accordance with SA 705.

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Standards on Auditing

● 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 Matters
paragraph in accordance with SA 706 or is required to do so by other SAs.

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.

Whilst the Audit team has identified few matters, they need your advice to conclude on the same. Engagement Partner have
asked them to review the Board minutes and other secretarial/ regulatory records based on which the following additional
matters were brought to the attention of the Partner:-
(i) The long term borrowings from the parent company has no written terms and neither the interest nor the principal has been
repaid so far.
(ii) Certain computers were received from the parent company free of cost, the value of which is Rs 0.23 lac and no accounting or
disclosure of the same has been made in the notes to accounts.
(iii) An amount of Rs 3.25 Lakhs per month is paid to M/s. WE CARE Associates, a partnership firm, which is a 'related party' in
accordance with the provisions of the Companies Act, 2013 for the marketing services rendered by them. Based on an
independent assessment, the consideration paid is higher than the arm's length pricing by Rs 0.25 Lakhs per month. Whilst the
transaction was accounted in the financial statements based on the amounts' paid, no separate disclosure of this related party
transaction has been made in the notes to accounts forming part of the financial statements highlighting the same as a 'related
party' transaction.
Audit Manager has reported that she had asked certain information relating to another 'related party' transaction (amounting to
approx. Rs 47 lac) but the CFO refused to provide the same since the same is perceived to be confidential and cannot be shared
with the Auditors.
You are required to advise about items to be reported to those charged with governance, where applicable, based on your audit
findings in the given situation.
(MTP 1, Nov 2020, 5 Marks)

M/s Manidhari & Associates have been appointed as an auditor of JIN Limited, a multinational company dealing in spare parts.
During the course of audit, CA Manidhari is facing many problems including the problem of not getting the desired information
from the management. Accordingly, he decided to communicate with those charged with the governance about significant
difficulties encountered during the audit. CA Manidhari seeks your guidance on matters which can be considered as significant
difficulties as per SA 260.
(RTP, May 2022, NA)

SA 265 - Communicating Deficiencies In Internal Control To Those


Charged With Governance And Management

Deficiency in internal control – This exists when:


● 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
● A control necessary to prevent, or detect and correct, misstatements in the financial statements on a
timely basis is missing.
Significant deficiency in internal control – A deficiency or combination of deficiencies in internal control that,
in the auditor’s professional judgment, is of sufficient importance to merit the attention of those charged with
governance.

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Requirements
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 management’s attention.

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.

Indicators of significant deficiencies in internal control


Indicators of significant deficiencies in internal control include
● Absence of a risk assessment process within the entity where such a process would ordinarily be
expected to have been established.
● Evidence of an ineffective entity risk assessment process, such as management’s failure to identify a
RMM that the auditor would expect the entity’s risk assessment process to have identified.
● Evidence of ineffective aspects of the control environment.
● Evidence of an ineffective response to identified significant risks
● Evidence of management’s inability to oversee the preparation of the financial statements.
● Misstatements detected by the auditor’s procedures that were not prevented, or detected & corrected, by
the entity’s internal control.

Auditors are required to obtain an understanding of internal control relevant to the audit when identifying and
assessing its effectiveness and risk of material misstatement. During the course of audit of ABC Ltd., you observed
that significant deficiency exists in the internal control system and you want to ascertain the same. Elucidate the

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various indicators of significant deficiencies which will help you in assessing the efficiency of internal control
system of the organization.
(SA, Jan 2021, 5 Marks)

CA.N has been appointed as an auditor of TRP Ltd. While conducting the audit he has identified some
deficiencies in the Internal control. He needs to determine whether a deficiency or combination of deficiencies in
internal control constitutes a "significant deficiency" and has to communicate them in writing to those charged
with Governance and management on a timely basis. Guide CA.N with some examples of matters to be
considered while determining `significant deficiency' in internal control with reference to relevant SA.
(SA, Nov 2020, 5 Marks)

Or

During the course of the audit of Tirthankara Limited, CA. Shreyansh Manager in the audit team identified that
there is significant risk in lease transactions due to complex cross -border sale and lease back arrangements. This
significant risk or risk of material misstatement was not identified in management's risk assessment process.
Upon various inquiries with Management regarding their risk assessment process, it was identified and
concluded by the audit team that the management's risk assessment process is not effective to identify all the
significant risks.
CA. Shreyansh decided that this in combination with other potential deficiencies in internal control constitutes
significant deficiencies in internal control and hence, is required to be communicated to those charged with
governance. However, the engagement partner had a different view regarding the audit of Tirthankara Limited.
According to him, the only matter that is identified and poses significant deficiencies due to their magnitude is
only required to be communicated. Matters of potential misstatements that are not actual misstatements cannot
be termed as significant deficiencies.
You are required to guide CA. Shreyansh with respect to examples of matters that the auditor may consider in
determining whether a deficiency or combination of deficiencies in internal control constitutes a significant
deficiency.
(MTP2, Nov 2022, 4 Marks)

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.
(ICAI Study Material)

Answer
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 -

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 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.
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

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resulting from a weakness in internal control.

SA 299 - Joint Audit of Financial Statements

Joint Audit’ and ‘Joint Auditors’


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.

Audit Planning, Risk Assessment and Allocation of Work


1. The engagement partner and other key members of the engagement team from each of the joint auditors shall
be involved in planning the audit.
2. The joint auditors shall jointly establish an overall audit strategy that sets the scope, timing and direction of
the audit, and that guides the development of the audit plan.
3. 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 audit area division and common areas among joint auditors to define each joint auditor's
scope.
b. Ascertain engagement's reporting objectives to plan audit timing and required communications.
c. Consider and communicate significant factors among joint auditors that guide the engagement team's
efforts.
d. Consider results of preliminary engagement activities and relevance of knowledge gained on previous
similar engagements by respective engagement partner(s).
e. Ascertain the nature, timing and extent of resources necessary to perform the engagement.
4. Each joint auditor should consider, assess, and communicate risks of material misstatement to others;
document whether risks pertain to overall financial statements or specific audit areas.

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5. Joint auditors should discuss, document, and communicate nature, timing, and extent of audit procedures for
common and specific audit areas to those charged with governance.
6. Joint auditors should obtain a common engagement letter and a common management representation letter.
7. Post work identification and allocation among joint auditors, the work allocation document should be signed
by all joint auditors and communicated to those charged with governance.

Responsibility and Co-ordination among Joint Auditors


● 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
● All the joint auditors shall be jointly and severally responsible for
○ the audit work which is not divided among the joint auditors and is carried out by all joint auditors;
○ 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.
○ 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;
○ examining that the financial statements of the entity comply with the requirements of the relevant
statutes;
○ presentation and disclosure of the financial statements as required by the applicable financial
reporting framework;
○ 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.
● If a joint auditor encounters matters relevant to others' responsibilities, requiring their attention, disclosure,
discussion, or judgment application, they should communicate these in writing to all other joint auditors
before the audit completion.
● Each joint auditor is responsible for determining the nature, timing, and extent of audit procedures applied
to their allocated work areas. They're individually responsible for studying and evaluating the internal
control system and risk assessment related to their allocated work areas.

Audit Conclusion and Reporting


Reporting
● Joint auditors are expected to issue a common audit report.
● In case of disagreement, auditors can issue separate audit reports.
● 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.
● Audit reports by joint auditors shall make reference separate report(s) issued by other joint auditor(s).
● Separate audit report(s) shall also reference to those issued by joint auditors.
● Such reference shall be made under the heading “Other Matter Paragraph” as per Revised SA 706, “Emphasis
of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”.

Work of other Joint Auditors


● Each joint auditor is entitled to assume
○ that 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.

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● The other joint auditors have shared any significant observations or departures from the financial
reporting framework relevant to their duties.
● Before finalizing the audit report, joint auditors should discuss and share their respective
conclusions.

Communication with Those Charged with Governance


● If joint auditors plan to modify the audit report's opinion, they must communicate with those charged with
governance about the circumstances leading to the expected modification and the proposed wording, in
compliance with SA 705.
● If an Emphasis of Matter or Other Matter paragraph is expected in the audit report, joint auditors should
communicate this and the proposed wording to those charged with governance, ensuring compliance with
SA 706.

What are the advantages and disadvantages of Joint Audit?

Advantages
● Pooling and sharing of expertise
● Reduced workload
● Better performance
● Improved service to the client
● Local firms can conduct audit in a better manner especially in case of multinational companies.
● A sense of healthy competition towards better performance.
● Low cost (in terms of development of staff and conducting audit)

Disadvantages
● The fees being shared.
● Psychological problem where firms of different standing are associated in the joint audit
● General superiority complexes of some auditors.
● Problems of coordination of the work.
● Areas of work of common concern being neglected,
● Uncertainty about the liability for the work done,
● Lack of clear definition of responsibility

KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct auditing for
the financial year 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 actuary reports. However, Mr. X agreed to Mr. Y’s
actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit report
due to majority of votes. Now, Mr. Z is in dilemma.
(i) You are required to briefly explain the responsibilities of auditors when they are jointly and severally
responsible in respect of audit conducted by them and also guide Mr. Z in such situation.
(ii) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty.
(RTP, Nov 2018, NA) (ICAI Study Material)

Your firm is one of the Joint Auditors of FMP Ltd. Under what circumstances joint auditors are jointly liable for the
work in relation to audit of financial statements? Is there any restriction on a joint auditor to communicate a
dissenting note differing from the majority opinion of the other joint auditors in the audit report issued under
section 143 of the Companies Act, 2013?
(SA, Nov 2018 (Old), 5 Marks)

NMN & Co., LLP and ABC & Associates, LLP are the joint statutory auditors of BHS Ltd. BHS Ltd. is a listed company
and has been in existence for the last 50 years. Since beginning this company was audited by MQS & Associates
but due to audit rotation, the company had to bring in new auditors. Considering the size of the company, two
auditors were appointed as joint auditors. Since the company is new to these auditors and the concept of joint

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auditors to whom audit work has been divided, management had a discussion and understood that 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. Advise.
(MTP2, May 2019, 4 Marks)

Dice Ltd. appointed two CA firms MN & Associates and PQ & Co. as joint auditors for conducting audit for the year
ended 31st March, 2023. In the course of audit, it has been observed that there is a major understatement in the
value of inventory. The inventory valuation work was looked after by MN & Associates but there was no
documentation for the division of the work between the joint auditors.
Comment on the above situation with regard to responsibilities among joint auditors.
(SA, May 2019, 5 Marks)

Excellent Bank Ltd. is a Public Limited Company. The said Bank has various branches all over India. The Bank
appoints 3 Joint Auditors for the financial year ending 31/03/2022. All the 3 Joint Auditors divide the work with
mutual consent. Verification of Consolidation, however, remained undivided. All branches and zones were divided
amongst the 3 Joint Auditors. During audit of zones, CA. Z, one of the joint auditors expressed a concern about
internal control in one of the large corporate branches situated in his zone. The irregularity was not reported in
the final accounts as the other 2 Joint Auditors were not in favour of reporting and decision of not reporting the
same was taken on the basis of majority. Subsequently, fraud has been detected in the said branch which was
audited by CA. Z.
The Bank seeks your advice about the responsibility of the 3 Joint Auditors in the above situation.
(SA, Nov 2019 (Old), 5 Marks)

SA 300 “Planning an Audit of Financial Statements”

Scope
This Standard on Auditing (SA) deals with the auditor’s responsibility to plan an audit of financial statements.

Objective
The objective of the auditor is to plan the audit so that it will be performed in an effective manner.

Involvement of Key Engagement Team Members


The engagement partner and other key members of the engagement team shall be involved in planning the
audit, including planning and participating in the discussion among engagement team members.

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

Audit Plan to Conduct an Effective Audit


Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting systems, policies and internal control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;
(c) determining and programming the nature, timing, and extent of the audit procedures to be performed;
and

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(d) coordinating the work to be performed.

Plans should be further developed and revised as necessary during the course of the audit.

Discussion of elements of planning with management


The auditor may decide to discuss elements of planning with the entity’s management to facilitate the conduct
and management of the audit engagement.

Although these discussions often occur, the overall audit strategy and the audit plan remain the auditor’s
responsibility. When discussing matters included in the overall audit strategy or audit plan, care is required in
order not to compromise the effectiveness of the audit.

Planning Activities
Audit Strategy
What is Audit Strategy

Overall audit strategy sets the scope, timing and direction of the audit, and guides the development of the more
detailed audit plan.

How would the audit strategy be helpful to the auditor?

The process of establishing the overall audit strategy assists the auditor to determine, subject to the completion
of the auditor’s risk assessment procedures, such matters as:

● 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
● The amount of resources to allocate to specific audit areas, such as the number of team members
assigned to observe the inventory count at material locations, the extent of review of other auditors’
work in the case of group audits, or the audit budget in hours to allocate to high risk areas
● When these resources are to be deployed, such as whether at an interim audit stage or at key cut-off
dates; and
● How such resources are managed, directed and supervised, such as when team briefing and debriefing
meetings are expected to be held, how engagement partner and manager reviews are expected to take
place (for example, on-site or off-site), and whether to complete engagement quality control reviews.

Establishment of Overall Audit Strategy

In establishing the overall audit strategy, the auditor shall ( POINTS TO BE KEPT IN MIND WHILE
DEVELOPING OVERALL AUDIT STRATEGY)

a. Identify the characteristics of the engagement that define its scope;


b. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of
the communications required.
c. Consider the factors that, in the auditor’s 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 engagements performed by the engagement partner for the entity is relevant; and

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e. Ascertain the nature, timing and extent of resources necessary to perform the engagement.

Audit Plan
Description of Audit Plan
As per SA 300 “Planning an Audit of Financial Statement” the audit plan shall be include a description of

❖ The nature, timing and extent of planned risk assessment procedures, as determined under SA 315.
❖ The nature , timing and extent of planned further audit procedures at the assertion level, as determined
under SA 330.
❖ Other planned audit procedures that are required to be carried out so that the engagement complies
with SAs. (Obtaining written representations from management)

● 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.

Relationship between the overall audit strategy and the audit plan
● Change in audit strategy will lead to change in audit plan and vice versa
● Audit plan is prepared after the audit strategy and is more detailed. Audit strategy gives less detail but
it forms the basis of the planning
● 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
● Detailed audit plans would include the nature, timing and extent of the audit procedures so as to obtain
sufficient appropriate audit evidence.

For Understanding Purpose Only

● SCOPE - Coverage (Consolidate financial statement or otherwise, branches are included or not, etc)
(regulatory or statutory reporting requirements)
● TIMING - Setting milestones for completion of audit work. (Deadlines) (Time Budgets)
● DIRECTION - How we are going to use the information / knowledge gained from other engagements,
Effect of preliminary evaluations of materiality, audit risk and internal control.

The audit strategy relates to the overall approach you will take to the audit, it decides the scope of the audit.

The audit plan is the detailed procedures you will use in your audit depending on what the strategy is.

For example- if you decide the organisation is new and doesn't have proper controls in place, you will decide
not to rely on any controls and perform only substantive testing- This is Audit Strategy

Audit plan is then deciding the substantive audit tests you will perform (AEIOU. Reperformance. External
Confirmation). This includes the nature, timing and extent of audit tests you will undertake to gain comfort
over the financial statement balances.

An audit plan is more detailed.

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Planning is a Continuous Process


Planning is not a discrete phase of an audit, but rather a continual and iterative process

Planning is not a discrete phase of an audit, but rather a continual and iterative process that 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 However includes consideration of the timing of certain activities and audit procedures that need to
be completed prior to the performance of further audit procedures. For example, planning includes the need to
consider, prior to the auditor’s identification and assessment of the risks of material misstatement, such
matters as

1. The analytical procedures to be applied as risk assessment procedures.


2. Obtaining a general understanding of the legal and regulatory framework applicable to the entity and
how the entity is complying with that framework.
3. The determination of materiality.
4. The Involvement of experts.
5. The performance of other risk assessment procedures.

Direction, Supervision and Review


The auditor shall
● plan the nature, timing and extent of
● direction and supervision of engagement team members and
● the review of their work.

The nature, timing and extent of the direction and supervision of engagement team members and review of
their work vary depending on many factors, including:
● The size and complexity of the entity.
● The area of the audit.
● The assessed risks of material misstatement
● The capabilities and competence of the individual team members performing the audit work.

Changes to planning decisions During the Audit


● The auditor shall update and change the overall audit strategy and the audit plan as necessary during
the course of the audit.
○ As a result of unexpected events,
○ changes in conditions, or
○ the audit evidence obtained from the results of audit procedures,
● the auditor may need to modify the audit plan & planned nature, timing and extent of further audit
procedures, based on the revised consideration of assessed risks.
● This may be the case when information comes to the auditor’s attention that differs significantly from
the information available when the auditor planned the audit procedures.
● For example, audit evidence obtained through the performance of substantive procedures may
contradict the audit evidence obtained through tests of controls.

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Documentation of Audit plan


The auditor shall document:
a. the overall audit strategy;
b. the audit plan; and
c. any significant changes made during the audit engagement to the overall audit strategy or the audit
plan, and the reasons for such changes.

Record of the 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.

Record of the proper planning


It also serves as a record of the proper planning of the audit procedures that can be reviewed and approved
prior to their performance.

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

Additional Considerations in Initial Audit Engagements


Purpose and Objective remains same
The purpose and objective of planning the audit are the same whether the audit is an initial or recurring
engagement.

Planning activities will be expanded


However, for an initial audit, the auditor may need to expand the planning activities because the auditor does
not ordinarily have the previous experience with the entity that is considered when planning recurring
engagements.

For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and
audit plan include the following:

● Performing procedures required by SA 220 regarding the acceptance of the client relationship and
specific audit engagement.
● Unless prohibited by law or regulation, arrangements to be made with the predecessor auditor, for
example, to review the predecessor auditor’s working papers.
● Other procedures required by the firm’s system of quality control for initial audit engagements (for
example, review of the overall strategy by senior partner before starting the audit)

Homework
Considerations in Establishing the Overall Audit Strategy

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Many of these matters will also influence the auditor’s detailed audit plan. The examples provided cover a broad
range of matters applicable to many engagements. While some of the matters referred to below may be required
by other SAs, not all matters are relevant to every audit engagement and the list is not necessarily complete.

Characteristics of the Engagement


● The financial reporting framework on which the financial information to be audited has been prepared,
including any need for reconciliations to another financial reporting framework.
● Industry-specific reporting requirements such as reports mandated by industry regulators.
● The expected audit coverage, including the number and locations of components to be included.
● The nature of the control relationships between a parent and its components that determine how the
group is to be consolidated.
● The extent to which components are audited by other auditors.
● The nature of the business segments to be audited, including the need for specialized knowledge.
● The reporting currency to be used, including any need for currency translation for the financial
information audited.
● The need for a statutory audit of standalone financial statements in addition to an audit for
consolidation purposes.
● The availability of the work of internal auditors and the extent of the auditor’s potential reliance on
such work.
● The entity’s use of service organizations and how the auditor may obtain evidence concerning the
design or operation of controls performed by them.
● The expected use of audit evidence obtained in previous audits, for example, audit evidence related to
risk assessment procedures and tests of controls.
● The effect of information technology on the audit procedures, including the availability of data and the
expected use of computer-assisted audit techniques.
● The coordination of the expected coverage and timing of the audit work with any reviews of interim
financial information and the effect on the audit of the information obtained during such reviews.
● The availability of client personnel and data.

Reporting Objectives, Timing of the Audit, and Nature of Communications


● The entity's timetable for reporting, such as at interim and final stages
● The organization of meetings with management and those charged with governance to discuss the
nature, timing and extent of the audit work.
● The discussion with management and those charged with governance regarding the expected type and
timing of reports to be issued and other communications, both written and oral, including the auditor’s
report, management letters and communications to those charged with governance.
● The discussion with management regarding the expected communications on the status of audit work
throughout the engagement.
● Communication with auditors of components regarding the expected types and timing of reports to be
issued and other communications in connection with the audit of components.
● The expected nature and timing of communications among engagement team members, including the
nature and timing of team meetings and timing of the review of work performed.
● Whether there are any other expected communications with third parties, including any statutory or
contractual reporting responsibilities arising from the audit.

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Significant Factors, Preliminary Engagement Activities, and Knowledge Gained


on Other Engagements
● The determination of materiality in accordance with SA 320 , and, where applicable:
● Determination of materiality for components and communication thereof to component auditors.
● Preliminary identification of significant components and material classes of transactions, account
balances and disclosures ¾ Preliminary identification of areas where there may be a higher risk of
material misstatement.
● The impact of the assessed risk of material misstatement at the overall financial statement level on
direction, supervision and review.
● The manner in which the auditor emphasizes to engagement team members the need to maintain a
questioning mind and to exercise professional skepticism in gathering and evaluating audit evidence.
● Results of previous audits that involved evaluating the operating effectiveness of internal control,
including the nature of identified deficiencies and action taken to address them.
● The discussion of matters that may affect the audit with firm personnel responsible for performing
other services to the entity.
● Evidence of management’s commitment to the design, implementation and maintenance of sound
internal control, including evidence of appropriate documentation of such internal control.
● Volume of transactions, which may determine whether it is more efficient for the auditor to rely on
internal control.
● Importance attached to internal control throughout the entity to the successful operation of the
business. Significant business developments affecting the entity, including changes in information
technology and business processes, changes in key management, and acquisitions, mergers and
divestments.
● Significant industry developments such as changes in industry regulations and new reporting
requirements.
● Significant changes in the financial reporting framework, such as changes in accounting standards.
● Other significant relevant developments, such as changes in the legal environment affecting the entity.

Preliminary Engagement Activities


The auditor shall undertake the following activities at the beginning of the current audit engagement:
● 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;
● Evaluating compliance with ethical requirements, including independence, as required by SA 220; and
● Establishing an understanding of the terms of the engagement, as required by SA 210.

Write short note on : Contents of an Audit Plan.


(RTP, Nov 2020, NA)

AB & Associates, a Chartered Accountant firm, was appointed auditors of KEY Company Ltd. for the financial
year ended 31st March 2023. Being the first year of audit, the audt firm AB & Associates, as per its system of
quality control, involve senior partner of the firm to review the overall audit strategy prepared by the team
members. What additional matters would be considered in initial audit engagement by the senior partner in
establishing the overall audit strategy and audit plan of KEY Company Ltd.?
(SA, Dec 2021 (Old), 5 Marks)

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Standards on Auditing

SA 315 Identifying and assessing the risk of material


misstatement through understanding the entity and its
environment
The objective of the auditor is to
● identify and assess the risks of material misstatement,
● whether due to fraud or error,
● at the financial statement and assertion levels,
○ through understanding the entity and its environment, including the entity’s internal control,
○ thereby providing a basis for designing and implementing responses to the assessed risks of
material misstatement.

Requirements of SA 315.
● Risk assessment Procedures
● Understanding of the Entity and Its Environment, Including the Entity’s Internal Control The Entity
and Its Environment.
● The Entity’s Internal Control
● Identifying and Assessing the Risks of Material Misstatement.
● Risks that Require Special Audit Consideration
● Revision of Risk Assessment
● Documentation

Risk assessment procedures


The audit procedures performed
● to obtain an understanding of the entity and its environment, including the entity’s internal control,
● to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial
statement and assertion levels.

Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit evidence on
which to base the audit opinion.

The risk assessment procedures shall include the following:


a. Inquiries of management and of others within the entity who in the auditor’s judgment may have
information that is likely to assist in identifying risks of material misstatement due to fraud or error.
b. Analytical procedures.
c. Observation and inspection.

The auditor shall consider whether information obtained from the auditor’s client acceptance or continuance
process is relevant to identifying risks of material misstatement.

Where the engagement partner has performed other engagements for the entity, the engagement partner shall
consider whether information obtained is relevant to identifying risks of material misstatement.

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When the auditor plans to utilize information from previous audits, they must determine if any changes have
occurred since then that may impact its relevance to the current audit.

Understanding of the Entity and Its Environment, Including the Entity’s


Internal Control The Entity and Its Environment.
As per SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the
Entity and Its Environment”, the auditor shall obtain an understanding of the following:
1. Relevant industry, regulatory and other external factors including applicable financial reporting
framework.
2. The nature of the entity, including:
a. Its operations;
b. Its ownership and governance structures;
c. The types of investments that the entity is making and plan to make: &
d. The way that the entity is structured and how it is financed.
3. The entity’s selection and application of accounting policies, including the reasons for changes thereto.
4. The entity’s objectives and strategies, and those related Business risks that may result in risks of
material Misstatement.
5. The measurement and review of the entity’s financial performance.

The Entity’s Internal Control


The auditor shall obtain an understanding of internal control relevant to the audit.
● Although most controls relevant to the audit are likely to relate to financial reporting, not all controls
that relate to financial reporting are relevant to the audit.
● It is a matter of the auditor’s professional judgment whether a control, individually or in combination
with others, is relevant to the audit.

For example - Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition
may include controls relating to both financial reporting and operations objectives.

The auditor's consideration of such controls is generally limited to those relevant to the reliability of financial
reporting. For example, use of access controls, such as passwords, that limit access to the data and programs
that process cash disbursements may be relevant to a financial statement audit.

Conversely, safeguarding controls relating to operations objectives, such as controls to prevent the excessive
use of materials in production, generally are not relevant to a financial statement audit.

Objectives of Internal Control


● Transactions are executed in accordance with management general or specific authorizations;
● All transactions are promptly recorded in the correct amount in the appropriate accounts and in the
correct accounting period to enable preparation of financial statement as per applicable financial
reporting framework.
● Assets are safeguard from unauthorised access, use or disposition; and
● The recorded assets are compared with the existing assets as at reasonable intervals and appropriate
action is taken with regard to any differences.

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Components of IC
The division of internal control into the following five components provides a useful framework for auditors to
consider how different aspects of an entity’s internal control may affect the audit:
1. The control environment;
2. The entity’s risk assessment process
3. The information system, including the related business processes, relevant to financial reporting, and
communication
4. Control activities
5. Monitoring of controls.

Benefits of IT to an entity’s Internal Control


As per SA 315, IT benefits an entity’s internal control by enabling an entity to:
● Consistently apply predefined business rules and perform complex calculations in processing large
volumes of transactions or data;
● Enhance the timeliness, availability, and accuracy of information ;
● Facilitate the additional analysis of information;
● Enhance the ability to monitor the performance of the entity’s activities and its policies and procedures;
● Reduce the risk that controls will be circumvented;and
● Enhance the ability to achieve effective segregation of duties by implementation security control in
applications, databases, and operating systems.

IT Related Risk
What are the specific risks related to internal control in an IT environment?
Risks related to internal control in IT environment: The specific risks related to internal control in an IT
environment includes the following
1. Reliance on systems or programs that are inaccurately processing data, processing inaccurate data, or
both. (either data is wrong or data processing is wrong)
2. 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.
3. The possibility of IT personnel gaining access privileges beyond those necessary to perform their
assigned duties thereby breaking down segregation of duties. (Lack of segregation of duties)
4. Unauthorized changes to data in master files.
5. Unauthorized changes to systems or programs.
6. Failure to make necessary changes to systems or programs.
7. Inappropriate manual intervention.

Identifying and Assessing the Risks of Material Misstatement.


The auditor shall perform risk assessment procedures to provide a basis for the identification and assessment of
risks of material misstatement at the financial statement and assertion levels.

For this purpose, the auditor shall: (Process )


a. Identify risks throughout the process of obtaining an understanding of the entity and its environment,
including relevant controls.
b. Assess the identified risks, and evaluate whether they relate more pervasively to the financial
statements as a whole and potentially affect many assertions;

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c. Relate the identified risks to what can go wrong at the assertion level.
d. Consider the likelihood of material misstatement.

Assessment of Risks of Material Misstatement at the Financial Statement Level


● Risks of material misstatement at the financial statement level refer to risks that relate pervasively to
the financial statements as a whole and potentially affect many assertions.
● Risks of this nature are not necessarily risks identifiable with specific assertions.
● They represent circumstances that may increase the risks of material misstatement at the assertion
level.
● Risks at the financial statement level may among other factors derive in particular from deficient
control environment.

Assessment of Risks of Material Misstatement at the Assertion Level


Risks of material misstatement at the assertion level for classes of transactions, account balances, and
disclosures need to be considered because such consideration directly assists in determining the nature, timing,
and extent of further audit procedures at the assertion level necessary to obtain sufficient appropriate audit
evidence.

For detailed discussion on assertion please refer basics chapter.

Risks that Require Special Audit Consideration


Significant risk
An identified and assessed risk of material misstatement that, in the auditor’s judgment, requires special audit
consideration.

As part of the risk assessment the auditor shall determine whether any of the risks identified are, in the
auditor’s judgment, a significant risk. In exercising this judgment, the auditor shall exclude the effects of
identified controls related to the risk.

In exercising judgment as to which risks are significant risks, the auditor shall consider the following:
1. Whether the risk is a risk of fraud;
2. Whether the risk is related to recent significant economic, accounting, or other developments;
3. The complexity of transactions;
4. Whether the risk involves significant transactions with related parties;
5. The degree of subjectivity in the measurement of financial information; and
6. Whether the risk involves significant unusual transactions.

Revision of Risk Assessment


● The auditor’s assessment of the risks of material misstatement at the assertion level may change during
the course of the audit as additional audit evidence is obtained.
● If any evidence or if new information is obtained, which is inconsistent with the audit evidence on
which the auditor originally based the assessment, the auditor shall revise the assessment and modify
the further planned audit procedures accordingly.

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Standards on Auditing

Documentation
The auditor shall document
a. The discussion among the engagement team, and the significant decisions reached;
b. Key elements of the understanding obtained regarding each aspect, the sources of information from
which the understanding was obtained; and the risk assessment procedures performed;
c. The identified and assessed risks of material misstatement at the financial statement level and at the
assertion level.
d. The risks identified, and related controls about which the auditor has obtained an understanding.

Components of Internal Control


The Control Environment
The auditor shall obtain an understanding of the control environment. As part of obtaining this understanding,
the auditor shall evaluate whether:
● Management has created and maintained a culture of honesty and ethical behavior; and
● The strengths in the control environment elements collectively provide an appropriate foundation for
the other components of internal control.

What is included in Control Environment?


The control environment includes:
● The governance and management functions and
● The attitudes, awareness, and actions of those charged with governance and management.
The control environment sets the tone of an organization, influencing the control consciousness of its people.

Elements of the Control Environment


Elements of the control environment that may be relevant when obtaining an understanding of the control
environment include the following:
a. Communication and enforcement of integrity and ethical values – These are essential elements that
influence the effectiveness of the design, administration and monitoring of controls.
b. Commitment to competence – Matters such as management’s consideration of the competence levels
for particular jobs and how those levels translate into requisite skills and knowledge.
c. Participation by those charged with governance – Attributes of those charged with governance such as:
i. Their independence from management.
ii. Their experience and stature.
iii. The extent of their involvement and the information they receive, and the scrutiny of activities.
iv. The appropriateness of their actions, including the degree to which difficult questions are raised
and pursued with management, and their interaction with internal and external auditors.
d. Management’s philosophy and operating style – Characteristics such as management’s:
i. Approach to taking and managing business risks.
ii. Attitudes and actions toward financial reporting.
iii. Attitudes toward information processing and accounting functions and personnel.
e. Organisational structure – The framework within which an entity’s activities for achieving its objectives
are planned, executed, controlled, and reviewed.
f. Assignment of authority and responsibility - Matters such as how authority and responsibility for
operating activities are assigned and how reporting relationships and authorisation hierarchies are
established.

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g. Human resource policies and practices – Policies and practices that relate to, for example, recruitment,
orientation, training, evaluation, counseling, promotion, compensation, and remedial actions.

Satisfactory Control Environment – not an absolute deterrent to fraud


The existence of a satisfactory control environment can be a positive factor when the auditor assesses the risks
of material misstatement. However, although it may help reduce the risk of fraud, a satisfactory control
environment is not an absolute deterrent to fraud. Conversely, deficiencies in the control environment may
undermine the effectiveness of controls, in particular in relation to fraud. For example, management’s failure to
commit sufficient resources to address IT security risks may adversely affect internal control by allowing
improper changes to be made to computer programs or to data, or unauthorized transactions to be processed.
As explained in SA 330, the control environment also influences the nature, timing, and extent of the auditor’s
further procedures.

The control environment in itself does not prevent, or detect and correct, a material misstatement. It may,
however, influence the auditor’s evaluation of the effectiveness of other controls (for example, the monitoring of
controls and the operation of specific control activities) and thereby, the auditor’s assessment of the risks of
material misstatement.

The Entity’s Risk Assessment Process– Component of IC


The auditor shall obtain an understanding of whether the entity has a process for:
a. Identifying business risks relevant to financial reporting objectives;
b. Estimating the significance of the risks;
c. Assessing the likelihood of their occurrence; and
d. Deciding about actions to address those risks.

NOTES
● The entity’s risk assessment process forms the basis for the risks to be managed.
● If that process is appropriate, it would assist the auditor in identifying risks of material misstatement.
● Whether the entity’s risk assessment process is appropriate to the circumstances is a matter of
judgment.

Information System - Component of IC


The auditor shall obtain an understanding of the information system, including the related business processes,
relevant to financial reporting, including the following are as:
a. The classes of transactions in the entity’s operations that are significant to the financial statements
b. The procedures by which those transactions are initiated, recorded, processed, corrected as necessary,
transferred to the general ledger and reported in the financial statements;
c. The related accounting records, supporting information and specific accounts in the financial
statements that are used to initiate, record, process and report transactions;
d. How the information system captures events and conditions that are significant to the financial
statements;
e. The financial reporting process used to prepare the entity’s financial statements;
f. Controls surrounding journal entries.

Control Activities - Component of IC


The auditor shall obtain an understanding of control activities relevant to the audit, which the auditor
considers necessary to assess the risks of material misstatement. An audit requires an understanding of only

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those control activities related to significant class of transactions, account balance, and disclosure in the
financial statements and the assertions which the auditor finds relevant in his risk assessment process.

Control activities are the policies and procedures that help ensure that management directives are carried out.

Control activities, whether within IT or manual systems, have various objectives and are applied at various
organisational and functional levels.

Control activities that are relevant to the audit are:


● Control activities that relate to significant risks and those that relate to risks for which substantive
procedures alone do not provide sufficient appropriate audit evidence.; or
● Those that are considered to be relevant in the judgment of the auditor.
● As part of the risk assessment, the auditor shall determine whether any of the risks identified are, in the
auditor’s judgment, a significant risk.

Monitoring of Control - Component of IC


Knowledge
● This is the client's process of assessing the effectiveness of controls over time and taking necessary
remedial action.
● Monitoring can be either ongoing or performed on a separate evaluation basis (or a combination of
both).
● Monitoring of internal controls is often the key role of internal auditors.

The auditor shall obtain an understanding of the major activities that the entity uses to monitor internal
control over financial reporting.

Monitoring of controls Defined: Monitoring of controls is a process to assess the effectiveness of internal
control performance over time.

1. Helps in assessing the effectiveness of controls on a timely basis: It involves assessing the effectiveness
of controls on a timely basis and taking necessary remedial actions.

2. Management accomplishes through ongoing activities, separate evaluations etc.: Management


accomplishes monitoring of controls through ongoing activities, separate evaluations, or a combination
of the two. Ongoing monitoring activities are often built into the normal recurring activities of an entity
and include regular management and supervisory activities.

3. Management’s monitoring activities include: Management’s monitoring activities may include using
information from communications from external parties such as customer complaints and regulator
comments that may indicate problems or highlight areas in need of improvement.

4. In case of Small Entities: Management’s monitoring of control is often accomplished by management’s


or the owner-manager’s close involvement in operations. This involvement often will identify
significant variances from expectations and inaccuracies in financial data leading to remedial action to
the control.

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Examples of Components of Internal Control (Read them for knowledge purpose, not for
exams)
1. Control environment - communication of ethical values to personnel through policy statements and
codes of conduct.
2. Risk assessment process – management monitors changes in the operating environment to plan for the
future.
3. Information system - quarterly management accounts are presented to the board of directors for their
consideration.
4. Control activities - an annual inventory count is held to confirm the quantities of inventories physically
held.
5. Monitoring of controls – Internal audit conducts a regular review of sales personnel's compliance with
the company's terms of sales contracts

Enumerate the specific risks that Information Technology (IT) systems can pose to an entity's internal control.
(SA, Nov 2017, 5 Marks)
In the course of audit of PB Ltd., You observe that there is a likelihood of misstatement in the account balances and disclosures
in the financial statements. What should be your considerations as an auditor for “Assessing the Risk of Material
Misstatements”?
(SA, Nov 2018 (Old), 4 Marks)

The identified risks are assessed by auditor as to its significance on account of its likely impact, by way of material misstatement
appearing in financial statements or by affecting internal control system. What may be the points of indication that may direct
the Auditor to judge that the risks identified may be significant?
(SA, Nov 2018, 4 Marks)

Or

You are engaged by M/s. Real Ltd. as an internal auditor for the financial year 2022-2023. While applying risk assessment
procedures of inquiring from management and various analytical procedures, you have identified some risks which in your
opinion may lead to material misstatement at the financial level and assertion level. Which factors as an auditor will you consider
while exercising judgement as to whether such risks are significant risks or not?
(SA, Jan 2021, 5 Marks)

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 occurrence and decides upon actions to respond to and manage them and the results thereof. Elucidate the
circumstances in which risks can arise or change.
(SA, Nov 2019, 5 Marks) (SA, Nov 2020 (Old), 5 Marks)

ABC Limited which deals with consumer products has extensively automated all its operations including the accounting
operations. The automation involves ERP, Robotic process automation, Analytics etc.
You are required to audit the entity duly considering the inherenet and control risk for material financial statement assertions.
Elucidate the key areas that you will focus on for identifying risks including the deficiencies.
(SA, Nov 2020 (Old), 4 Marks)

SA 320 – Materiality in planning & performing an audit.


This Standard on Auditing (SA) deals with the auditor’s responsibility to apply the concept of materiality in
planning and performing an audit of financial statements.

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Standards on Auditing

Materiality in the context of an Audit


Financial reporting frameworks often discuss the concept of materiality in the context of the preparation and
presentation of financial statements they generally explain that:
● Misstatements, including omissions, are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the
basis of the financial statements;
● Judgments about materiality are made in the light of surrounding circumstances, and are affected by
the size or nature of a misstatement, or a combination of both; and
● 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.

Such a discussion, if present in the applicable financial reporting framework, provides a frame of reference to
the auditor in determining materiality for the audit.

If the applicable financial reporting framework does not include a discussion of the concept of materiality, the
characteristics referred above provide the auditor with such a frame of reference.

The auditor’s determination of materiality is a matter of professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of the financial statements.

Determining Materiality and Performance Materiality


Materiality for the financialstatements as a whole.
When establishing the overall audit strategy, the auditor shall determine materiality for the financial
statements as a whole.

Performance Materiality
● Performance materiality means
● The amount or amounts set by the auditor
● at less than materiality
● for the financial statements as a whole

● to reduce to an appropriately low level


● the probability
● that the aggregate of misstatements exceed materiality for the financial statements as a whole.

If, in the specific circumstances of the entity,


● there is one or more particular classes of transactions, account balances or disclosures
● for which misstatements of lesser amounts than the materiality for the financial statements as a whole
○ could reasonably be expected
○ to influence the economic decisions of users taken on the basis of the financial statements,

the auditor shall also determine the (PERFORMANCE) materiality level or levels to be applied to those
particular classes of transactions, account balances or disclosures”

● Performance materiality is also known as Tolerable misstatements

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● A percentage based on risk at the financial statement level is multiplied by planning materiality to
determine tolerable misstatement, or performance materiality.

Factors giving indications to determine performance materiality.


● Requirement of law or regulation (Example remuneration of management, Related party transactions)
● Disclosures depending on Industry (For example, research and development costs for a pharmaceutical
company).
● Specific item important for users in a particular case (Purchase price of new acquired business)

Benchmarking
Benchmarking is one recognized method through which an Auditor determines the materiality level. Under this
method, a percentage is often applied to a chosen benchmark, as a starting point in determining materiality for
the Financial Statements as a whole.

The auditor has to apply his professional judgement in determining materiality, choosing appropriate
benchmark and determining level of benchmark.

Factors that may affect the identification of an appropriate benchmark include –


a. Elements of the Financial Statement (e.g., Assets, Liabilities, Equity, Revenue, Expenses)
b. Whether there are items on which the attention of the users of the particulars Entity’s Financial
Statement tends to be focused (e.g., profit, revenue or net assets)
c. Nature of the Entity, where the Entity is at in its
life cycle, and the industry and economic
environment in which the Entity operates
d. Ownership Structure and Financial Pattern (e.g.,
if an entity is financed more by Debt rather than
Equity, users may put more emphasis on
Assets, and claims on them, than on the
Entity’s Earning) and
e. The relative volatility of the benchmark.

Some examples of suitable benchmark


depending upon various circumstances
Examples of benchmarks that may be appropriate,
include categories of reported income such as PBT, Total
Revenue, Gross Profit and Total Expenses, Total
Equity or Net Asset Value.
a. Profit Before Tax from continuing
operations is often used for profit-oriented
entities. In this regard if Profit Before Tax from
continuing operations is volatile, other benchmark may be more appropriate.
b. In an audit of the entities doing public utility programs/projects, Total Cost or Net Cost (Expenses less
Revenues) may be appropriate benchmarks for that particular program/project activity.
c. Where an entity has custody of the assets, assets may be an appropriate benchmark.
Percentage applied to profit before tax from continuing operations will normally be higher than a percentage
applied to total revenue.

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Standards on Auditing

Revision as the Audit Progresses


Materiality for the financial statements as a whole (and, if applicable, the materiality level or levels for
particular classes of transactions, account balances or disclosures) may need to be revised as a result of a
● change in circumstances that occurred during the audit (for example, a decision to dispose of a major
part of the entity’s business),
● new information, or
● a change in the auditor’s understanding of the entity and its operations as a result of performing
further audit procedures.

For example, if during the audit it appears that actual financial results are likely to be substantially different
from the anticipated period end financial results that were used initially to determine materiality for the
financial statements as a whole, the auditor revises that materiality.

Documenting the materiality


The audit documentation shall include the following amounts and the factors considered in their
determination:
● Materiality for the financial statements as a whole;
● If applicable, the materiality level or levels for particular classes of transactions, account balances or
disclosures ;
● Performance materiality ; and
● Any revision in above as the audit progressed.

Materiality and Audit Risk


In conducting an audit of financial statements, the overall objectives of the auditor are
● to obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error,
● thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in
all material respects, in accordance with an applicable financial reporting framework;
● and to report on the financial statements, and communicate as required by the SAs, in accordance with
the auditor’s findings.

The auditor obtains reasonable assurance by obtaining sufficient appropriate audit evidence to reduce audit
risk to an acceptably low level .

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated.

Audit risk is a function of the risks of material misstatement and detection risk .

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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Case Studies

You are an audit manager with PKCA & Associates, and you have just been approached by Mishti, the Managing Director of
Mishti YT Ltd., who has asked PKCA & Associates to become Statutory auditors to Mishti YT Ltd.

Mishti YT Ltd. is in the service sector (was being operated as a proprietorship) which has existed for a number of years. Mishti
explains that the company has recently become legally required to have an audit. It has not had an audit in the past. PKCA &
Associates was recommended by Mishti’s friend.

Mishti is not very familiar with the audit process. She has asked for further information about audit planning and audit
documents.

Which of the following considerations/actions should the auditor take before the audit of Mishti YT Ltd. is accepted?

1. Consider if the audit firm is independent from Mishti YT Ltd..


2. Communicate with the previous auditors.
3. Obtain the agreement of Mishti YT Ltd. management that it acknowledges its responsibility to prepare financial
statements.
4. Sign an agreement to give a Clean Opinion.

● 1 and 2
● 1 and 3
● 2 and 4
● 3 and 4

Which TWO of the following must be included in the engagement letter between PKCA & Associates and Mishti YT Ltd.?
● Management’s acknowledgement of its responsibilities with regard to accounts preparation, internal control and
provision of information to the auditors.
● Mishti YT Ltd’s Business Plan.
● Details about Internal Control.
● Auditor’s responsibilities with regard to the audit
● Audit risk evaluation
● The Audit Fees to be charged.

SA 320 on “Materiality in Planning and Performing an Audit” requires that an auditor


a. should not consider materiality and its relationship with audit risk while conducting an audit.
b. should consider materiality and its relationship with audit risk while conducting an audit.
c. should not consider materiality but should consider its relationship with audit risk while conducting an audit.
d. should consider materiality but need not consider its relationship with audit risk while conducting an audit

When planning the audit,


a. the auditor considers what would make the financial information materially misstated.
b. the auditor need not consider what would make the financial information materially misstated
c. the auditor need not consider what would make the financial information materially misstated at planning stage
d. the auditor needs to consider what would make the financial information materially misstated while conducting audit
only

SA 315 Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and Its Environment
requires auditors to obtain an understanding of the audited entity.

Which of the following methods should PKCA & Associates use to obtain information about Mishti YT Ltd.?

1. Ask management to tell them about the business.

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2. Understand Relevant industry, regulatory and other external factors including applicable financial reporting
framework
3. Perform analytical review on current and historical financial information
4. Visit Mishti YT Ltd. and watch its activities
5. Ask the previous auditors to tell them about the client.

● 1, 2, 3 and 5
● 2 and 3 only
● 1 and 4 only
● 1, 3 and 4
● 1, 2, 3, 4

Which of the following statements concerning audit documents is TRUE?


● Mishti is entitled to access and review of the firm’s working papers relating to Mishti YT Ltd..
● Audit working papers are the property of the auditor and Mishti is unlikely to be granted access to them.
● The auditors may not show Mishti any working papers for ethical reasons.
● The auditors may not use documents generated by Mishti YT Ltd. staff as working papers.

Y & Co., Chartered Accountants have come across in the course of audit of a company that certain machinery had been imported
for production of new product. Although the Auditors have applied the concept of materiality for the financial statements as a
whole, they now want to re-evaluate the materiality concept for this transaction involving foreign exchange. Give your views in
this regard.
(SA, May 2018, 5 Marks)

You are being appointed as the auditor of X Ltd. for the first time. You want to determine the materiality level and for that you
have applied percentage to choose benchmark as a starting point in determining materiality for the financial statements as a
whole. What are the factors that may affect the identification of materiality while auditing?
(SA, Nov 2020 (Old), 5 Marks)

OR

CA. B was appointed as the auditor of SRT Limited for the financial year 2022-23. During the course of planning for the audit,
CA. B intends to apply for 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 appropraite benchmark for this purpose.
What benchmark should be adopted by CA. B, if SRT 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.
(SA, Nov 2022, 5 Marks)

SA 330 - The Auditor’s Responses to Assessed Risks


The objective of the auditor is
● to obtain sufficient appropriate audit evidence (What - Kya karna hai)
● about the assessed risks of material misstatement, (Why - Kis liye)
● through designing and implementing appropriate responses to those risks. (How - Kaise)

Requirements
● Overall Responses
● Audit Procedures Responsive to the Assessed Risks of Material Misstatement at the Assertion Level.
● Tests of Controls.

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● Substantive Procedures.
● Evaluating the Sufficiency and Appropriateness of Audit Evidence
● Documentation.

Overall Responses - ROMM at FS Level.


The auditor shall design and implement overall responses to address the assessed risks of material
misstatement at the financial statement level.

Audit Procedures Responsive to the Assessed Risks of Material


Misstatement at the Assertion Level
Design and Perform FAP - NET Responsive to ROMM at 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 at the assertion level.

In designing the further audit procedures to be performed, the auditor shall


● Consider the reasons for the assessment given to the risk of material misstatement including
○ The likelihood of material misstatement due to the particular characteristic.(Inherent risk)
○ Whether the risk assessment takes into account the relevant controls (i.e., the control risk), and
● Obtain more persuasive audit evidence the higher the auditor’s assessment of risk

Test of control
Meaning
An audit procedure
● designed to evaluate the operating effectiveness of controls
● in preventing, or detecting and correcting, material misstatements at the assertion level.

Why and When (Circumstances)?


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) He expects that the controls are operating effectively, 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.

Nature and Extent of Tests of Controls


In designing and performing tests of controls, the auditor shall
● Perform audit procedures (Enquiry, Inspection, Observation, Reperformance, Etc) to obtain audit
evidence about the operating effectiveness of the controls, including:
○ How the controls were applied at relevant times during the period under audit.
○ The consistency with which they were applied.
○ By whom or by what means they were applied.
● Determine whether the controls to be tested depend upon other controls (indirect controls), and if so,
whether it is necessary to obtain audit evidence supporting the effective operation of those indirect
controls.

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Interim period Audit Evidence


When the auditor obtains audit evidence about the operating effectiveness of controls during an interim period,
the auditor shall
a. Obtain audit evidence about significant changes to those controls subsequent to the interim period; and
b. Determine the additional audit evidence to be obtained for the remaining period.

Using audit evidence obtained in previous audits


In determining whether it is appropriate to use audit evidence about the operating effectiveness of
controls obtained in previous audits the auditor shall consider the following:
a. The effectiveness of other elements of internal control, (including the control environment, the entity’s
monitoring of controls, and the entity’s risk assessment process);
b. The risks arising from the characteristics of the control, including whether it is manual or automated;
(In manual the risk is of inconsistency, In IT it may be of Unauthorised access)
c. The effectiveness of general IT-controls;
d. The effectiveness of the control and its application by the entity, deviation noticed in the previous audit
or change in personnel affecting control.
e. Whether the lack of a change in a particular control poses a risk due to changing circumstances; and
f. The risks of material misstatement and the extent of reliance on the control.

Establish the continuing relevance


Obatin Evidence
If the auditor plans to use audit evidence from a previous audit the auditor shall establish the continuing
relevance of that evidence by obtaining audit evidence about changes in those controls subsequent to the
previous audit.

How to obtain evidence


The auditor shall obtain this evidence by performing inquiry combined with observation or inspection, to
confirm change or no change in controls

Changes in Continuing Relevance


If there have been changes that affect the continuing relevance of the audit evidence from the previous audit,
the auditor shall test the controls in the current audit

No changes
If there have not been such changes,
● the auditor shall test the controls at least once in every third audit, and

Test some controls each audit


The auditor shall test some controls each audit to avoid the possibility of testing all the controls on which the
auditor intends to rely in a single audit period.

Factors that may decrease the period for retesting a control


The length of time between retesting such controls is also a matter of professional judgment.
In general, the higher the risk of material misstatement, or the greater the reliance on controls, the shorter the
length of time should be between restesting.

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Factors that may decrease the period for retesting a control are as follows.
● A deficient control environment.
● Deficient monitoring of controls.
● A significant manual element to the relevant controls.
● Personnel changes that significantly affect the application of the control.
● Changing circumstances that indicate the need for changes in the control.
● Deficient general IT-controls.

When the auditor plans to rely on controls over a risk the auditor has determined to be a significant risk, the
auditor shall test those controls in the current period.

Timing of Test of Controls


The auditor shall test controls for the particular time, or throughout the period for which the auditor intends to
rely on those controls.

Evaluating the Operating Effectiveness of Controls


The auditor should evaluate whether the internal controls are designed and operating as expected in the
preliminary assessment of control risk.
○ In case of deviations, the auditor will evaluate the deviations.
○ Auditor may be required to revise the level of control risk and in that case NET of substantive
procedures must also be changed.

Substantive procedure
Meaning
An audit procedure designed to detect material misstatements at the assertion level. Substantive procedures
comprise
● Tests of details (of classes of transactions, account balances, and disclosures), and
● Substantive analytical procedures.

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.

Substantive Procedures Related to the Financial Statement Closing Process


The auditor’s substantive procedures shall include the following audit procedures related to the financial
statement closing process
a. Agreeing or reconciling the financial statements with the underlying accounting records.
b. Examining material journal entries and other adjustments made during the course of preparing the
financial statement

Substantive Procedures Responsive to Significant Risks


When the auditor has determined that an assessed risk of material misstatement at the assertion level is a
significant risk, the auditor shall perform substantive procedures that are specifically responsive to that risk.

Timing of Substantive Procedures


Substantive procedures may be performed either at an interim date or at period end.

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When substantive procedures are performed at an interim date, the auditor shall cover the remaining period by
performing:
a. substantive procedures, combined with tests of controls for the intervening period; or
b. if the auditor determines that it is sufficient, further substantive procedures only;
that provide a reasonable basis for extending the audit conclusions from the interim date to the period end

If misstatements that the auditor did not expect when assessing the risks of material misstatement are detected
at an interim date, the auditor shall evaluate whether the related assessment of risk and the planned nature,
timing, or extent of substantive procedures covering the remaining period need to be modified.

Evaluating the Sufficiency and Appropriateness of Audit Evidence


Assessment of ROMM is appropriate
Based on the audit procedures performed and the audit evidence obtained, the auditor shall evaluate before the
conclusion of the audit whether the assessments of the Risk of Material misstatement remain appropriate.

Conclude : SAAE Obtained?


The auditor shall conclude whether sufficient appropriate audit evidence has been obtained.
SAAE Not Obatained - Attempt to obtain
If the auditor has not obtained sufficient appropriate audit evidence with respect to a material assertion, the
auditor shall attempt to obtain further audit evidence.

Unable to obtain
If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall express a a qualified
opinion or a disclaimer of opinion.

Documentation
The auditor shall document
● The overall responses to address the assessed risks of material misstatement at the financial statement
level,
● The nature, timing and extent of the further audit procedures performed to address the ROMM at
assertion level and the linkage of those procedures with the assessed risks at the assertion level
● The results of the audit procedures, including the conclusions.
● If the auditor plans to use audit evidences about the operating effectiveness of controls obtained in
previous audits, the auditor shall document the conclusions reached about relying on such controls.
● The auditors’ documentation shall demonstrate that the financial statements agree or reconcile with the
underlying accounting records.

In the course of audit of Z Ltd, its auditor wants to rely on audit evidence obtained in previous audit in respect of effectiveness
of internal controls instead of retesting the same during the current audit. As an advisor to the auditor kindly caution him
about the factors that may warrant a re-test of controls.
(RTP, Nov 2018, NA) (MTP1, Nov 2019, 4 Marks) (RTP, May 2022, NA)

While formulating the audit plan and responding to the risks of material misstatement identified and assessed in related party
transaction and relationships, Ms. K the engagement manager of the audit team of ABC Limited, decided to rely upon the
internal controls placed for identification and disclosure of related party relationships and transactions in accordance with the
applicable financial reporting framework. You are requested to guide Ms. K regarding the necessity to test the controls to

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obtain sufficient and appropriate audit evidence. Also guide, whether Ms. K can use the audit evidence obtained, regarding
operative effectiveness of control on identification and disclosure of related party relationships and transactions, in the interim
period.
(RTP, Nov 2021, NA)

SA 402 - Audit Considerations relating to an Entity Using a


Service Organisation

Definition
Complementary user entity controls
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.

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Report on the description and design of controls at a service organisation (referred to in this
SA as a Type 1 report)
A report that comprises of
● A description, prepared by management of the service organisation, of the service organisation’s system,
control objectives and related controls that have been designed and implemented as at a specified date;
and
● A report by the service auditor with the objective of conveying reasonable assurance that includes the
service auditor’s opinion on the description of the service organisation’s system, control objectives and
related controls and the suitability of the design of the controls to achieve the specified control
objectives.

Report on the description, design, and operating effectiveness of controls at a service


organisation (referred to in this SA as a Type 2 report)
A report that comprises
● A description, prepared by management of the service organisation, of the service organisation’s system,
control objectives and related controls, their design and implementation as at a specified date or
throughout a specified period and, in some cases, their operating effectiveness throughout a specified
period; and
● A report by the service auditor with the objective of conveying reasonable assurance that includes
○ The service auditor’s opinion on the description of the service organisation’s system, control
objectives and related controls, the suitability of the design of the controls to achieve the
specified control objectives, and the operating effectiveness of the controls; and
○ A description of the service auditor’s tests of the controls and the results thereof.

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Service auditor
An auditor who, at the request of the service organisation, provides an assurance report on the controls of a
service organisation.

Service organisation
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.

Service organisation’s system


The policies and procedures designed, implemented and maintained by the service organisation to provide user
entities with the services covered by the service auditor’s report.

Subservice organisation
A service organisation used by another service organisation to perform some of the services provided to user
entities that are part of those user entities’ information systems relevant to financial reporting.

User auditor
An auditor who audits and reports on the financial statements of a user entity.

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User entity
An entity that uses a service organisation and whose financial statements are being audited.

Obtaining an Understanding of the Services Provided by a Service


Organisation, Including Internal Control.
MIO Ltd. is a mobile phone operating company. Barring the marketing function it had outsourced the
entire operations like maintenance of mobile infrastructure, customer billing, payroll, accounting functions,
etc. Assist the auditor of MIO Ltd. as to how he can obtain an understanding of how MIO Ltd. uses the
services of the outsourced agency in its operations.[MTP- Nov 2019]

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;
b. The nature and materiality of the transactions processed or accounts or financial reporting processes
affected by the service organisation;
c. The degree of interaction between the activities of the service organisation and those of the user entity;
and
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.

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.

The user auditor shall determine whether a sufficient understanding of the nature and significance of the
services provided by the service organisation and their effect on the user entity’s internal control relevant to the
audit has been obtained to provide a basis for the identification and assessment of risks of material
misstatement

If the user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall
obtain that understanding from one or more of the following procedures

a. Obtaining a Type 1 or Type 2 report, if available;


b. Contacting the service organisation, through the user entity, to obtain specific information;
c. Visiting the service organisation and performing procedures that will provide the necessary information
about the relevant controls at the service organisation; or
d. Using another auditor to perform procedures that will provide the necessary information about the
relevant controls at the service organisation.

Responding to the Assessed Risks of Material Misstatement


In responding to assessed risks in accordance with SA 330 , the user auditor shall

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● Determine whether sufficient appropriate audit evidence concerning the relevant financial statement
assertions is available from records held at the user entity; and, if not,
● 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.

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, noncompliance 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.

Type 1 and Type 2 Reports that Exclude the Services of a Subservice


Organisation.
If a service organisation uses a subservice organisation, the service auditor’s report may either include or
exclude the subservice organisation’s relevant control objectives and related controls in the service
organisation’s description of its system and in the scope of the service auditor’s engagement.

These two methods of reporting are known as the inclusive method and the carve-out method, respectively.

If the Type 1 or Type 2 report excludes the controls at a subservice organisation, and the services provided by
the subservice organisation are relevant to the audit of the user entity’s financial statements, the user auditor is
required to apply the requirements of this SA in respect of the sub service organisation.

The nature and extent of work to be performed by the user auditor regarding the services provided by a
subservice organisation depend on the nature and significance of those services to the user entity and the
relevance of those services to the audit.

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

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When a sub-service organization performs services for a service organization, there are two alternative methods of
presenting the description of controls. The service organization determines which method will be used. As a user auditor
what information would you obtain about controls at a sub-service organization? May 2015 Exams

Controls at a Sub-Service Organisation


In accordance with SA 402 “Audit Considerations relating to an Entity Using a Service Organisation”, a user entity may use a
service organisation that in turn uses a sub-service organisation to provide some of the services provided to a user entity that
are part of the user entity’s information system relevant to financial reporting. The sub-service organisation may be a separate
entity from the service organisation or may be related to the service organisation.

A user auditor may need to consider controls at the sub-service organisation. In situations where one or more sub-service
organisations are used, the interaction between the activities of the user entity and those of the service organisation is
expanded to include the interaction between the user entity, the service organisation and the sub-service organisations. The
degree of this interaction, as well as the nature and materiality of the transactions processed by the service organisation and the
sub-service organisations are the most important factors for the user auditor to consider in determining the significance of the
service organisation’s and sub-service organisation’s controls to the user entity’s controls.

Further, the user auditor shall determine whether a sufficient understanding of the nature and significance of the services
provided by the service organisation and their effect on the user entity's internal control relevant to the audit has been
obtained to provide a basis for the identification and assessment of risks of material misstatement.

If the user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall obtain that
understanding by application of the following two methods of presenting description of internal controls i.e. (i) Type 1 report;
or (ii) Type 2 report.

If a service organisation uses a subservice organisation, the service auditor's report may either include or exclude the subservice
organisation's relevant control objectives and related controls in the service organisation's description of its system and in the
scope of the service auditor's engagement.

These two methods of reporting are known as the inclusive method and the carve-out method, respectively.

If the Type 1 or Type 2 report excludes the control at a subservice organization and the services provided by the subservice
organization are relevant to the audit of the user entity’s financial statements, the user auditor is required to apply the
requirements of the SA 402 in respect of the subservice organization.

The nature and extent of work to be performed by the user auditor regarding the services provided by a subservice organization
depend on the nature and significance of those services to the user entity and relevance of those services to the audit.

Durafone Mobile Co. Ltd. have pan India presence and market leader in mobile operation. It has outsourced all its revenue
operation including accounting functions to Set Solutions (P) Ltd. As an Auditor of the mobile company, enumerate the factors
to be taken into consideration related to its financial reporting.
(SA, May 2018 (Old), 5 Marks)

G Ltd. is a mobile phone operating company. Barring the marketing function, it had outsourced the entire operations like
maintenance of mobile infrastructure, customer billing, payroll, accounting functions, etc. Assist the auditor of G Ltd. as to how
he can obtain an understanding of how G Ltd. uses the services of the outsourced agency in its operations.
(MTP 2, Nov 2018, 4 Marks) (RTP, Nov 2018, NA) (MTP1, Nov 2019, 4 Marks)

OM Limited is availing the services of APP Private Limited for its payroll operations. Payroll cost accounts for 65% of total cost
for OM Limited. APP Limited has provided the type 2 report as specified under SA 402 for its description, design and operating
effectiveness of control. APP Private Limited has also outsourced a material part of payroll operation M/s PMS & Associates in
such a way that M/s PMS & Associates is sub-service organization to OM Limited. The Type 2 report which was provided by

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APP Private Limited was based on carve-out method as specified under SA 402.
CA Sheetal while reviewing the unmodified audit report drafted by his assistant found that, a reference has been made to the
work done by the service auditor. CA Sheetal hence asked his assistant to remove such reference and modify report accordingly.
Comment whether CA Sheetal is correct in removing the reference of the work done by service auditor?
(RTP, Nov 2020, NA) (MTP2, May 2021, 5 Marks) (MTP1, Nov 2022, 4 Marks)

In the course of audit of Tech limited you observed that processing of accounting data was given to a third party on account of
certain considerations like cost reduction, own computer working to full capacity. Tech Limited used a service organisation to
record transactions and process related data. As an auditor, what would be your considerations regarding the nature and extent
of activities undertaken by service organisation so as to determine whether those activities are relevant to the audit and, if so, to
assess their effect on audit risk. Discuss with reference to relevant Standard on Auditing.
(SA, Dec 2021, 5 Marks)

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

SA 450 - Evaluation of misstatements identified during the


audit

Objective
The objective of the auditor is to evaluate:
● The effect of identified misstatements on the audit; and
● The effect of uncorrected misstatements, if any, on the financial statements.

Definitions
Misstatement
A difference between the amounts, classification, presentation, or disclosure of a reported financial statement
item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance
with the applicable financial reporting framework. Misstatements can arise from error or fraud.

Misstatements may result from:


● An inaccuracy in gathering or processing data from which the financial statements are prepared;
● An omission of an amount or disclosure;
● An incorrect accounting estimate arising from overlooking, or clear misinterpretation of, facts; and
● Judgments of management concerning accounting estimates that the auditor considers unreasonable or
the selection and application of accounting policies that the auditor considers inappropriate.

To assist the auditor in evaluating the effect of misstatements accumulated during the audit and in
communicating misstatements to management and those charged with governance, it may be useful to
distinguish between factual misstatements, judgmental misstatements and projected misstatements.

● Factual misstatements are misstatements about which there is no doubt.

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● Judgmental misstatements are differences arising from the judgments of management concerning
accounting estimates that the auditor considers unreasonable, or the selection or application of
accounting policies that the auditor considers inappropriate.
● Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the
projection of misstatements identified in audit samples to the entire populations from which the
samples were drawn. Guidance on the determination of projected misstatements and evaluation of the
results is set out in SA 530

Uncorrected misstatements
Misstatements that the auditor has accumulated during the audit and that have not been corrected.

Requirements
Accumulation of Identified Misstatements
The auditor shall accumulate misstatements identified during the audit, other than those that are clearly
trivial.

Consideration of Identified Misstatements as the Audit Progresses


The auditor shall determine whether the overall audit strategy and audit plan need to be revised if:
● The nature of identified misstatements and the circumstances of their occurrence indicate that other
misstatements may exist that, when aggregated with misstatements accumulated during the audit,
could be material; or
● The aggregate of misstatements accumulated during the audit approaches materiality determined in
accordance with SA 320.

Communication and Correction of Misstatements


● The auditor shall communicate on a timely basis all misstatements accumulated during the audit with
the appropriate level of management, unless prohibited by law or regulation.
● The auditor shall request management to correct those misstatements.
● If, at the auditor’s request, management has examined a class of transactions, account balance or
disclosure and corrected misstatements that were detected, the auditor shall perform additional audit
procedures to determine whether misstatements remain.
● If management refuses to correct some or all of the misstatements communicated by the auditor, the
auditor shall obtain an understanding of management’s reasons for not making the corrections and
shall take that understanding into account when evaluating whether the financial statements as a
whole are free from material misstatement.

Evaluating the Effect of Uncorrected Misstatements


● Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality
determined in accordance with SA 320 to confirm whether it remains appropriate in the context of the
entity’s actual financial results.

● The auditor shall determine whether uncorrected misstatements are material, individually or in
aggregate. In making this determination, the auditor shall consider

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○ The size and nature of the misstatements, both in relation to particular classes of transactions,
account balances or disclosures and the financial statements as a whole, and the particular
circumstances of their occurrence; and
○ The effect of uncorrected misstatements related to prior periods on the relevant classes of
transactions, account balances or disclosures, and the financial statements as a whole.

Communication with Those Charged with Governance


● The auditor shall communicate with those charged with governance uncorrected misstatements and
the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report, unless
prohibited by law or regulation. The auditor’s communication shall identify material uncorrected
misstatements individually. The auditor shall request that uncorrected misstatements be corrected.

● The auditor shall also communicate with those charged with governance the effect of uncorrected
misstatements related to prior periods on the relevant classes of transactions, account balances or
disclosures, and the financial statements as a whole.

Written Representation
The auditor shall request a written representation from management and, where appropriate, those charged
with governance whether they believe the effects of uncorrected misstatements are immaterial, individually
and in aggregate, to the financial statements as a whole. A summary of such items shall be included in or
attached to the written representation.

Documentation
The audit documentation shall include
● The amount below which misstatements would be regarded as clearly trivial;
● All misstatements accumulated during the audit and whether they have been corrected; and
● The auditor’s conclusion as to whether uncorrected misstatements are material, individually or in
aggregate, and the basis for that conclusion.

In audit plan for T Ltd, as the audit partner you want to highlight the sources of misstatements, arising from other than fraud,
to your audit team and caution them. Identify the sources of misstatements.
(RTP, Nov 2018, NA) (RTP, May 2022, NA)

SA 500 Audit Evidence


Meaning of Audit Evidence
Audit evidence – 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.

Information contained in the accounting records


Accounting records include
● the records of initial accounting entries and supporting records
● Invoices;
● Contracts
● the ledgers, journal entries and other adjustments to the financial statements.

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● records such as worksheets and spreadsheets supporting cost allocations, computations, reconciliations
and disclosures.

Other information
Other information that authenticates the accounting records and also supports the auditor’s rationale behind
the true and fair presentation of the financial statements:
Other information which the auditor may use as audit evidence includes, for example
● minutes of the meetings,
● written confirmations from trade receivables and trade payables,
● manuals containing details of internal control etc.

Sufficient and Appropriate Audit Evidence


Sufficiency of Audit Evidence
● Sufficiency is the measure of the quantity of audit evidence.
● The quantity of audit evidence needed is affected by the auditor’s assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and
● also by the quality of such audit evidence (the higher the quality, the less may be required).

Appropriateness of Audit Evidence


Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in
providing support for the conclusions on which the auditor’s opinion is based.

Relevance
● Relevance means the relationship of the evidence with audit procedure and the assertion being
checked.
● A given set of audit procedures may provide audit evidence that is relevant to certain assertions, but not
others.
● For example, confirmation of balance from a customer is a relevant evidence as regards existence of
receivable, but it may not be relevant as regards collectability of the balance due from customer.
● Also, physical observation of inventories is relevant evidence relating to existence, but is not
appropriate evidence to ensure that the entity owns the inventories.
● On the other hand, audit evidence from different sources or of a different nature may often be relevant
to the same assertion. For example Checking the terms of the agreement and confirming the same from
the third party.
● The term competence is also used in place of relevance.

Reliability of Audit Evidence


● You measure reliability by deciding whether the evidence is credible.
● As an auditor, you should adopt an attitude of professional skepticism.
● In order to obtain reliable audit evidence, information produced by the entity that is used for
performing audit procedures needs to be sufficiently complete and accurate.

As per SA 500 "Audit Evidence", the reliability of information to be used as audit evidence, and therefore of the
audit evidence itself, is influenced by its
● source and
● its nature, (Direct, indirect, oral, written or original, photocopies) and

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● the circumstances under which it is obtained,


● including the controls over its preparation and maintenance where relevant.

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.

For example, information obtained from an independent external source may not be reliable if the source is not
knowledgeable, or a management's expert may lack objectivity.

While recognising that exceptions may exist, the following generalisations about the reliability of audit
evidence may be useful

1. The reliability of audit evidence is increased when it is obtained from independent sources outside the
entity.
2. The reliability of audit evidence that is generated internally is increased when the related controls,
including those over its preparation and maintenance, imposed by the entity are effective.
3. Audit evidence obtained directly by the auditor (for example, observation of the application of a control)
is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the
application of a control).
4. Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable than
evidence obtained orally (for example, a contemporaneously written record of a meeting is more reliable
than a subsequent oral representation of the matters discussed).
5. Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles, or documents that have been filmed, digitised or otherwise transformed into
electronic form, the reliability of which may depend on the controls over their preparation and
maintenance.
6. Circumstances prevailing in the organisation can have a severe impact on the reliability of the audit
evidence.

Audit Procedures to Obtain Audit Evidence


Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is obtained by
performing
➔ Risk assessment procedures; and
➔ Further audit procedures, which comprise:
◆ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
◆ Substantive procedures, including tests of details and substantive analytical procedures.
➔ The audit procedures described below may be used as
◆ risk assessment procedures,
◆ tests of controls or
◆ substantive procedures,
● Depending on the context in which they are applied by the auditor.
Audit procedures to obtain audit evidence can include
1. Inspection
2. Observation
3. External Confirmation

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4. Recalculation
5. Reperformance
6. Analytical Procedure
7. Enquiry

Inspection
● examining records or documents,
○ whether internal or external,
○ in paper form, electronic form, or other media, or
● a physical examination of an asset.
● Inspection of records and documents provides audit evidence
○ of varying degrees of reliability,
○ depending on their nature and source and,
● Example - Documentation related to authorisation

Observation
● Observation consists of witnessing a process or procedure being performed by others.
● For example, the auditor may observe the counting of inventories being performed by client's personnel.

External Confirmation
An external confirmation represents audit evidence obtained by the auditor as a direct written response to the
auditor from a third party ( the confirming party), in paper form, or by electronic or other medium.

External confirmation procedures frequently are relevant when addressing assertions associated with certain
account balances and their elements. However, external confirmations need not be restricted to account
balances only.

External confirmation procedures also are used to obtain audit evidence about the absence of certain
conditions.

Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be
performed manually or electronically.

Re-performance
Re-performance involves the auditor’s independent execution of procedures or controls that were originally
performed as part of the entity’s internal control.

Analytical Procedures
● Analytical procedures consist of evaluations of financial information by a study of relationships among
both financial and non- financial data.
● Analytical Procedures refers to studying significant ratios and trends and investigating unusual
fluctuations.

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Inquiry

Inconsistency in or Doubts over Reliability of Audit Evidence


If:
a. audit evidence obtained from one source is inconsistent with that obtained from another; or
b. the auditor has doubts over the reliability of information to be used as audit evidence,
the auditor shall determine what modifications or additions to audit procedures are necessary to resolve the
matter, and shall consider the effect of the matter, if any, on other aspects of the audit.

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Management’s expert

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Question
CA. Needle had been appointed as an auditor of M/s Fabric Ltd. in the course of audit, it had been observed that inventory
including work-in-process had been valued by management by using experts hired by them. Analyse relevant factors to
decide as to whether or not to accept the findings from the work of management expert in valuation of inventories.
Or,
Y Ltd. Engaged an actuary to ascertain its employee cost, gratuity and leave encashment liabilities. As the auditor of Y Ltd.
You would like to use the report of the actuary as an audit evidence. How do you evaluate the work of actuary.
Or,
What are the procedures to be followed by a statutory auditor for verifying the provision for accrued liability for retirement
benefits which is based on a certificate of a reputed actuary?
Or,
Comment on the following: Z Ltd. had appointed an outside expert to assess accrued gratuity liability of the company.
Based on the said report, the company provides ₹ 80 lakhs as gratuity in the financial statements.

Answer

Part 1

As per SA 500 “Audit Evidence”, 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-
1. Evaluate the competence, capabilities and objectivity of that expert;
2. Obtain an understanding of the work of that expert; and
3. Evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion.

Part 2

The auditor may obtain information regarding the competence, capabilities and objectivity of a management’s expert from a
variety of sources, such as personal experience with previous work of that expert; discussions with that expert; discussions
with others who are familiar with that expert’s work; knowledge of that expert’s qualifications; published papers or books
written by that expert.

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Part 3

The auditor may also consider the following while evaluating the appropriateness of the management’s expert’s work as audit
evidence for the relevant assertion:
1. The relevance and reasonableness of that expert’s findings or conclusions, their consistency with other audit evidence,
and whether they have been appropriately reflected in the financial statements;
2. If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those
assumptions and methods; and
3. If that expert’s work involves significant use of source data, the relevance completeness, and accuracy of that source
data.

The auditor of SS Ltd. accepted the gratuity liability valuation based on the certificate issued by a qualified actuary. However, the
auditor noticed that the retirement age adopted is 65 years as against the existing retirement age of 60 years. The company is
considering a proposal to increase the retirement age. Comment.
(SA, Nov 2011, 5 Marks) (MTP2, May 2018, 5 Marks)

Gap Ltd. possesses some investment for which there is no ready market and to assess its fair market value it hires an expert, the
result of which it can use in preparing its financial statement. Being an Auditor of the Company, state the matters which may
affect the nature, timing and extent of audit procedure to be adopted by you in the instant case.
(SA, May 2018 (Old), 5 Marks)

During the course of audit of a Limited company, the statutory auditors collected written representations from the Management.
The audit was finalized in addition to other audit procedures but, without making any inquiries, as the statutory auditors were
short of time. In the light of this information, state the importance of inquiry as one of the methods of collecting Audit
Evidence.
(SA, July 2021 (Old), 5 Marks)

SA 501 - Audit Evidence – Additional Considerations for


Specific Items

Objective
The objective of the auditor is to obtain sufficient appropriate audit evidence regarding the:
a. Existence and condition of inventory;
b. Completeness of litigation and claims involving the entity; and
c. Presentation and disclosure of segment information in accordance with the applicable financial
reporting framework.

Inventory
SAAE Regarding Existence and condition of inventory
When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit
evidence regarding the existence and condition of inventory by
a. 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

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iv. Perform test counts; and


b. Performing audit procedures over the entity's final inventory records to determine whether they
accurately reflect actual inventory count results.

Physical inventory counting is conducted at a date other than the date of the financial
statements
If physical inventory counting is conducted at a date other than the date of the financial statements, the auditor
shall, in addition to the procedures mentioned above, perform audit procedures to obtain audit evidence about
whether changes in inventory between the count date and the date of the financial statements are properly
recorded.

If the Auditor is unable to Attend Physical Inventory Counting due to Unforeseen


Circumstances
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.

Attendance at Physical Inventory Counting


Attendance at Physical Inventory Counting Involves:
a. Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test
counts;
b. Observing compliance with management’s instructions and the performance of procedures for
recording and controlling the results of the physical inventory count; and
c. Obtaining audit evidence as to the reliability of management’s count procedures.

Matters Relevant in Planning Attendance at Physical Inventory Counting


Matters relevant in planning attendance at physical inventory counting include,
● Nature of inventory.
● Stages of completion of work in progress.
● The risks of material misstatement related to inventory.
● The nature of the internal control related to inventory.
● Whether adequate procedures are expected to be established and proper instructions issued for physical
inventory counting.
● The timing of physical inventory counting.
● Whether the entity maintains a perpetual inventory system.
● The locations at which inventory is held, including the materiality of the inventory and the risks of
material misstatement at different locations, in deciding at which locations attendance is appropriate
● Whether the assistance of an auditor’s expert is needed.

Attendance is impracticable
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.

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In some cases 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 other cases, however, 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 requires
the auditor to modify the opinion in the auditor’s report as a result of the scope limitation.

Inventory under the custody and control of a third party


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.

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
1. Attending, or arranging for another auditor to attend, the third party’s physical counting of inventory, if
practicable.
2. Obtaining service auditor’s report, on the adequacy of the third party’s internal control for ensuring that
inventory is properly counted and adequately safeguarded.
3. Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts.
4. Requesting confirmation from other parties when inventory has been pledged as collateral.

Litigation and Claims


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, including:
a. Inquiry of management and, where applicable, others within the entity, including in-house legal
counsel;
b. Reviewing minutes of meetings of those charged with governance and correspondence between the
entity and its external legal counsel; and
c. Reviewing legal expense accounts.

If the auditor assesses a risk of material misstatement regarding litigation or claims that have been identified,
or when audit procedures performed indicate that other material litigation or claims may exist, the auditor
shall, in addition to the procedures required by other SAs, 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. If law, regulation or the respective
legal professional body prohibits the entity’s external legal counsel from communicating directly with the
auditor, the auditor shall perform alternative audit procedures

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Modification in the opinion


If-
a. management refuses to give the auditor permission to communicate or meet with the entity’s external
legal counsel, or the entity’s external legal counsel refuses to respond appropriately to the letter of
inquiry, or is prohibited from responding; and
b. the auditor is unable to obtain sufficient appropriate audit evidence by performing alternative audit
procedures,

the auditor shall modify the opinion in the auditor’s report in accordance with SA 705.

Written Representations
The auditor shall request management and, where appropriate, those charged with governance to provide
written representations that
● all known actual or possible litigation and claims
● whose effects should be considered when preparing the financial statements
● have been
○ disclosed to the auditor and
○ appropriately accounted for and disclosed in accordance with the applicable financial reporting
framework.

Segment Information
Obtain sufficient appropriate audit evidence regarding the presentation and disclosure of
segment information.
The auditor shall 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,


and (Auditor un methods ki understanding obtain karega jinhe use karke management segment
information determine karti hai)

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○ Evaluating whether such methods are likely to result in disclosure in accordance with the
applicable financial reporting framework
○ Where appropriate, testing the application of such methods; and
● Performing analytical procedures or other audit procedures appropriate in the circumstances.

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:
1. Sales, transfers and charges between segments, and elimination of inter-segment amounts.
2. Comparisons with budgets and other expected results, for example, operating profits as a percentage of
sales.
3. The allocation of assets and costs among segments.
4. Consistency with prior periods, and the adequacy of the disclosures with respect to inconsistencies.

LMN Ltd. supplies navy uniforms across the country. The company has 4 warehouses at different locations throughout the
India and 5 warehouses at the borders. The major stocks are generally supplied from the borders. LMN Ltd. appointed M/s
OPQ & Co. to conduct its audit for the financial year 2022-23. Mr. O, partner of M/s OPQ & 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 OPQ & Co.,
(a) How sufficient appropriate audit evidence regarding the existence and condition of inventory may be obtained?
(b) How an auditor is supposed to deal when attendance at physical inventory counting is impracticable?
(RTP, May 2018, NA) (RTP, May 2021, NA)
OR
Crush Ltd. is a dealer in fast moving consumer goods. The Company has warehouses throughout the country where the stocks
are stored. The Auditor of the Company normally conduct physical verification of stocks along with the Management at the end
of the financial year. However, the Auditor could not be physically present during stock-tacking at two places on account of
certain disturbances in the region.
In the light of the above facts:
(i) How sufficient appropriate audit evidence regarding the condition and existence of inventory may be obtained?
(ii) How an Auditor is supposed to deal when attendance at physical inventory counting is impracticable?
(SA, May 2018 (Old), 5 Marks)

Your firm has been appointed as the statutory auditors of GBM Private Limited for the financial year 2022-23. While
verification of company’s inventories as on 31st March 2023, you found that the significant amount of inventories belonging to
the company are held by other parties. However, the company has kept all the records of the inventories maintained by other
parties. What is your duty as an auditor in order to ensure that third parties are not such with whom the stock should not be
held and the stock as disclosed in company’s records actually belongs to them?
(RTP, Nov 2019, NA)

You are the auditor of Easy Communications Ltd. for the year 2022–23. The inventory as at the end of the year i.e. 31.3.2023 was
Rs. 2.25 crores. Due to unavoidable circumstances, you could not be present at the time of annual physical verification. Under
the above circumstances how would you ensure that the physical verification conducted by the management was in order?
(RTP, May 2020, NA)

Moon Ltd. is a dealer in electronic appliances. The Company has a centralised warehouse attheoutskirts of Mumbai. The
Auditors of the company M/s JK Associates normally attend the physical verification of stocks carried out by the Management
at the end of the financial year. However, on account of certain disturbances in the region, the physical inventory counting
could not be carried out at the year end. The stock taking is decided to be done by management at some other date
subsequently, after a month.

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In the light of the above facts: Enumerate the audit procedures to be considered by M/s JK Associates, if physical inventory
counting is conducted at a date other than the date of the financial statements with reference to the relevant Standard on
Auditing.
(SA, Nov 2020, 5 Marks)

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.
(SA, Jan 2021, 5 Marks)

The Engagement Partner of the audit team of High Inventory Limited assessed that the inventory is material with respect to
the audit of the financial statement for the current period. Upon inquiring with the management, the Engagement Partner
identified that the management will be performing an annual physical inventory count at all the warehouses where the entity
stores and maintains its inventory. Moreover, management confirmed in its written representation that they will be performing
a 100% physical count of inventory for the current period.
As a result, the engagement Partner decided not to perform any physical count of inventory as it will be a duplication of the
work. Moreover, he decided that the written representation from management stating “the inventory exists and is in
appropriate physical condition” will be sufficient and appropriate with respect to audit evidence to conclude that the inventory
balance in the financial statement is free from any material misstatement.
In the light of SA 501, evaluate whether the decision taken by the Engagement Partner is appropriate or not.
(MTP2, Nov 2022, 5 Marks)

SA 505 - External Confirmations

External confirmation Meaning


Audit evidence obtained as a direct written response to the auditor from a third party (the confirming party), in
paper form, or by electronic or other medium.

External Confirmation Procedure


When using external confirmation procedures, the auditor shall maintain control over external confirmation
requests, including
● Determining the information to be confirmed or requested.
● Selecting the appropriate confirming party
● Designing the confirmation requests, including determining that requests are properly addressed and
contain return information for responses to be sent directly to the auditor
● Sending the requests, including follow-up requests when applicable, to the confirming party

Management’s Refusal to Allow the Auditor to Send a Confirmation


Request
If management refuses to allow the auditor to send a confirmation request, the auditor shall
● Inquire as to management’s reasons for the refusal, and seek audit evidence as to their validity and
reasonableness

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● Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of
material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit
procedures; and
● Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

If the auditor concludes that management’s refusal to allow the auditor to send a confirmation request is
unreasonable, or the auditor is unable to obtain relevant and reliable audit evidence from alternative audit
procedures, the auditor shall communicate with those charged with governance in accordance with SA 260.
The auditor also shall determine the implications for the audit and the auditor’s opinion in accordance with
SA 705.

Types of Confirmation request


Positive confirmation request Negative confirmation request

Request that the confirming party respond directly to A request that the confirming party respond directly
the auditor indicating whether the confirming party to the auditor only if the confirming party disagrees
agrees or disagrees with the information in the with the information provided in the request.
request, or providing the requested information.

A response to a positive confirmation request ordinarily is expected to provide reliable audit evidence. There is
a risk, however, that a confirming party may reply to the confirmation request without verifying that the
information is correct.

The auditor may reduce this risk by using positive confirmation requests that do not state the amount (or other
information) on the confirmation request and ask the confirming party to fill in the amount or furnish other
information.

Results of the External Confirmation Procedures


Reliability of Responses to Confirmation Requests
Doubts about the reliability.
If the auditor identifies factors that give rise to doubts about the reliability of the response to a confirmation
request, the auditor shall obtain further audit evidence to resolve those doubts.

Response to a confirmation request is not reliable.


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.

Non-Responses
Meaning - A failure of the confirming party to
● respond, or fully respond, to a positive confirmation request, or
● a confirmation request returned undelivered.

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In the case of each non-response, the auditor shall perform alternative audit procedures to obtain relevant and
reliable audit evidence.

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.

When a Response to a Positive Confirmation Request is Necessary to Obtain Sufficient


Appropriate Audit Evidence
If the auditor has determined that a response to a positive confirmation request is necessary to obtain sufficient
appropriate audit evidence, alternative audit procedures will not provide the audit evidence the auditor
requires.
If the auditor does not obtain such confirmation, the auditor shall determine the implications for the audit and
the auditor’s opinion in accordance with SA 705

Exceptions
A response that indicates a difference between
● information requested to be confirmed, or contained in the entity’s records, and
● information provided by the confirming party.

Negative Confirmations (When to use?)


Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly, the
auditor shall not use negative confirmation requests as the sole substantive audit procedure to address an
assessed risk of material misstatement at the assertion level unless all of the following are present
a. The auditor has assessed the risk of material misstatement as low and has obtained sufficient
appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertion;
b. The population of items subject to negative confirmation procedures comprises a large number of
small, homogeneous, account balances, transactions or conditions;
c. A very low exception rate is expected; and
d. The auditor is not aware of circumstances or conditions that would cause recipients of negative
confirmation requests to disregard such requests.

Evaluating the Evidence Obtained


The auditor shall evaluate whether the results of the external confirmation procedures provide relevant and
reliable audit evidence, or whether performing further audit procedures is necessary.

Factors that are to be considered while designing a confirmation request


As per SA -505 "External Confirmations", the design of a confirmation request may directly affect the
confirmation response rate, and the reliability and the nature of the audit evidence obtained from responses.

The following factors should be considered while designing a confirmation request: -


a. The assertions being addressed.
b. Specific identified risks of material misstatement, including fraud risks.
c. The layout and presentation of the confirmation request.
d. Prior experience on the audit or similar engagements.

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e. The method of communication (कैसे बताए )


f. Management's authorisation to the confirming parties to respond to the auditor. (क्यों तझ
ु को चाहें )
g. The ability of the confirming party to provide the requested information (यारा बता ना पाए – ability)

External Confirmation to be used as Substantive Procedures


Factors to be considered in determining whether external confirmation procedures are to be performed as
substantive audit procedures include:
1. The confirming party’s knowledge of the subject matter – responses may be more reliable if provided by a
person at the confirming party who has the requisite knowledge about the information being confirmed.
2. The ability or willingness of the intended confirming party to respond – for example, the confirming party
a. May not accept responsibility for responding to a confirmation request;
b. May consider responding too costly or time consuming;
c. May have concerns about the potential legal liability resulting from responding;
d. May account for transactions in different currencies; or
e. May operate in an environment where responding to confirmation requests is not a significant
aspect of day-to-day operations.
In such situations, confirming parties may not respond, may respond in a casual manner or may attempt
to restrict the reliance placed on the response.
3. The objectivity of the intended confirming party – if the confirming party is a related party of the entity,
responses to confirmation requests may be less reliable.

Never Permit Limited refused to allow you to get direct confirmation of the outstanding balances of trade receivables. You want
to ensure on grounds of materiality that atleast outstanding above a threshold limit needs to be confirmed and reconciliation is
to be carried out before finalising the audit. If the company does not relent, how will you respond?
(SA, May 2018, 4 Marks)
OR
Your firm has been appointed as the statutory auditors of AGM Private Limited for the financial year 2022-23. While verification
of company’s trade receivables as on 31st March 2023, accountant of AGM Ltd. has requested you, not to send
balanceconfirmations to a particular group of trade receivables since the said balances are under dispute and the matter is
pending in the Court. As a Statutory Auditor, how would you deal in this situation?
(RTP, May 2020, NA) (Study Material)

M/s ABC & Co, LLP are appointed auditors of Sharp Company Ltd. for the year ended 31st March, 2023. As part of the audit
process, they want to use confirmation procedures as audit evidence during the course of audit. In view of the fact that positive
confirmations are not responded favorably, the firm also intends to use negative confirmation requests. What are the factors to
be considered for the same?
(SA, May 2019 (Old), 7 Marks)

Mr. Agarwal, in the course of audit of PQ Limited, wants to perform external confirmation procedures to obtain audit evidence.
Guide Mr. Agarwal, listing out the factors that may assist him in determining whether external confirmation procedures are to
be performed as substantive audit procedures.
(SA, Dec 2021, 5 Marks)

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

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

SA 510 Initial Audit Engagements - Opening Balances


Objective
In conducting an initial audit engagement, the objective of the auditor with respect to opening balances is to
obtain sufficient appropriate audit evidence about whether
a. Opening balances contain misstatements that materially affect the current period’s financial
statements; and
b. Appropriate accounting policies reflected in the opening balances have been consistently applied in the
current period’s financial statements, or changes thereto are properly accounted for and adequately
presented and disclosed in accordance with the applicable financial reporting framework.

Definitions
Initial audit engagement
An engagement in which either:
● The financial statements for the prior period were not audited; or
● The financial statements for the prior period were audited by a predecessor auditor.

Opening balances
Those account balances that exist at the beginning of the period. Opening balances also include matters
requiring disclosure that existed at the beginning of the period, such as contingencies and commitments.

Predecessor auditor
The auditor from a different audit firm, who audited the financial statements of an entity in the prior period
and who has been replaced by the current auditor.

Audit Procedures
Opening Balances
Read the latest FS and PAR
The auditor shall read the most recent financial statements, if any, and the predecessor auditor’s report thereon,
if any, for information relevant to opening balances, including disclosures.

The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain
misstatements that materially affect the current period’s financial statements by
a. Determining whether the prior period’s closing balances have been correctly brought forward to the
current period or, when appropriate, any adjustments have been disclosed as prior period items in the
current year’s Statement of Profit and Loss
b. Determining whether the opening balances reflect the application of appropriate accounting policies;
and
c. Performing one or more of the following:

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i. Where the prior year financial statements were audited, perusing the copies of the audited
financial statements including the other relevant documents relating to the prior period
financial statements;
ii. Evaluating whether audit procedures performed in the current period provide evidence relevant
to the opening balances; or
iii. Performing specific audit procedures to obtain evidence regarding the opening balances.

Financial Statements Audited by another Auditor


Ordinarily, the current auditor can place reliance on the closing balances contained in the financial statements
for the preceding period, except when during the performance of audit procedures for the current period the
possibility of misstatements in opening balances is indicated.
Audit of Financial Statements for the First Time
Since it will not be possible for auditor to perform certain procedures, e.g., observing physical verification of
inventories, etc. the auditor may obtain confirmation, etc. and perform suitable procedures in respect of fixed
assets, investments, etc. The auditor can also obtain management representation with regards to the opening
balances.

Evidence that the opening balances contain misstatements


If the auditor obtains audit evidence that the opening balances contain misstatements that could materially
affect the current period’s financial statements, the auditor shall perform such additional audit procedures as
are appropriate in the circumstances to determine the effect on the current period’s financial statements.

Misstatements exist in the current period’s financial statements


If the auditor concludes that such misstatements exist in the current period’s financial statements, the auditor
shall communicate the misstatements with the appropriate level of management and those charged with
governance in accordance with SA 450

Audit Procedures - Consistency of Accounting Policies


The auditor shall obtain sufficient appropriate audit evidence about whether the accounting policies reflected
in the opening balances have been consistently applied in the current period’s financial statements, and
whether changes in the accounting policies have been properly accounted for and adequately presented and
disclosed in accordance with the applicable financial reporting framework.

Audit Procedures - Relevant Information in the Predecessor Auditor’s Report


If the prior period’s financial statements were audited by a predecessor auditor and there was a modification
to the opinion, the auditor shall evaluate the effect of the matter giving rise to the modification in assessing
the risks of material misstatement in the current period’s financial statements in accordance with SA 315

Audit Conclusions and Reporting


Opening balances
If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the
auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance with SA 705.

If the auditor concludes that the opening balances contain a misstatement that materially affects the current
period’s financial statements, and the effect of the misstatement is not properly accounted for or not

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adequately presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion, as
appropriate, in accordance with SA 705.

Consistency of Accounting Policies


If the auditor concludes that
a. the current period’s accounting policies are not consistently applied in relation to opening balances in
accordance with the applicable financial reporting framework; or
b. a change in accounting policies is not properly accounted for or not adequately presented or disclosed
in accordance with the applicable financial reporting framework,
the auditor shall express a qualified opinion or an adverse opinion as appropriate in accordance with SA 705.

Modification to the Opinion in the Predecessor Auditor’s Report


If the predecessor auditor’s opinion regarding the prior period’s financial statements included a modification
to the auditor’s opinion that remains relevant and material to the current period’s financial statements, the
auditor shall modify the auditor’s opinion on the current period’s financial statements in accordance with SA
705 and SA 710.

In an initial audit engagement, the auditor will have to satisfy about the sufficiency and appropriateness of ‘Opening balances’
to ensure that they are free from instatements, which may materially affect the current financial statements. Lay down the audit
procedure, you will follow, when financial statements are audited for the first time.
If, after performing the procedure, you are not satisfied about the correctness of ‘Opening Balances’, what approach you will
adopt in drafting your audit report?
(MTP2, May 2018, 5 Marks) (MTP1, Nov 2019, 6 Marks) (Study Material)

CA Mr. Jack, a recently qualified practicing Chartered Accountant got his first audit assignment of Futura (P) Ltd. for the
financial year 2022- 23. He obtained all the relevant appropriate audit evidence for the items related to Statement of Profit and
Loss. However, while auditing the Balance Sheet items, CA Jack left out obtaining appropriate audit evidence, say,
confirmations, from the outstanding Accounts Receivable amounting Rs. 100 lakhs, continued as it is from the last year, on the
affirmation of the management that there is no receipts and further credits during the year. CA Jack, therefore, excluded from
the audit programme, the audit of accounts receivable on the understanding that it pertains to the preceding year which was
already audited by predecessor auditor. Comment.
(MTP2, Nov 2018, 5 Marks) (MTP1, May 2020, 5 Marks)

You have been appointed as statutory auditor of M/s Moon Ltd. for the financial year 2022-23. As the auditor of the company
you want to ensure that closing balances of previous year have been correctly brought forward as opening balances in the
current year. State the audit procedures for the same to ensure that there is no misstatement.
(SA, Nov 2019 (Old), 5 Marks)

OR

Mr. X has been appointed as an auditor of M/s ABC Ltd., Mr. X wants to be satisfied about the sufficiency and appropriateness
of ‘Opening Balances’ to ensure that they are free from misstatements. Lay down the audit procedure, Mr. X should follow, in
the initial audit engagement of M/s ABC Ltd. Also suggest the approach to be followed regarding mention in the audit report if
Mr. X is not satisfied about the correctness of ‘Opening Balances’?
(SA, Nov 2019, 4 Marks)

(I) In an initial audit engagement ,the auditor will have to satisfy about the sufficiency and appropriateness of‘ Opening
Balances’ toensure that they are free from misstatements, which may materially affect the current financial statements.
Laydown the audit procedure, you will follow in cases (i) when the financial statements are audited for the preceding
period by another auditor; and (ii) when financial statements are audited for the first time.
(Il) If, after performing the procedure, you are not satisfied about the correctness of‘ Opening Balances’; what approach you

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will adopt in drafting your audit report in two situations mentioned in (I) above?
(RTP, May 2021, NA)

SA 520 - Analytical Procedures


Information
This Standard on Auditing (SA) deals with the auditor’s use of analytical procedures as substantive procedures (“substantive
analytical procedures”), and as procedures near the end of the audit that assist the auditor when forming an overall conclusion
on the financial statements.

The use of analytical procedures as risk assessment procedures is dealt with in SA 315. SA 330 includes requirements and
guidance regarding the nature, timing and extent of audit procedures in response to assessed risks; these audit procedures may
include substantive analytical procedures.

Objectives
The objectives of the auditor are.
a. To obtain relevant and reliable audit evidence when using substantive analytical procedures; and
b. To design and perform analytical procedures near the end of the audit that assist the auditor when
forming an overall conclusion as to whether the financial statements are consistent with the auditor’s
understanding of the entity.

Definition and Nature


Definition
The term “analytical procedures” means
● evaluations of financial information
● through analysis of plausible relationships
● among both financial and non-financial data.

Analytical procedures also includes


● such investigation as is necessary of identified fluctuations or relationships that are inconsistent with
other relevant information or that differ from expected values by a significant amount.

Nature
Analytical procedures include
● comparisons of the entity’s financial information with, for example
● Comparable information for prior periods.
● Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor,
such as an estimation of depreciation.
● Similar industry information, such as a comparison of the entity’s ratio of sales to accounts
receivable with industry averages or with other entities of comparable size in the same industry.

Analytical procedures also include


● Consideration of relationships, for example
● Among elements of financial information
○ that would be expected to conform to a predictable pattern,

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■ such as gross margin percentages.


● Between financial information and relevant non-financial information,
○ such as payroll costs to number of employees.

Requirements
● Substantive Analytical Procedures
● Analytical Procedures that Assist When Forming an Overall Conclusion
● Investigating Results of Analytical Procedures

Substantive Analytical Procedures


When designing and performing substantive analytical procedures in accordance with SA 330 , the auditor shall

Determine the suitability


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

Factors to be considered for considering suitability


● Substantive analytical procedures are generally more applicable to large volumes of transactions that
tend to be predictable over time.
● The auditor’s assessment of how effective it will be in detecting a misstatement that may cause the
financial statements to be materially misstated.
● The nature of the assertion and the auditor’s assessment of the risk of material misstatement. If risk is
high due to lack of controls we will use more tests of details and less (or even no) substantive analytical
procedure.
● Substantive analytical procedure may also be considered suitable to support the test of details.

Reliability of data
Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed.

Factors to be considered for considering Reliability


The following are relevant when determining whether data is reliable for purposes of designing substantive
analytical procedures:
1. Source of the information available. For example, information may be more reliable when it is obtained
from independent sources outside the entity;
2. Nature and relevance of the information available. For example, whether budgets have been established
as results to be expected rather than as goals to be achieved; and
3. Comparability of the information available. For example, broad industry data may need to be
supplemented to be comparable to that of an entity that produces and sells specialised products;
4. Controls over the preparation of the information that are designed to ensure its completeness, accuracy
and validity. For example, controls over the preparation, review and maintenance of budgets.

Develop an expectation of recorded amounts


Develop an expectation of recorded amounts 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

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The auditor will be able to develop a more precise expectation if disaggregated information is obtained and
analysed. For example, when performing analytical procedures over revenue, it may be more meaningful if sales
by month/customer/product/region are analysed rather than the revenue figure as a whole.

Determine the amount of any difference


Determine the amount of any difference of recorded amounts from expected values that is acceptable without
further investigation.

Analytical Procedures that Assist When Forming an Overall Conclusion


The auditor shall design and perform analytical procedures near the end of the audit that assist the auditor
when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s
understanding of the entity.

Investigating Results of Analytical Procedures


If analytical procedures performed in accordance with this SA 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.

Audit evidence relevant to management’s responses may be obtained by evaluating those responses taking into
account the auditor’s understanding of the entity and its environment, and with other audit evidence obtained
during the course of the audit.

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.

Examples
In case of Payroll cost - Where an entity has a known number of employees at fixed rates of pay throughout the
period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with a
high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and
reducing the need to perform tests of details on the payroll.

In case of Room Rental Income of Hotel, different types of analytical procedures provide different levels of
assurance. Analytical procedures involving the prediction of total rental income in case of hotel taking the
room tariff rates, the number of rooms and vacancy rates into consideration, can provide persuasive evidence
and may eliminate the need for further verification by means of tests of details, provided the elements are
appropriately verified.

In audit of DEF Limited, the auditor had made use of certain analytical procedures with regard to certain key data in the
statement of profit and loss. The results obtained showed inconsistencies with other relevant information. State the course of
action that the Auditor should take to ensure that the risk of Material misstatement would be contained to a low level fixed as

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per materiality level.


(SA, Nov 2018, 4 Marks)

You have been appointed as an auditor of M/s Excellent Hotels Ltd. As a senior partner, you want to use analytical procedures
in respect of room rentals as well as payroll expenses. Discuss.
(SA, May 2019 (Old), 5 Marks)

SA 530 - Audit Sampling

Objective
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.

Definition
Sampling
The application of audit procedures to less than 100% of items within a population of audit relevance such that
all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to
draw conclusions about the entire population.

Population
The entire set of data from which a sample is selected and about which the auditor wishes to draw conclusions.

Sampling unit
The individual items constitute a population.

Requirements
● Sample Design, Size and Selection of Items for Testing.
● Performing Audit Procedures
● Nature and Cause of Deviations and Misstatements
● Projecting Misstatements
● Evaluating Results of Audit Sampling

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Sample Design, Size and Selection of Items for Testing.


● When designing an audit sample, the auditor shall consider the purpose of the audit procedure and the
characteristics of the population from which the sample will be drawn.
● The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level.
● The auditor shall select items for the sample in such a way that each sampling unit in the population
has a chance of selection

Performing Audit Procedures


● The auditor shall perform audit procedures, appropriate to the purpose, on each item selected.
● If the audit procedure is not applicable to the selected item, the auditor shall perform the procedure on
a replacement item.
● If the auditor is unable to apply the designed audit procedures, or suitable alternative procedures, to a
selected item, the auditor shall treat that item as a deviation from the prescribed control, in the case of
tests of controls, or a misstatement, in the case of tests of details.

Nature and Cause of Deviations and Misstatements


Investigate the nature and cause, evaluate possible effect.
The auditor shall investigate the nature and cause of any deviations or misstatements identified, and evaluate
their possible effect on the purpose of the audit procedure and on other areas of the audit.

Deviation or misstatement is an anomaly


In the extremely rare circumstances when the auditor considers a misstatement or deviation discovered in a
sample to be an anomaly,
● the auditor shall obtain a high degree of certainty that such misstatement or deviation is not
representative of the population.
● The auditor shall obtain this degree of certainty by performing additional audit procedures to obtain
sufficient appropriate audit evidence that the misstatement or deviation does not affect the remainder
of the population.

Anomaly
A misstatement or deviation that is demonstrably not representative of misstatements or deviations in a
population.

Projecting Misstatements
● For tests of details, the auditor shall project misstatements found in the sample to the population.
● When a misstatement has been established as an anomaly, it may be excluded when projecting
misstatements to the population. However, the effect of any such misstatement, if uncorrected, still
needs to be considered in addition to the projection of the non-anomalous misstatements.
● For tests of controls, no explicit projection of deviations is necessary since the sample deviation rate is
also the projected deviation rate for the population as a whole.

Evaluating Results of Audit Sampling


The auditor shall evaluate
● The results of the sample; and

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● Whether the use of audit sampling has provided a reasonable basis for conclusions about the population
that has been tested.

When the projected misstatement plus anomalous misstatement, if any, exceeds tolerable misstatement, the
sample does not provide 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
● Request management to investigate misstatements that have been identified and the potential for
further misstatements and to make any necessary adjustments.
● 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

Tolerable Misstatement and Deviation


Tolerable misstatement
A monetary amount set by the auditor
● in respect of which the auditor seeks to obtain an appropriate level of assurance
● that it is not exceeded by the actual misstatement in the population.

Tolerable rate of deviation


A rate of deviation from prescribed internal control procedures set by the auditor
● in respect of which the auditor seeks to obtain an appropriate level of assurance
● that it is not exceeded by the actual rate of deviation in the population

Factors Influencing Sample Size for Tests of Controls


The following are factors that the auditor may consider when determining the sample size for tests of controls.

FACTOR EFFECT ON SAMPLE SIZE

An increase in the extent to which the auditor’s risk assessment takes into Increase (Higher the
account relevant controls (The extent of reliance auditor places on IC.) reliance, greater the the
sample size.)

An increase in the tolerable rate of deviation Decrease

An increase in the expected rate of deviation of the population to be tested Increase

An increase in the auditor’s desired level of assurance Increase

Examples of Factors Influencing Sample Size for Tests of Details


The following are factors that the auditor may consider when determining the sample size for tests of details.

FACTOR EFFECT ON SAMPLE SIZE

An increase in the auditor’s assessment of the risk of material Increase (High ROMM)
misstatement

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An increase in the use of other substantive procedures directed at the Decrease


same assertion.

An increase in the auditor’s desired level of assurance. Increase

An increase In Tolerable misstatement. Decrease

An increase in the amount of misstatement the auditor expects to find in Increase


the population

Stratification of the population when appropriate Decrease

Sampling risk

Sampling Risk in Test of Details

The recorded value of population is

OK Not OK

OK ● Correct Decision ● Incorrect Decision


● Risk of Incorrect
Acceptance
The sample indicates ● Not effective
that the population is
Not OK ● Incorrect Decision ● Correct Decision

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● Risk of Incorrect
Rejection
● Not Efficient

Sampling Risk in Test of Control

The actual operation of control is

OK Not OK

OK ● Correct Decision ● Incorrect Decision


● Risk of Over reliance
The sample indicates ● Risk of assessing the CR too
that the control in low
operation in ● Not effective

Not OK ● Incorrect Decision ● Correct Decision


● Risk of under reliance
● Risk of Assessing the
CR too high
● Not Efficient

Non-Sampling Risk
“Non-sampling risk” arises from factors that cause the auditor to reach an erroneous conclusion for any reason
not related to the size of the sample.

For example,
- the auditor might use inappropriate audit procedures, or
- the auditor might misinterpret audit evidence and fail to recognize an error.
- Human Mistakes.

Sample Selection Methods


Some of the important methods of selecting the sample are discussed below -

Random Sampling
- Random selection ensures that all items in the population have a equal chance of selection.
- It may involve use of random number tables.
- Random sampling includes two very popular methods which are discussed below

Simple Random Sampling


- Under this method each unit of the whole population e.g. purchase or sales invoice has an equal chance
of being selected.
- Samples are selected through a random number table.
- Random number tables are simple and easy to use and also provide assurance that the auditors’ bias
does not affect the selection.

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- Each item in a population is selected by use of a random number table either with the help of a
computer or picking up a number in a random way.

This method is considered appropriate provided the population to be sampled consists of reasonably similar
units and fall within a reasonable range i.e it is suitable for a homogeneous population having a similar range.
Example

The population can be considered homogeneous, if say, trade receivables balances fall within the range of ₹
50,000 to ₹ 2,00,000 and not in the range between ₹500 to ₹ 11,50,000.

Stratified Sampling
This method involves dividing the whole population to be tested in a few separate groups called strata and
taking a sample from each of them.
- Each stratum is treated as if it was a separate population and
- items are selected from each of these stratum.
- The number of groups into which the whole population has to be divided is determined on the basis of
auditor judgement.

Example
The population in the range between ₹500 to ₹ 11,50,000 say for trade receivables balances may be divided into
groups as follows:-

1. balances in excess of ₹ 10,00,000;


2. balances in the range of ₹ 7,75,001 to ₹ 10,00,000;
3. balances in the range of ₹ 5,50,001 to ₹ 7,75,000
4. balances in the range of ₹ 2,25,001 to ₹ 5,50,000; and
5. balances ₹ 2,25,000 and below.
From these above groups the auditor may pick up different percentages of items from each of the group.
- From the top group i.e. balances in excess of ₹ 10,00,000, the auditor may examine all the items;
- from the second group 25 per cent of the items;
- from the third group 10 percent of the items; and
- from the lowest group 2 percent of the items may be selected.

● Random sample is chosen from each stratum using random number tables.
● The reasoning behind the stratified sampling is that for a highly diversified population, weights should
be allocated to reflect these differences.
● It can be seen that the stratified sampling is simply an extension of simple random sampling.

Stratification means
- dividing a heterogeneous (Diversified) population
- into a Homogeneous (having similar characteristics) sub population,
- where samples are drawn from each subpopulation.

Interval Sampling or Systematic Sampling


- Systematic selection is a selection method in which the number of sampling units in the population is
divided by the sample size to give a sampling interval, for example 50,
- and having determined a starting point within the first 50,

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- each 50th sampling unit thereafter is selected.

The starting point may be determined haphazardly, the sample is more likely to be truly random if it is
determined by use of a computerised random number generator or random number tables.

When using systematic selection, the auditor would need to determine that sampling units within the
population are not structured in such a way that the sampling interval corresponds with a particular pattern in
the population.

Example
If in a population of branch sales, particular branch sales occur only as every 50th item and the sampling
interval selected is also 50. The result would be that either the auditor would have selected all or none of the
sales of that particular branch.

Therefore, systematic sampling when chosen as a method should be carefully applied to bring together every
type of transaction within its purview. More than one starting point can be considered to minimise such risk.

Monetary Unit Sampling


It is a type of
- value-weighted selection in which
- sample size,
- selection and
- evaluation results in a conclusion in monetary amounts.
In this individual monetary units are identified as sampling units.

Value-Weighted Selection
● Values are given weight.
● This selection is done in such a way that high value items for example invoice have high chance of
selection.
● Having selected specific monetary units from within the population, for example, the accounts
receivable balance, the auditor may then examine the particular items, for example, individual balances,
that contain those monetary units.
● One benefit of this approach is that audit effort is directed to the larger value items because they have a
greater chance of selection, and can result in smaller sample sizes.This approach may be used in
conjunction with the systematic method of sample selection and is most efficient when selecting items
using random selection.

Haphazard sampling
Haphazard selection, in which the
- auditor selects the sample
- without following a structured technique.

The auditor should try to avoid any conscious bias or predictability (for example, avoiding difficult to locate
items, or always choosing or avoiding the first or last entries on a page) and thus attempt to ensure that all
items in the population have a chance of selection.

Haphazard selection is not appropriate when using statistical sampling.

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Haphazard sampling has


- no structured approach,
- does not involve judgement and
- does not even use the random number tables.

Block Sampling
- This method involves
- selection of a block(s) of
(in sequence)
- Contiguous items from within the population.

Block selection cannot ordinarily be used in audit sampling because most populations are structured such that
items in a sequence can be expected to have similar characteristics to each other, but different characteristics
from items elsewhere in the population.

Although in some circumstances it may be an appropriate audit procedure to examine a block of items, it would
rarely be an appropriate sample selection technique when the auditor intends to draw conclusion about the
entire population based on the sample.

If the client has the idea of the block selection pattern of the auditor, then material misstatements and
deviations can be easily manipulated by management’s practice of recording them.

Example
● Take the first 100 sales invoices from the sales day book in the month of September; alternatively take
any four blocks of 25 sales invoices.
● Therefore, once the first item in the block is selected, the rest of the block follows items to the
completion.
● There is a close similarity between this method and non-statistical sampling. Consequently it has
similar characteristics, namely, simplicity and economy. On the other hand there is a risk of bias and of
establishing a pattern of selection which may be noted by the auditees.

APPROACHES TO SAMPLING
1. Non-statistical or
2. Statistical sampling approaches.

Statistical Sampling
Probability Theory
Statistical sampling is an approach to sampling that has the
- random selection of the sample units;
- and the use of probability theory
- in determining the appropriate sample size
- In Sample selection
- to evaluate sample results,
- including measurement of sampling risk characteristics.

Mathematical and statistical methods


Sample is chosen by applying certain mathematical and statistical methods.

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More Scientific
Statistical Sampling- More Scientific

Probability theory, a branch of mathematics concerned with the analysis of random phenomena. The outcome of a random event cannot be determined before it
occurs, but it may be any one of several possible outcomes. The actual outcome is considered to be determined by chance.
(https://www.britannica.com/science/probability-theory)

Large number of similar items


Widely used where a population to be tested consists of a large number of similar items and more in the case of
transactions involving compliance testing, trade receivables’ confirmation, payroll checking, vouching of
invoices and petty cash vouchers.

No personal bias
There Is no personal bias of the auditor in the case of statistical sampling.

Projection more reliable


Since it is scientific, the results of the sample can be evaluated and projected on the whole population in a more
reliable manner.

For Example: An auditor while verifying the Purchases during the year realised that the purchase transactions
in that year are more than 95000 in number, then in such case, statistical sampling will be highly recommended
in the audit program.

Advantages of Statistical Sampling


1. The amount of testing (sample size) does not increase in proportion to the increase in the size of the
area (universe) tested. (Smaller sample size gives a better representation of the population, in
judgemental or non statistical sampling sample size is large still it does not give a fair representation of
the population )
2. The sample selection is more objective and thereby more defensible.
3. The method provides a means of estimating the
● minimum sample size associated with a specified risk. (Basically helps in determining the
sample size depending upon audit risk)
4. It provides a means for deriving a “calculated risk” (sampling error) i.e. the probable difference in result
due to the use of a sample in lieu of examining all the records in the group (universe), using the same
audit procedures.
5. It may provide a better description of a large mass of data when compared to a non-statistical approach
of sampling.
6. Results of sampling can be evaluated and projected in a better way

Non-Statistical Sampling
The sample size and its composition are determined on the basis of the
- personal experience and
- knowledge of the auditor.

Does not have any of the characteristics of random selection and use of probability theory.

This approach is simple. The sample may not be a true representative of the total population because of
personal bias and no scientific method of selection.

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For example,
- April, August and March may be selected in year one and different months would be selected in the
next year,
- On the basis of the value of items, The top 10 highest values. Etc.
● An attempt would be made to avoid establishing a pattern of selection year after year.
● An element of surprise is maintained.
● It is a common practice to check large numbers of items towards the close of the year so that the
adequacy of cut-off procedures can also be determined.
● Also, because year end transactions are prone to high risk of misappropriation.

The non-statistical sampling is criticised on the grounds that it is neither objective nor scientific.
- Expected degree of objectivity cannot be assured in nonstatistical sampling
- because the risk of personal bias in selection of sample items cannot be eliminated.

Projection may not be as accurate as it was in statistical sampling because the sample has not been selected in
accordance with the mathematically based statistical techniques.

The auditor with his experience and knowledge of the client’s business can evaluate the sample findings to
make audit decisions without the mathematical proof of accuracy.

SA 540 - Auditing accounting estimates, including fair value


accounting estimates and related disclosures

Scope
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.

Objective of auditor
To obtain sufficient appropriate audit evidence whether:
a) Accounting estimates, including fair value accounting estimates are reasonable ;and
b) Related disclosures in the financial statements are adequate.

Definition
Accounting Estimate
An approximation of a monetary amount in the absence of a precise means of measurement.

Fair value accounting estimate - Involves measurement of fair value. Example - Value of Net realisable value of
Inventory or Valuation of a financial instrument.

Estimation Uncertainty
The suspecticity of an accounting estimate and related disclosures to an inherent lack of precision in its
measurement. (एक accounting estimate कितना expose है to Inherent lack of precision). (How much Inherent

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lack of precision is there, Higher Inherent lack of Precision, Higher estimation uncertainty) or (How
difficult it is to calculate with precision, the higher the difficulty, the higher the estimation uncertainity)

Factors influencing Degree of Estimation Uncertainty


The degree of estimation uncertainty associated with an accounting estimate may be influenced by factors such
as-
1. The extent to which the accounting estimates depend on judgment.
2. The sensitivity of the accounting estimate to changes in assumptions.
3. The existence of recognised measurement techniques that may mitigate the estimation uncertainty.
4. The length of the forecast period,
5. The relevance of data drawn from past events to forecast future events.
6. The availability of reliable data from external sources.

Risk Assessment Procedures & Related Activities


Auditor shall obtain an understanding of the following in order to identify and assess the risks of material
misstatements for accounting estimates:
1. The requirements for applicable financial reporting framework.
2. How management identifies those transactions events and conditions that may give rise to the need for
accounting estimates.
3. The estimation making process adopted by the management including :
a. The method, including where applicable the model used in making the accounting estimates.
b. Whether management has used an expert.
c. Relevant controls
d. The assumptions underlying the accounting estimates
e. Where there has been a change from the prior period in the methods for making the
accounting estimates, and if so why, and
f. How management has assessed the effect of estimation uncertainty.
4. The auditor shall review the outcome of accounting estimates included in the prior period financial
statements. (If significant difference is there between AE and Outcome- ROMM High)
5. The auditor shall determine whether, in the auditor’s judgement, any of those accounting estimates
that have been identified as having high estimation uncertainty give rise to significant risks.

Responses to the Assessed Risks


Based on the assessed risks of material misstatement, the auditor shall determine.
a) Whether management has appropriately applied the relevant requirements of applicable financial
reporting framework. (Requirements of FRF Apt. Applied or not)
b) Whether the methods are appropriate and have been applied consistently, and whether changes, if any,
in accounting estimates or in method are appropriate in the circumstance. (Method Appropriate,
Consistently Applied, Changes Appropriate)

In responding to the assessed risks of material misstatement, as required by SA 330, the auditor shall
undertake one or more of the following.
● The auditor shall obtain sufficient appropriate audit evidence about
○ whether the accounting estimates are reasonable and
○ their disclosure in the financial statements is appropriate.
● For accounting estimates that give rise to significant risks,

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○ the auditor shall check


■ adequacy of the disclosures of their estimation uncertainty in the financial statements.
● The auditor shall obtain written representation from management
○ whether management believes significant assumptions used by it in making accounting
estimates are reasonable.

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:
1. 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.
2. Whether the significant assumptions used by management are reasonable.
3. Management’s intent to carry out specific courses of action and its ability to do so.
4. If, in the auditor’s judgment, management has not adequately addressed the effects of estimation
uncertainty the auditor shall develop a range with which to evaluate the reasonableness of the
accounting estimate.

Written Representations as to Accounting Estimates:


SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures”
requires the auditor to obtain written representations from the management and, where appropriate, those
charged with governance
● whether they believe significant assumptions used in making accounting estimates are reasonable.

Depending on the nature, materiality and extent of estimation uncertainty, written representations may include
representations:
● About the appropriateness of the measurement processes, including related assumptions and models,
used by management.
● That the assumptions appropriately reflect management’s intent and ability to carry out specific
courses of action on behalf of the entity.
● That disclosure related to accounting estimates are complete and appropriate under the applicable
FRF.
● That no subsequent event requires adjustment to the accounting estimates and disclosures included in
the financial statements.

Matters that the auditor may consider in obtaining an understanding of the


assumptions underlying the accounting estimates
Assumptions are integral components of accounting estimates. Matters that the auditor may consider in
obtaining an understanding of the assumptions underlying the accounting estimates include, for example:

● The nature of the assumptions, including which of the assumptions are likely to be significant
assumptions. (External environment or Internal Environment) (If business is completely dependent on government regulation then
assumption about it are significant assumption)
● How management assesses whether the assumptions are relevant and complete (that is, that all relevant
variables have been taken into account).
● Where applicable, how management determines that the assumptions used are internally consistent.

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● Whether the assumptions relate to matters within the control of management (for example,
assumptions about the maintenance programs that may affect the estimation of an asset’s useful life),
and how they conform to the entity’s business plans and the external environment, or to matters that
are outside its control (for example, assumptions about interest rates, mortality rates, potential judicial
or regulatory actions, or the variability and the timing of future cash flows).
● The nature and extent of documentation, if any, supporting the assumptions.

Assumptions may be made or identified by an expert to assist management in making the accounting
estimates. Such assumptions, when used by management, become management’s assumptions.

Management Bias
A lack of neutrality by management in the preparation and presentation of information.
● During the audit, the auditor may become aware of judgments and decisions made by management
which give rise to indicators of possible management bias.
● Such indicators may affect the auditor’s conclusion as to whether the auditor’s risk assessment and
related responses remain appropriate, and the auditor may need to consider the implications for the
rest of the audit.

Examples of indicators of possible management bias with respect to accounting estimates include
● Changes in an accounting estimate, or the method for making it, where management has made a
subjective assessment that there has been a change in circumstances. (There is no change in
circumstance and management is claiming that there is change and accordingly changes the AE or
Method of making of AE)
● Use of an entity’s own assumptions for fair value accounting estimates when they are inconsistent with
observable marketplace assumptions.
● Selection or construction of significant assumptions that leads to a point estimate favourable for
management objectives.
● Selection of a point estimate that may indicate a pattern of optimism or pessimism.

Documentation
The audit documentation shall include :
a) The basis for the auditor’s conclusion about the reasonableness of accounting estimates and their
disclosure that give rise to significant risks; and
b) Indicators of possible management bias, if any.

Example of accounting estimates


Example of accounting estimates, other than fair value accounting estimates
● 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.

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Examples of Fair Value Accounting Estimates


● 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.

During the Audit of Data Solutions Ltd., a listed company, your audit manager observed that several
estimates are made by the Company. He seeks your guidance to know areas of accounting estimates that
may give rise to lower levels of risk of material misstatement. Guide him with examples

Answer
As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”, some
accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements,
for example
● Accounting estimates arising in entities that engage in business activities that are not complex.
● Accounting estimates that are frequently made and updated because they relate to routine transactions.
● 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.
● 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.
● Fair value accounting estimates where the model used to measure the accounting estimate is wellknown or generally
accepted, provided that the assumptions or inputs to the model are observable.

For some accounting estimates, however, there may be relatively high estimation uncertainty, particularly where they are based
on significant assumptions, for example

● Accounting estimates relating to the outcome of litigation.


● Fair value accounting estimates for derivative financial instruments not publicly traded.
● Fair value accounting estimates for which a highly specialised entity-developed model is used or for which there are
assumptions or inputs that cannot be observed in the marketplace.

Mr. L while conducting the audit of ABC Ltd., observed that a substantial amount is recognized in respect of obsolescence of
inventory and warranty obligation in the financial statements. Mr. L wants to obtain written representation from the
management to determine whether the assumptions and estimates used are reasonable.
Guide Mr. L with reference to the relevant Standard on Auditing.
(SA, Nov 2019, 5 Marks) (Study Material)

M/s. HK & Co. was appointed as an auditor of GSB Limited, a company operating its business in telecom sector. As per
spectrum allocation agreement with Government, GSB Limited is required to pay certain percentage of its annual revenue as
license fee. GSB Limited paid the license fee on its core business for last two years. At the end of third year, the communication
was received from Government that it needs to pay agreed percentage on its total revenues and not only on core business
revenues. Matter was disputed a nd went to court of law. On prudence basis, GSB Limited made a provision on estimated
business in its books of accounts of agreed percentage on non-core business receipts also. The amount of provision was of such
huge amount that the GSB Limited's profit a nd loss account for that quarter reflected loss due to that provision. How you as an
auditor can evaluate this accounting estimate which involves significant risk and what if Management has not addressed the
effects of estimation uncertainty on provision made?
(SA, Jan 2021, 4 Marks)

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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?
(MTP2, May 2021, 4 Marks)

Assumptions are integral components of accounting estimates. State the matters that the auditor may consider in obtaining an
understanding of the assumptions underlying the accounting estimates with reference to relevant SAs.
(SA, July 2021 (Old), 5 Marks)

CA Harry is appointed as a Statutory Auditor of Delist Limited for the financial year 2022-23. M/s Delist Limited is a listed
entity at National Stock Exchange and the financial statements are to be drawn up in compliance with Ind AS. M/s Delist
Limited made certain fair value accounting estimates on complex financial instruments which are not traded in an active and
open market. CA Harry is concerned with identification and assessment of the risks of material misstatement for accounting
estimates. Guide him with regard to the estimation making process adopted by management with reference to the relevant
Standard on Auditing.
(SA, May 2022, 4 Marks)

SA 550 - Related Parties

Objective
The objectives of the auditor are
To obtain an understanding of related party relationships and transactions (RPRT) sufficient to be able:
a. To recognise fraud risk factors, if any, arising from related party relationships and transactions that are
relevant to the identification and assessment of the risks of material misstatement due to fraud.( Recog-
FRAUDRF- FROM RPRT - IAROMMDTF)
b. To conclude whether the financial statements, insofar as they are affected by those relationships and
transactions: (Whether FS Affected by RPRT)
i. Achieve a true and fair presentation; or
ii. Are not misleading; (Compliance Framework) and
c. To obtain sufficient appropriate audit evidence about whether RPRT have been appropriately identified,
accounted for and disclosed (IAD) in the financial statements in accordance with the applicable
financial reporting framework. (SAAE - RPRT - Apt IAD in FS in acc AFRF)

Related party
A related party as defined in the applicable financial reporting framework; or

Where the applicable financial reporting framework establishes minimal or no related party requirements
a. A person or other entity that has control or significant influence,
■ directly or indirectly
■ through one or more intermediaries,
■ over the reporting entity;
b. Another entity over which the reporting entity has control or significant influence, directly or
indirectly through one or more intermediaries; or
c. Another entity that is under common control with the reporting entity through having: —

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■ Common controlling ownership;


■ Owners who are close family members; or
■ Common key management.
However, entities that are under common control by a state (i.e., a national, regional or local government) are
not considered related unless they engage in significant transactions or share resources to a significant extent
with one another.

Risk Assessment Procedure and Related Activities


Understanding the Entity's RPRT
The auditor shall inquire of management regarding:
○ The identity of the entity's related parties, including changes from the prior period;
○ The nature of the relationships between the entity and these related parties; and
○ Whether the entity entered into any transactions with these related parties during the period and, if so, the
type and purpose of the transactions.
○ The auditor shall inquire of management and others within the entity, and perform other risk assessment
procedures considered appropriate, to obtain an understanding of the controls if any in that management
has established to
■ Identify, account for, and disclose related party relationships and transactions in accordance with
the applicable financial reporting framework.
■ Authorise and approve significant transactions and arrangements with related parties; and
■ Authorise and approve significant transactions and arrangements outside the normal course of
business.

Maintaining Alertness for Related Party Information


When Reviewing Records or Documents maintain alertness with respect to RPRT. They may indicate RPR/T
not identified or disclosed by Mgt.

Sharing Related Party Information with the Engagement Team


The auditor shall share relevant information obtained about the entity's related parties with the other members
of the engagement team.

Documents and records that may be helpful in gathering information about related party
relationships and transactions.
As per SA 550 “Related Parties”, during the audit, the auditor shall remain alert, when inspecting records or
documents, for information that may indicate the existence of related party relationships or transactions that
management has not previously identified or disclosed to the auditor. Example-
● Bank, legal and third party confirmations obtained as part of the auditor’s procedures
● Minutes of meetings of shareholders and of those charged with governance
● Entity Income Tax Returns.
● Information supplied by the entity to regulatory authorities.
● Shareholder registers to identify the entity’s principal shareholders.
● Contracts and agreements with key management or those charged with governance.
● Significant contracts and agreements not in the entity’s ordinary course of business.
● Life insurance policies acquired by the entity.
● Significant contracts re-negotiated by the entity during the period.
● Documents associated with the entity’s filings with a securities regulator (e.g prospectus etc.)

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● Arrangements that may indicate the existence of previously unidentified or undisclosed related party
relationships or transactions.

Identification of Previously Unidentified or Undisclosed Related Parties or


Significant Related Party Transactions
The auditor identifies related parties or significant related party transactions that management has not
previously identified or disclosed to the auditor, the auditor shall
1. Promptly communicate to Engagement Team.
2. Request management to identify all transactions with the newly identified related parties for the
auditor's further evaluation; and
3. Inquire as to why the entity's controls over RPRT failed
4. Perform appropriate substantive audit procedures relating to such newly identified related parties or
significant related party transactions;
5. Reconsider the risk that other related parties or significant related party transactions may exist that
management has not previously identified or disclosed to the auditor, and perform additional audit
procedures as necessary; and
6. If the non-disclosure by management appears intentional evaluate the implications for the audit.

Identified Significant Related Party Transactions outside the Entity's


Normal Course of Business
For identified significant related party transactions outside the entity's normal course of business, the auditor
shall:
1. Inspect the underlying contracts or agreements, if any, and evaluate whether:
a. The business rationale (or 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;
b. The terms of the transactions are consistent with management's explanations; and
c. The transactions have been appropriately accounted for and disclosed in accordance with the
applicable financial reporting framework; and
2. Obtain audit evidence that the transactions have been appropriately authorized and approved.

Evaluation of the Accounting for and Disclosure of Identified RPRT


In forming an opinion on the financial statements the auditor shall evaluate:
● Whether the identified RPRT have been appropriately
○ accounted for and
○ disclosed in accordance with the applicable financial reporting framework; and
● Whether the effects of the RPRT
○ Prevent the financial statements from achieving true and fair presentation; or
○ Cause the financial statements to be misleading. (Compliance Framework)

Written Representations
The auditor shall obtain written representations from management and, where appropriate, those charged with
governance that
● They have disclosed to the auditor

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○ the identity of the entity’s related parties and


○ all the related party relationships and transactions of which they are aware and
● They have appropriately accounted for and disclosed such relationships and transactions in accordance
with the requirements of the framework

Communication with Those Charged with Governance


Unless all of those charged with governance are involved in managing the entity , the auditor shall
communicate with those charged with governance significant matters arising during the audit in connection
with the entity’s related parties.

Documentation
In meeting the documentation requirements of SA 230 and other SAs, the auditor shall include in the audit
documentation the names of the identified related parties and the nature of the related party relationships.

Discussion among the Engagement Team


Matters that may be addressed in the discussion among the engagement team include
1. The nature and extent of the entity’s relationships and transactions with related parties. (Nature and
Extent)
2. 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.
(EOIMPS)
3. 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. (For
example complex organisational structure) (Circumstances)
4. The records or documents that may indicate the existence of related party relationships or transactions.
(RECORDS or DOCS)
5. The importance that management and those charged with governance attach to the identification,
appropriate accounting for, and disclosure of related party relationships and transactions.
(IMPORTANCE BY MGT and TCWG)

In addition, the discussion in the context of fraud may include specific consideration of how related parties may
be involved in fraud. For example
● How special-purpose entities controlled by management might be used to facilitate earnings
management. (Showing fake sales or purchases and creating companies specifically for the same)
● How transactions between the entity and a known business partner of a key member of management
could be arranged to facilitate misappropriation of the entity’s assets.

In the course of audit of Q Ltd, its statutory auditor wants to be sure of the adequacy of related party disclosures? Kindly guide
the auditor in identifying the possible source of related party information.
(MTP2, Nov 2018, 4 Marks)
OR
JY & Co. is appointed as auditor of Breeze Ltd. JY & Co. seeks your guidance for reviewing the records and documentation of
the company regarding ‘related party transactions in the normal course of business’. Describe the steps to be followed.
(MTP1, May 2019, 4 Marks)
OR

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The financial statements of Beta Ltd. have been prepared by the Management with due disclosures for related parties and
transactions with them. However, as the auditor of the Company, you are not sure of the reliability of the said disclosures.
Mention the documents and records that may be helpful in gathering information about related party relationships and
transactions.
(SA, Nov 2019 (Old), 5 Marks)

Mr. X, while conducting audit of PQR Ltd, comes across certain transactions which according to him are significant
transactions with related parties and identified to be outside the entity's normal course of business. Guide Mr. X with
examples of such transactions and to understand the nature of significant transactions outside the entity's normal course of
business.
(SA, Nov 2020, 5 Marks)

In the given case of PQR Ltd, Mr. X, while conducting audit has come across certain significant related party transactions
which are identified to be outside the entity’s normal course of business. Mr. X wants guidance through examples of such
significant transactions which are given in SA 550
As per SA 550 “Related Parties”, examples of transactions outside the entity’s normal course of business may include:
1. Complex equity transactions, such as corporate restructurings or acquisitions.
2. Transactions with offshore entities in jurisdictions with weak corporate laws.
3. The leasing of premises or the rendering of management services by the entity to another party if no consideration is
exchanged.
4. Sales transactions with unusually large discounts or returns
5. Transactions with circular arrangements, for example, sales with a commitment to repurchase.
6. Transactions under contracts whose terms are changed before expiry.

JKL Limited is engaged in the business of Construction and real estate having various projects across states. M/s YT & Co,
Chartered Accountants have been appointed as Statutory Auditors. Audit Team from M/s YT & Co for audit of JKL Limited
comprises of CA Z-Engagement Partner, CA Q, a paid assistant and 3 Articled Assistants. During preliminary verification, CA
Z observed that huge amount of sub-contract payments were made to M/s JB Associates, a partnership firm in which Director
of JKL Limited is a managing partner. The engagement team discussed that SA 315 and SA 240 shall include specific
consideration of the susceptibility of the financial statements to material misstatement due to fraud or error that could result
from the JKL Limited's related party relationships and transaction. Highlight the matters that are to be addressed in the
discussion by CA Z with engagement team members with reference to the relevant Standard on Auditing.
(SA, May 2022, 5 Marks)

SA 560 Subsequent Event

Background
SA 700 explains that the date of the auditor’s report informs the reader that the auditor has considered the
effect of events and transactions of which the auditor becomes aware and that occurred up to that date.

Meaning of Subsequent Events.


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.

Other Definitions
Date of the financial statements
The date of the end of the latest period covered by the financial statements.

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Date of approval of the financial statements


The date on which all the statements that comprise the financial statements, including the related notes, have
been prepared and those with the recognised authority have asserted that they have taken responsibility for
those financial statements.

Date of the auditor’s report


The date the auditor dates the report on the financial statements in accordance with SA 700

Date the financial statements are issued


The date that the auditor’s report and audited financial statements are made available to third parties.

Objective
● Obtain Sufficient And Appropriate Evidence about whether
○ 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
○ are appropriately reflected in those financial statements; and
● Respond appropriately
○ to facts that become known to the auditor after the date of the auditor's report,
○ that, had they been known to the auditor at that date,
■ may have caused the auditor to amend the auditor's report.

Audit procedures for subsequent events


Risk Assessment Procedures w.r.t Subsequent Events
The following procedures may be followed to identify the subsequent events
● Obtaining an understanding of any procedures management has established to ensure that subsequent
events are identified.
● Inquiring of management and, where appropriate, those charged with governance as to whether any
subsequent events have occurred which might affect the financial statements.
● Read the minutes of meeting of board of directors, executive committee, meeting of shareholders held
after balance sheet date
● Read latest interim financial statements.

SAAE - Indentification of Subsequent Events


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 and are appropriately reflected in those financial statements.

Written Representations
The auditor shall request management and, where appropriate, those charged with governance, to provide a
written representation that

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● 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.

Inquiries of management regarding subsequent events


The auditor may may make specific inquiries about the following matters:
● Whether new commitments, borrowings or guarantees have been entered into.
● Whether sales or acquisitions of assets have occurred or are planned.
● Whether there have been increases in capital or issuance of debt instruments such as the issue of new
shares or debentures, or an agreement to merge or liquidate has been made or is planned.
● Whether any assets have been appropriated by government or destroyed, for example, by fire or flood.
● Whether there have been any developments regarding contingencies.
● Whether any unusual accounting adjustments have been made or are contemplated.
● Whether any events have occurred or are likely to occur that will bring in question the appropriateness
of accounting policies used in the finance statements, as would be the case, for example, if such events
call ir question the validity of the going concern assumption.
● Whether any events have occurred that are relevant to the measurement estimates or provisions made
in the financial statements.
● Whether any events have occurred that are relevant to the recoverability assets.

Subsequent events and branch auditor's report


If branch auditor has already audited the branch and submitted the report to principal auditor, the principal
auditor would follow audit procedures in respect events occurring between the date of signing of the audit
report of the auditor of branch and the date of signing of his (principal) report.

Facts Which Become Known To The Auditor After The Date Of The
Auditor's Report But Before The Date The Financial Statements Are Issued
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
■ Discuss the matter with management and, where appropriate, those charged with
governance.
■ Determine whether the financial statements need amendment and, if so,
■ Inquire how management intends to address the matter in the financial statements.

Management Amends
If management amends the financial statements, the auditor shall
a. Carry out the audit procedures necessary in the circumstances on the amendment.
b. Extend the audit procedures to the date of the new auditor’s report
c. Provide a new auditor’s report on the amended financial statements.

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No Amendment By Management
When management does not amend the financial statements in circumstances where the auditor believes they
need to be amended
● If the auditor’s report has not yet been provided to the entity, the auditor shall modify the opinion as
required by SA 705 and then provide the auditor’s report or
● If the auditor’s report has already been provided to the entity,
○ the auditor 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 auditor shall take appropriate action, to seek to prevent reliance on
the auditor’s report.

Facts Which Become Known to the Auditor After the Financial Statements
have been Issued.
After the financial statements have been issued, the auditor has no obligation to perform any audit procedures
regarding such financial statements.
● However, when, after the financial statements have been 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
■ Discuss the matter with management and, where appropriate, those charged with
governance.
■ Determine whether the financial statements need amendment and, if so,
■ Inquire how management intends to address the matter in the financial statements.

Management Amends
If the management amends the financial statements, the auditor shall
a. Carry out the audit procedures necessary in the circumstances on the amendment.
b. Review the steps taken by management to ensure that anyone in receipt of the previously issued
financial statements together with the auditor’s report thereon is informed of the situation.
c. Extend the audit procedures to the date of the new auditor’s report, and
d. Provide a new auditor’s report on the amended financial statements.

Emphasis of Matter paragraph or Other Matter Paragraph


The auditor shall include in the new or amended auditor’s report an Emphasis of Matter paragraph or Other
Matter(s) paragraph referring to a note to the financial statements that more extensively discusses the reason
for the amendment of the previously issued financial statements and to the earlier report provided by the
auditor.

No Steps by Management and No Amendments


If management
● does not take the necessary steps to ensure that anyone in receipt of the previously issued financial
statements is informed of the situation and

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● does not amend the financial statements in circumstances where the auditor believes they need to be
amended,
the auditor shall
● notify management and those charged with governance,
● that the auditor will seek to prevent future reliance on the auditor’s report.
If, despite such notification, management or those charged with governance do not take these necessary steps,
● the auditor shall take appropriate action to seek to prevent reliance on the auditor’s report.

For your reading


Types Of Subsequent Events
Type 1
Those events that provide additional evidence with respect to conditions that existed on the date of balance
sheet and effect the estimation made in the preparation of the financial statements. The statement should be
adjusted for any change in estimates resulting from the use of evidence of subsequent events.

For example
● Debtors as on balance sheet date are declared insolvent after the balance sheet date but before auditor's
report
● Settlement of legal disputes before audit report date, which arose before balance sheet date.

Type 2
Those events which provide evidence with respect to conditions that did not exist on the date of the balance
sheet being reported on but arose subsequent to the date. These events should not result in adjustments of the
financial statements. Some of these events however may be of such a nature that disclosure of them is required
to keep the financial statements from not being misleading.

For example
Purchase of business, Sale of shares and debentures, Loss of plant or inventory as a result of fire

Amudhan & Co., are the Auditors of XYZ Company Ltd., for the year ended on 31/03/2022. The Audit Report for that year was
signed by the Auditors on 04/05/2022. The Annual General Meeting was decided to be held during the month of August 2022.
On 06/05/2022, the Company had received a communication from the Central Government that an amount of Rs. 5800 crore
kept pending on account of incentives pertaining to Financial Year 2021-22 had been approved and the amount would be paid
to the Company before the end of May 2022. 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 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 31.03.2022. On
08.05.2022, the Board amended the accounts, approved the same and requested the Auditor to consider this event and issue a
fresh Audit Report for the year ended on 31.03.2022. Analyse the issues involved and give your views as to whether or not the
Auditor could accede to the request of the Board of Directors.
(SA, Nov 2018, 5 Marks)

M/s LMP Associates, Chartered Accountants while conducting the audit of PQR Ltd want to conduct an inquiry of
management and those charged with governance as to whether any subsequent events have occurred which might affect the
financial statements. Guide M/s LMP Associates with the matters where specific enquiry may be conducted to evaluate
subsequent events.
(SA, May 2019 (Old), 7 Marks) (MTP2, May 2022, 4 Marks)

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You are the auditor of PQR Ltd. which is in the business of supplying food products to various airline companies operating
aircrafts in domestic circle only. As per terms of agreement with airlines, the company needs to stock various non-perishable
food items for coming one month (average holding of inventory to the tune of INR 75 Crores). Also the payment terms have
been settled and the company receives payment in 45 days after the supply of goods. Everything was going-on well till the end
of March 2021 when pandemic Covid hit the world and everything came to a standstill. Aviation sector was hit hard and there
were no flights from April 2020 onwards. Consequently, the business of PQR Ltd. also got severely affected and the scheduled
supplies of goods to airlines also were not made. Also, the liquidity position of airline companies got hit and the scheduled
payments were also not received on due dates. As the auditor of PQR Ltd. what audit procedures would you perform to ensure
that all subsequent events are considered, so that financial statements for the year ended 31.03.2021 represent true and fair
view?
(SA, Nov 2020, 5 Marks)

SA 570 - Going Concern


Responsibilities of management
It is management's responsibility to assess the entity's ability to continue as a going concern even if the
financial reporting framework does not include an explicit requirement to do so.

Responsibilities of the auditor


The auditor's responsibility is to
● obtain sufficient appropriate audit evidence
● about the appropriateness of management's use of the going concern assumption.

He shall consider
● whether there is a material uncertainty related to events and conditions
● that may cast significant doubt
● about the entity's ability to continue as a going concern.

Report in accordance with this SA

NOTE
As per SA 200 The absence of any reference to going concern uncertainty in an auditor's report cannot be
viewed as a guarantee as to the entity's ability to continue as a going concern.

Risk assessment procedures and related activities


Consider events and conditions
The auditor shall remain alert as to whether there are events or conditions that may cast significant doubt on
the entity's ability to continue as a going concern.
In doing so, the auditor shall determine
● whether management has already performed a preliminary assessment of the entity's ability to continue
as a going concern.
○ If done - Discuss with management.
○ If not - Discuss with management the basis of use of going concern assumption.

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Standards on Auditing

Evaluating Management’s Assessment


The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern and
consider whether all relevant information, as known to auditor, is included in the assessment.

If management’s assessment of the entity’s ability to continue as a going concern covers less than twelve
months from the date of the financial statements, the auditor shall request management to extend its
assessment period to at least twelve months from that date.

Period beyond Management’s Assessment (Enquire Knowledge of Events or Condition)


The auditor shall inquire of management as to its knowledge of events or conditions beyond the period of
management’s assessment that may cast significant doubt on the entity’s ability to continue as a going concern.

Additional audit procedures when events or conditions are identified


When 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 perform procedures as follows:
● 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 future actions in relation to its going concern assessment
● When the entity has prepared a cash flow forecast, then consider its reliability and also the underlying
assumptions.
● Considering whether any additional facts or information have become available since the date on which
management made its assessment.
● Requesting written representations from management or those charged with governance, regarding
their plans for future action and the feasibility of these plans.

Auditor Conclusions
Appropriateness of management’s use of the going concern
The auditor shall evaluate whether sufficient appropriate audit evidence has been obtained regarding, and shall
conclude on, the appropriateness of management’s use of the going concern basis of accounting in the
preparation of the financial statements.

Existence of Material Uncertainty


Based on the audit evidence obtained, the auditor shall conclude whether, in the auditor’s judgment, a material
uncertainty exists related to events or conditions that, individually or collectively, may cast significant doubt on
the entity’s ability to continue as a going concern.

Material Uncertainty
A material uncertainty exists when the
● magnitude of its potential impact and
● likelihood of occurrence
● is such that,
● in the auditor’s judgment,
● appropriate disclosure of the nature and implications of the uncertainty is necessary as per the AFRF.

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Standards on Auditing

Implications for the Auditor’s Report


Use of Going Concern Basis of Accounting Is NOT Appropriate
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.
Use of Going Concern Basis of Accounting Is Appropriate but a Material Uncertainty Exists
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
○ Draw attention to the note in the financial statements that discloses the matters.
○ 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.

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 Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA
705
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.

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.

Significant Delay in the Approval of Financial Statements


If there is significant delay in the approval of the financial statements by management or those charged with
governance after the date of the financial statements,
● the auditor shall inquire as to the reasons for the delay.
● If the auditor believes that the delay could be related to
○ events or conditions relating to the going concern assessment,
■ The auditor shall perform those additional audit procedures (as discussed under the
heading - Additional audit procedures when events or conditions are identified)
necessary,
■ as well as consider the effect on the auditor’s conclusion regarding the existence of a
material uncertainty.

Adequacy of Disclosures When Events or Adequacy of Disclosures When


Conditions Have Been Identified and a Material Events or Conditions Have Been
Uncertainty Exists Identified but No Material
Uncertainty Exists

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Standards on Auditing

The auditor shall determine whether the financial The auditor shall evaluate whether, in
statements. view of the requirements of the applicable
Adequately disclose the financial reporting framework, the
● principal events or conditions financial statements provide adequate
○ that may cast significant doubt on disclosures about these events or
○ the entity’s ability to continue as a going conditions.
concern
● and management’s plans to deal with these events
or conditions; and
Disclose clearly that
● there is a material uncertainty related to events or
conditions
● that may cast significant doubt on the entity’s
ability to continue as a going concern and,
● therefore, that it may be unable to realize its
assets and discharge its liabilities in the normal
course of business.

Indicators that there are events or conditions that may cast significant doubt on the entity's
ability to continue as a going concern.

Financial indicators
➔ Negative Net worth/working capital;
➔ Arrears / discontinuance of Dividends;
➔ Adverse financial ratio;
➔ Substantial operating losses;
➔ Borrowings approaching maturity without any chance of renewal/ repayment;
➔ Short term borrowing for long term asset financing;
➔ No payment to creditors on the due date.
➔ Non-compliance with terms in loan agreement;
➔ Negative cash flow from operations;
➔ Rearrangement with creditors for reduction in liability; or
➔ Change from creditors to cash on delivery transaction with supplier.

Operating indicators
➔ Loss of key management and no replacement available;
➔ Loss of major market or supplier;
➔ Labour unrest, strikes etc; or
➔ Loss of major licence, franchise, etc.

Other indicators
➔ Pending legal proceedings;
➔ Change in Govt. Policy affecting the entity adversely; or
➔ Non- compliance with Statutory requirements

However, such indications may be mitigated by some positive factors.

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Standards on Auditing

For example: loss of some major suppliers may be compensated by availability of some alternate source of
supply.

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.
(SA, Nov 2018, 5 Marks)

AQP Limited is one of the prominent players in the chemicals industry. The company is a public company domiciled in India
and listed on BSE and NSE. The Company was facing extreme liquidity constraints and there were multiple indicators that
casted doubt over the company’s ability to continue as a going concern.
The Company was led into insolvency proceedings by consortium of banks led by PNB and the NCLT ordered the
commencement of corporate insolvency process against the Company on 31 August 2023. The company invited prospective
lenders, investors and others to submit their resolution plans to the Resolution Professional (RP) latest by 1 January 2023. The
RP reviewed the resolution plans and ensured conformity with Insolvency and Bankruptcy Code 2016. Thecompliant plans were
presented to Committee on Creditors (CoC) on 2 February 2023 and the resolution plan submitted by PQR Ltd. was evaluated as
highest evaluated Compliant Resolution Plan. CoC of AQP Ltd approved the Resolution Plan submitted by PQR Ltd. on 2
March 2023. The approval of NCLT was finally obtained on 4 May 2023.
PQR Ltd submitted detailed plans and commitments as part of the resolution plan including clearance of all outstanding debts
which were leading to negative cash flows.
Please suggest how would you deal with this situation as the auditors of AQP Ltd.
(MTP1, May 2019, 5 Marks) (RTP, Nov 2019, NA

Enumerate the Operating conditions of an entity that may cast significant doubt on the entity’s ability to continue as a “Going
Concern”.
(SA, May 2019 (Old), 4 Marks)

Star 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 Star Ltd. This happened in the month
of December 2022 and as such entire power generation process of Star 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 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 Star Ltd. What
course of action should the statutory auditor of the Company consider in such situation?
(RTP, May 2021, NA)

OM Ltd. is a company engaged in the business of manufacture of spare parts. Shanti & Associates are the statutory auditors of
the company for the FY 2022-23. During the course of audit, CA Shanti 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 OM Ltd. ended for an unforeseeable
time period. When discussed with the management, CA Shanti was told that the company is in the process of identifying new
customers for their products. CA Shanti 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 OM Ltd. for the FY 2022-23. How should CA Shanti deal with this matter in the auditor’s report for the FY
2022-23 in accordance with relevant Standard on Auditing?

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Standards on Auditing

(MTP2, Nov 2021, 5 Marks)

Abhinandan Limited a chemical manufacturing company, having its factory located at Nanded Village, for the year 2022-23
appointed Subahu & Co. as their statutory auditors. During the course of the audit, Subahu & Co. identified that Abhinandan
Limited received a show cause notice from National Green Tribunal based on the investigation performed by the regional forest
department for violating environmental laws. Upon gathering a further understanding of the said matter, it was identified that
Abhinandan Limited was dumping toxic solid waste, without treating it, on the nearby grounds, and because of this, the nearby
water bodies were getting polluted. Based on the preliminary investigation performed by the regional forest department under
the directions of the National Green Tribunal, it was identified that these practices were carried out since 2009 and a lot of
damage has been done to the environment by Abhinandan Limited. A show cause notice was already issued to Abhinandan
Limited by the National Green Tribunal for levying the penalty of an amount of Rs 500 crore. The unaudited profit for the
financial year 2022-23 of Abhinandan Limited was Rs 35 crore and the unaudited turnover was Rs 100 crore. Upon inquiry it
was identified that Abhinandan Limited has disclosed this matter in the financial statements by way of footnote, the extract of
which is provided below:
“The company has received a show cause notice from the National Green Tribunal for some potential violation of
environmental laws and the company’s legal department has assessed and found that the judgment would be in favour of the
company. Accordingly, no provision has been created for such notices.”
In the light of the above scenario kindly provide what should be the appropriate opti on for the statutory auditor of the
company to report this matter.
(RTP, Nov 2022, NA)

ABC Company files a law suit against Unlucky Company for Rs. 5 crores. The Attorney of Unlucky Company feels that the suit
is without merit, so Unlucky Company merely discloses the existence of the law suit in the notes accompanying its financial
statements. As an auditor of Unlucky Company, how will you deal with the situation?
(Study Material)

SA 580 - Written Representations

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Standards on Auditing

Objective of Auditor
The objectives of the auditor are:
a. To obtain
➢ written representations from management and, where appropriate, those charged with
governance
➢ that they believe that they have fulfilled their responsibility for the preparation of the financial
statements and for the completeness of the information provided to the auditor;
b. To support
➢ other audit evidence relevant to the financial statements or specific assertions in the financial
statements by means of written representations, and
c. To respond appropriately
➢ to written representations provided or
➢ Written representations requested by the auditor.

From Whom
● Auditors shall request written representations from management with appropriate responsibilities for
the financial statements and knowledge of the matters concerned.
● People from whom written representation is to be requested may vary depending on the governance
structure of the entity, and relevant law or regulations; however, management (rather than TCWG) is
often the responsible party.
● Written representations may therefore be requested from the entity’s CEO and CFO, or other equivalent
persons in entities that do not use such titles. In some circumstances , however, other parties, such as
TCWG , are also responsible for the preparation and presentation of the financial statements.

Doubt as to the Reliability of Written Representations and Requested


Written Representations Not Provided
If the auditor has concerns about the competence, integrity, ethical values or diligence of management, or about
its commitment to or enforcement of these, the auditor shall determine the effect that such concerns may have
on the reliability of representations (oral or written) and audit evidence in general.

In particular, if written representations are inconsistent with other audit evidence, the auditor shall perform
audit procedures to attempt to resolve the matter.

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Standards on Auditing

The auditor may consider whether the risk assessment remains appropriate and, if not, revise the risk
assessment and determine the nature, timing and extent of further audit procedures to respond to the assessed
risks.

If the auditor concludes that the written representations are not reliable, the auditor shall take appropriate
actions, including determining the possible effect on the opinion in the auditor’s report in accordance with SA
705.

Requested Written Representations Not Provided


If management does not provide one or more of the requested written representations, the auditor shall
● Discuss the matter with management.
● Re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of
representations (oral or written) and audit evidence in general.
● Take appropriate actions, including determining the possible effect on the opinion in the auditor’s
report in accordance with SA 705.

Written Representations about Management’s Responsibilities


The auditor shall disclaim an opinion on the financial statements in accordance with SA 705 if
● The auditor concludes that there is sufficient doubt about the integrity of management such that the
written representations about management’s responsibilities are not reliable.
● Management does not provide the written representations about it’s responsibilities.

Form of Written Representations


● The written representations shall be in the form of a representation letter addressed to the auditor.
● If law or regulation requires management to make written public statements about its responsibilities,
and the auditor determines that such statements provide representations as required by this SA
regarding management responsibilities, the relevant matters covered by such statements need not be
included in the representation letter.

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Standards on Auditing

Date of and Period(s) Covered by Written Representations


● 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.
● The written representations shall be for all financial statements and period(s) referred to in the auditor’s
report.
● 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.

State briefly the basic elements of Management Representation Letter.


Basic Elements of a Management Representation Letter: As per SA 580 “Written Representations”, some of the basic elements
of a Management Representation letter are-
1. It is a written statement by management provided to the auditor to confirm certain matters or to support other audit
evidence.
2. It does not include financial statements, the assertions therein, or supporting books and records.
3. The auditor shall request management to provide a written representation that it has fulfilled its responsibility for the
preparation of the financial statements in accordance with the applicable financial reporting framework, including
where relevant their fair presentation, as set out in the terms of the audit engagement.
4. The written representations shall be for all financial statements and period(s) referred to in the auditor’s report.

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Standards on Auditing

In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a special audit conducted at the instance of the
management on a possible suspicion of a fraud and requested for a copy of the report to enable him to report on the fraud
aspects. Despite many reminders it was not provided. In absence of the special audit report, Mr. 'N' insisted that he be provided
with at least a written representation in respect of fraud on/by the company. For this request also, the management remained
silent. Please guide Mr. 'N'
(RTP, May 2018, NA) (MTP2, Nov 2018, 5 Marks) (Study Material)

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.
(RTP, May 2019, NA) (MTP1, May 2021, 4 Marks)

Comment on the following: Statutory auditor of O Ltd requested the management for a written representation in respect of
obsolescence of inventory and warranty obligations recognized by the company in its financial statements. The management
denied the representation on the ground that during the course of audit, all the required procedures were performed by the
auditor and after obtaining sufficient appropriate audit evidence, auditor has issued a clean report. Please comment.
(MTP1, May 2019, 4 Marks)

The Auditor of PQR Pvt. Ltd. having turnover of ₹ 12 crores, was not able to get the confirmation about the existence and
value of certain stock. However, a certificate from the management has been obtained regarding the existence and value of
the stock at the year end. The auditor relied on the same and without any further procedure, signed the Audit Report. Is he
right in his approach?

Answer
Validity of Written Representation:
● The physical verification of stock is the primary responsibility of the management.
● The auditor, however, is required to examine the verification programme adopted by the management.
● He must satisfy himself about the assertions related to inventory which includes existence, rights and obligations,
completeness, valuation and the condition of the inventory

In the case of PQR Pvt. Ltd., the auditor has not been able to verify the existence and value of certain stock despite the
verification procedure followed in routine audit. He accepted the certificate given to him by the management without making
any further enquiry.

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

He should evaluate whether such representations are reasonable and consistent with other evidence and should consider
whether individuals making such representations can be expected to be well informed on the matter.

“Written Representations” cannot be a substitute for other audit evidence that the auditor could reasonably expect to be
available.

If the auditor is unable to obtain sufficient appropriate audit evidence regarding a matter, which may have a material effect on
the financial information, this will constitute a limitation on the scope of his examination even if he has obtained a
representation from management on the matter.

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Standards on Auditing

Therefore, the approach adopted by the auditor is not tenable.

SA 600 - Using the Work of Another Auditor


SA 200 Reference
Despite delegating work or using work of other auditors/experts, the auditor is responsible for the final opinion. Can
rely on others' work, provided he exercises adequate skill and care and is not aware of any reason to believe that he
should not have so relied. (na rely karne ka koi reason nahi tha)

Basics
● Applicable in situations
○ where an auditor
○ reporting on the financial information of an entity,
○ uses the work of another auditor
○ On the financial information of components
○ included in the financial information of the entity.

● This Standard 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.
● When the principal auditor concludes that the financial information of a component is immaterial, the
procedures outlined in this standard do not apply.

Definitions
● "Principal auditor" means the auditor with responsibility for reporting on the financial information of an
entity when that financial information includes the financial information of one or more components audited
by another auditor. (Jiski responsibility hai to report on FI of the entity, when that FI includes FI of Component(s))
● "Other auditor" means an auditor, other than the principal auditor, with responsibility for reporting on the
financial information of a component which is included in the financial information audited by the principal
auditor. (Responsibility to report on FI of Comp, Which is included in FI audited by PA)
● "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.

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Standards on Auditing

The Principal Auditor’s Procedures- Consideration by the Principal Auditor


before and while using the work of Another Auditor.

1. The law may allow the principal auditor to review a component's accounts by visiting a component if
necessary. Ordinarily, he can rely on another auditor's work, unless special circumstances require his direct
review by visiting the component or to examine the books of accounts
2. 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. 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. The principal auditor should ordinarily
perform the following procedures
a. advise the other auditor of the use that is to be made of the other auditor's work and report and
b. make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit.
c. The principal auditor would inform the other auditor of matters such as
➢ areas requiring special consideration,
➢ procedures for the identification of inter-component transactions that may
require disclosure and
➢ the time-table for completion of audit; and
d. advise the other auditor
➢ of the significant accounting, auditing and reporting requirements and obtain representation
as to compliance with them.
4. The principal auditor might
○ discuss with the other auditor the audit procedures applied or
○ review a written summary of the other auditor’s procedure and findings which may be in the form of a
completed questionnaire or checklist.
5. The principal auditor should consider the significant findings of the other auditor.
6. The principal auditor may consider it appropriate to discuss with the other auditor and the management of
the component,
a. the audit findings or other matters affecting the financial information of the components.
7. Principal auditor should document the
a. significant findings of the component whose financial statements was audited by the other auditor,
b. name of the auditor,
c. conclusions reached that the individual component is not material,
d. performed procedures and
e. conclusions reached,
f. how he deals with the qualifications or adverse remarks contained in the other auditor’s report.

PQ Limited, a listed entity, headquartered in Mumbai and is having 15 branches all over India. The Company is in
the business of buying paddy grown by farmers directly and processing to produce final products for selling in
domestic as well as international markets. PQ Limited appointed four firms of Chartered Accountants for audit of
its head office and branches. Your firm is one of those firms. It was agreed that your firm will act as Principal
auditor. 'What factors will be considered by you while accepting the position of Principal auditor ?
(SA, July 2021, 5 Marks)

Factors to be considered while accepting the position of Principal auditor -


As per SA 600 “Using the work of Another Auditor”, the auditor should consider whether the auditor's own
participation is sufficient to be able to act as the principal auditor. For this purpose, the auditor would consider:

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Standards on Auditing

(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. (Whether PA will be able to
apply procedures mentioned in this SA)

FYI - If the risk of material misstatement in a component is high, the principal auditor may need to invest more time and resources in
order to assess and mitigate this risk. They may need to engage in detailed discussions with the other auditor, review their audit work, or
even perform additional audit procedures themselves.

Coordination 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
coordinate with the principal auditor.
● 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.
● The principal auditor can require answers to a detailed questionnaire from the other auditor, who should
respond on a timely basis.

(Sufficient liaison hona chaiye, PA Written Communiation issue kar sakta hai, OA ko coordinate karna chaiye, PA ko OA
ko advise karna chaiye on matters having bearing on OA’s work, PA OA se detailed questionnaire answer karwa sakta hai
OA ko usey respond karna chaiye on a timely basis)

Reporting Considerations
Work of another auditor cannot be used and PA is not able to perform procedures.
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.

Other Auditor issues or intends to issue, a modified auditor's report


If the other auditor modifies their report, the principal auditor should consider if this warrants a similar
modification in their own report.

Division of Responsibility
If the principal auditor is using the work and reports of other auditors as a base of his opinion on FI of entity, the
principal auditor's report should make a clear statement about the division of responsibility for the financial
information of the entity. It must clearly indicate the extent to which the financial information audited by other auditors
has been included in the financial information of the entity as a whole. For example, the number of
divisions/branches/subsidiaries or other components audited by other auditors.

B Ltd is the Subsidiary company of A Ltd. ABC & Associates has been appointed as auditor of A Ltd. for the
Financial Year and XYZ & Associates has been appointed as auditor of B Ltd for the year. Explain the role of ABC &
Associates and XYZ & Associates as auditors of the parent company and subsidiary respectively.

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Standards on Auditing

November 2016 CA Final Exams - Q4(a) - Source www.icai.org

Role of Auditor in case of Parent Company and Subsidiary Company


● As per SA 600 “Using the Work of Another Auditor”, there should be sufficient liaison between the
principal auditor and the other auditor.

Role of Principal Auditor (ABC & Associates- Auditor of Parent Company)


● It is necessary to issue written communication(s) as a principal auditor to the other auditor.
● 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.
● When considered necessary by him, the principal auditor may require the other auditor to answer a
detailed questionnaire regarding matters on which the principal auditor requires information for
discharging his duties.

Role of Other Auditor (XYZ & Associates- Auditor of Subsidiary Company)


● The other auditor, knowing the context in which his work is to be used by the principal auditor, should
coordinate with the principal auditor.
● For example,
○ by bringing to the principal auditor’s immediate attention on 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.
○ The other auditor should respond to the questionnaire on a timely basis sent by the Principal
Auditor.

SA 610 - Using the work of Internal Auditor

Relationship between SA 315 and SA 610


● Knowledge and experience of the internal audit function can affect the external auditor’s understanding of
the entity and its environment and identification and assessment of risks of material misstatement.
● This SA addresses the external auditor’s responsibilities when, based on the external auditor’s preliminary
understanding of the internal audit function obtained as a result of procedures performed under SA 315, the
external auditor expects to use the work of the internal audit function or using internal auditor to provide
direct assistance.

Definitions
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.

Using the work of IAF


Determining Whether, in Which Areas, and to What Extent the Work of the Internal Audit Function Can Be Used
1. Evaluating the internal audit function
2. Determining the nature and extent of the work of the internal audit function that can be used
3. Using the work of internal audit function

Evaluating the internal audit function


The external auditor shall determine whether the work of the internal audit function can be used for purposes of the

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audit by evaluating the following


● The extent to which the internal audit function's organizational status and relevant policies and procedures
support the objectivity of the internal auditors;
● The level of competence of the internal audit function; and
● Whether the internal audit function applies a systematic and disciplined approach, including quality control.

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 control.

Determining the nature and extent of the work of the internal audit function that can be used
The external auditor shall consider the
● nature and scope of the work that has been performed, or is planned to be performed, by the internal audit
function and
● its relevance to the external auditor's overall audit strategy and audit plan

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.

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.

The external auditor shall, in communicating with those charged with governance an overview of the planned scope
and timing of the audit in accordance with SA 260, communicate how the external auditor has planned to use the work
of the internal audit function

Using the Work of 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.
● 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.
● The external auditor shall perform sufficient audit procedures on the work of the internal audit function as a
whole that the external auditor plans to use to determine its adequacy for purposes of the audit, including
evaluating whether:
○ The work of the function had been properly planned, performed, supervised, reviewed and
documented
○ Sufficient appropriate evidence had been obtained to enable the function to draw reasonable
conclusions; and
○ Conclusions reached are appropriate in the circumstances and the reports prepared by the function
are consistent with the results of the work performed

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Using IA to provide DA under DSR of EA


Determining Whether, in Which Areas, and to What Extent Internal Auditors Can Be Used to Provide Direct
Assistance
1. Determining Whether Internal Auditors Can Be Used to Provide Direct Assistance for Purposes of the Audit
2. Determining the Nature and Extent of Work that Can Be Assigned to Internal Auditors Providing Direct
Assistance
3. Using Internal Auditors to Provide Direct Assistance

Direct assistance
The use of internal auditors to perform audit procedures under the direction, supervision and review of the external
auditor.

Determining Whether Internal Auditors Can Be Used to Provide Direct Assistance for
Purposes of the Audit
● Using internal auditors to provide direct assistance must not be prohibited by law or regulation.
● The external auditor shall evaluate the
○ existence and significance of threats to objectivity and
○ the level of competence of the internal auditors who will be providing such assistance.

The external auditor Shall not use an internal auditor to provide direct assistance if:
● There are significant threats to the objectivity of the internal auditor; or
● The internal auditor lacks sufficient competence to perform the proposed work

Determining the Nature and Extent of Work that Can Be Assigned to Internal Auditors
Providing Direct Assistance
Areas where direct assistance shall not be taken.
The external auditor shall not use internal auditors to provide direct assistance to perform procedures that:
● Involve making significant judgments in the audit
● Relate to higher assessed risks of material misstatement where the judgment required in performing the
relevant audit procedures or evaluating the audit evidence gathered is more than limited;
● Relate to work with which the internal auditors have been involved and which has already been, or will be,
reported to management or those charged with governance by the internal audit function
● Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function
and the use of its work or direct assistance.

In communicating with those charged with governance an overview of the planned scope and timing of the audit in
accordance with SA 260, communicate the nature and extent of the planned use of internal auditors to provide direct
assistance so as to reach a mutual understanding that such use is not excessive in the circumstances of the
engagement.

Areas where significant judgment is involved and hence The external auditor shall not use internal
auditors to provide direct assistance.
● 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

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● Evaluating the adequacy of disclosures in the financial statements, and other matters affecting the auditor’s
report.
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.

Using Internal Auditors to Provide Direct Assistance


Prior to using internal auditors to provide direct assistance for purposes of the audit, the external auditor shall:
● Obtain Written agreement from an authorized representative of the entity that the internal auditors will be
allowed to follow the external auditor's instructions, and that the entity will not intervene in the work the
internal auditor performs for the external auditor; and
● Obtain written agreement from the internal auditors that they will keep confidential specific matters as
instructed by the external auditor and inform the external auditor of any threat to their objectivity.
● The external auditor shall direct, supervise and review the work performed by internal auditors on the
engagement in accordance with SA 220.
● The direction, supervision and review by the external auditor of the work performed by the internal auditors
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.

Documentation
If the external auditor uses the work of the internal audit function, the external auditor shall include in the audit
documentation:
● The evaluation of:
○ Whether the function’s organizational status and relevant policies and procedures adequately
support the objectivity of the internal auditors.
○ The level of competence of the function; and
○ Whether the function applies a systematic and disciplined approach, including quality control;
● The nature and extent of the work used and the basis for that decision; and
● The audit procedures performed by the external auditor to evaluate the adequacy of the work used.

If the external auditor uses internal auditors to provide direct assistance on the audit, the external auditor shall
Include in the audit documentation:
● 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;
● The basis for the decision regarding the nature and extent of the work performed by the internal auditors;
● Who reviewed the work performed and the date and extent of that review in accordance with SA 230
● The written agreements obtained from an authorized representative of the entity and the internal auditors; and
● The working papers prepared by the internal auditors who provided direct assistance on the audit engagement

Annexure
Factors to be considered while determining objectivity
Objectivity refers to the ability to perform those tasks without allowing bias, conflict of interest or undue influence of
others to override professional judgments. Factors that may affect the external auditor’s evaluation include the
following:
● Whether the organizational status of the internal audit function, including the function’s authority and
accountability, supports the ability of the function to be free from bias, conflict of interest or undue influence
of others to override professional judgments. For example, whether the internal audit function reports to

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those charged with governance or an officer with appropriate authority, or if the function reports to
management, whether it has direct access to those charged with governance.
● Whether the internal audit function is free of any conflicting responsibilities, for example, having managerial
or operational duties or responsibilities that are outside of the internal audit function.
● Whether those charged with governance oversee employment decisions related to the internal audit function,
for example, determining the appropriate remuneration policy.
● Whether there are any constraints or restrictions placed on the internal audit function by management or
those charged with governance, for example, in communicating the internal audit function’s findings to the
external auditor.
● Whether the internal auditors are members of relevant professional bodies and their memberships obligate
their compliance with relevant professional standards relating to objectivity, or whether their internal
policies achieve the same objectives.

Factors to be considered while determining competence


Competence of the internal audit function refers to the attainment and maintenance of knowledge and skills of the
function as a whole at the level required to enable assigned tasks to be performed diligently and in accordance with
applicable professional standards. Factors that may affect the external auditor’s determination include the following
● Whether the internal audit function is adequately and appropriately resourced relative to the size of the entity
and the nature of its operations.
● Whether there are established policies for hiring, training and assigning internal auditors to internal audit
engagements.
● Whether the internal auditors have adequate technical training and proficiency in auditing. Relevant criteria
that may be considered by the external auditor in making the assessment may include, for example, the
internal auditors’ possession of a relevant professional designation and experience.
● Whether the internal auditors possess the required knowledge relating to the entity’s financial reporting and
the applicable financial reporting framework and whether the internal audit function possesses the necessary
skills (for example, industry-specific knowledge) to perform work related to the entity’s financial statements.
● Whether the internal auditors are members of relevant professional bodies that oblige them to comply with the
relevant professional standards including continuing professional development requirements.

Factors that may affect the external auditor’s determination of whether the internal audit
function applies a systematic and disciplined approach include the following:
● The existence, adequacy and use of documented internal audit procedures or guidance covering such areas as
risk assessments, work programs, documentation and reporting, the nature and extent of which is
commensurate with the size and circumstances of an entity.
● Whether the internal audit function has appropriate quality control policies and procedures, for example, such
as those policies and procedures in SQC 1 that would be applicable to an internal audit function (such as
those relating to leadership, human resources and engagement performance) or quality control requirements in
standards set by the relevant professional bodies for internal auditors. Such bodies may also establish other
appropriate requirements such as conducting periodic external quality assessments.

SA 620 - Using the Work of an Auditor’s Expert


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

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Objective
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.

Definitions
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

Expertise
Skills, knowledge and experience in a particular field.

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.

Determining the Need for an Auditor’s Expert


Expertise in a field other than accounting or auditing may include expertise in relation to such
matters as
1. 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.
2. The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.
3. The estimation of oil and gas reserves.
4. The valuation of environmental liabilities, and site clean-up costs.
5. The interpretation of contracts, laws and regulations.
6. The analysis of complex or unusual tax compliance issues.

Areas in which - expert may be needed to assist the auditor


An auditor’s expert may be needed to assist the auditor in one or more of the following
● Obtaining an understanding of the entity and its environment, including its internal control.
● Identifying and assessing the risks of material misstatement.
● Determining and implementing overall responses to assessed risks at the financial statement level.
● Designing and performing further audit procedures to respond to assessed risks at the assertion level,
comprising tests of controls or substantive procedures.
● Evaluating the sufficiency and appropriateness of audit evidence obtained in forming an opinion on the
financial statements.

Considerations when deciding whether to use an auditor’s expert


● 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.

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● The expected nature of procedures to respond to identified risks, including the auditor’s knowledge of and
experience with the work of experts in relation to such matters; and the availability of alternative sources of
audit evidence.

Management used 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.

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, for example:
● 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.

Nature, Timing and Extent of Audit Procedures


While determining the nature, timing and extent of the procedures to be performed w.r.t. the requirements of this
SA, 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.

More extensive procedures.


The following factors may suggest the need for different or more extensive procedures.
1. The work of the auditor's expert relates to a significant matter that involves subjective and complex
judgments.
2. 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.
3. The auditor's expert is performing procedures that are integral to the audit, rather than being consulted to
provide advice on an individual matter.

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4. The expert is an auditor's external expert and is not, therefore, subject to the firm's quality control policies
and procedures.

The Competence, Capabilities and Objectivity of the Auditor’s Expert


The competence, capabilities and objectivity of an auditor’s expert are factors that significantly affect whether the
work of the auditor’s expert will be adequate for the auditor’s purposes.
● Competence relates to the nature and level of expertise of the auditor’s expert.
● Capability relates to the ability of the auditor’s expert to exercise that competence in the circumstances of
the engagement.
● Objectivity relates to the possible effects that bias, conflict of interest, or the influence of others may have on
the professional or business judgment of the auditor’s expert.

Information regarding the competence, capabilities and objectivity of an auditor’s expert may come from a variety of
sources, such as:
● Personal experience with previous work of that expert.
● Discussions with that expert.
● Discussions with other auditors or others who are familiar with that expert’s work.
● Knowledge of that expert’s qualifications, membership of a professional body or industry association, license
to practice, or other forms of external recognition.
● Published papers or books written by that expert.
● The auditor’s firm’s quality control policies and procedures

Objectivity
When evaluating the objectivity of an auditor’s external expert, it may be relevant to
● 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.
● 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, including by the organisation in the case of an external
expert that is an organisation.
○ 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.

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.

Agreement with the Auditor’s Expert


The auditor shall agree, in writing when appropriate, on the following matters with the auditor’s expert
● The nature, scope and objectives of that expert’s work
● The respective roles and responsibilities of the auditor and that expert.

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● 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
● The need for the auditor’s expert to observe confidentiality requirements

Factors suggesting the need for more detailed and written agreement between
the auditor and auditor’s expert.
● The auditor’s expert will have access to sensitive or confidential entity information.
● The respective roles or responsibilities of the auditor and the auditor’s expert are different from those
normally expected.
● Multi-jurisdictional legal or regulatory requirements apply.
● 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.

When there is no written agreement between the auditor and the auditor’s expert, evidence of the agreement may
be included in, for example:
● Planning memoranda, or related working papers such as the audit program
● The policies and procedures of the auditor’s firm. In the case of an auditor’s internal expert, the
established policies and procedures to which that expert is subject may include particular policies and
procedures in relation to that expert’s work. The extent of documentation in the auditor’s working papers
depends on the nature of such policies and procedures. For example, no documentation may be required in
the auditor’s working papers if the auditor’s firm has detailed protocols covering the circumstances in
which the work of such an expert is used.

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;
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
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.

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.

Specific procedures to evaluate the adequacy


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:
○ Observing the auditor’s expert’s work;
○ Examining published data, such as statistical reports from reputable, authoritative sources;
○ Confirming relevant matters with third parties;
○ Performing detailed analytical procedures; and o Re-performing calculations.

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● 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.

Reference to the Auditor’s Expert in the Auditor’s Report


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.

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.

SA 700 Forming an Opinion and Reporting on Financial Statements

Objectives of the auditor as per SA 700


The objectives of the auditor as per SA 700 (Revised), “Forming An Opinion And Reporting On Financial
Statements” 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.

Definitions
General purpose financial statements
Financial statements prepared in accordance with a general purpose framework.

General purpose framework


A financial reporting framework designed to meet the common financial information needs of a wide range of
users. The financial reporting framework may be a fair presentation framework or a compliance framework.

Fair presentation framework


The term “fair presentation framework” is used to refer to a financial reporting framework that requires
compliance with the requirements of the framework and:
● Acknowledges management may provide disclosures beyond those specifically required by the
framework; or
● Acknowledges management may depart from a requirement of the framework to achieve fair
presentation of the financial statements. Such departures are expected to be necessary only in extremely
rare circumstances.

Compliance framework
The term “compliance framework” is used to refer to a financial reporting framework that requires compliance
with the requirements of the framework, but does not contain the acknowledgements as above

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Extra reading
SA 800 - Special Considerations - Audits of Financial Statements Prepared in Accordance with Special Purpose
Frameworks.

Example - Framework that does not comply with fundamental assumptions of general purpose framework. For
example financial statements prepared using a cash basis. Such financial statements may be helpful for certain
stakeholders that are interested in knowing the liquidity position of the entity like creditors.

Financial statements prepared according to taxation regulations ignoring normal accounting norms. Many
times tax regulations contradict accounting norms. If financial statements are prepared according to guidance
provided by taxation authorities then it is a special purpose financial statement based on special purpose
framework.

Language to be used in Audit Report

Requirements
● Forming an Opinion on the Financial Statements.
● Form of Opinion
● Auditor’s Report
● Auditor’s Report for Audits Conducted in Accordance with Standards on Auditing

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 conclude as to
● whether the auditor has obtained reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error. That conclusion shall take
into account:
➔ The auditor’s conclusion, in accordance with SA 330, whether sufficient appropriate audit
evidence has been obtained;

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➔ The auditor’s conclusion, in accordance with SA 450, whether uncorrected misstatements are
material, individually or in aggregate and
➔ The evaluations as required

Evaluations
The auditor shall evaluate whether the financial statements are prepared, in all material respects, in accordance
with the requirements of the applicable financial reporting framework. This evaluation shall include
consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible
bias in management’s judgments.

In particular, the auditor shall evaluate whether, in view of the requirements of the applicable financial
reporting framework.
a. The financial statements adequately disclose the significant accounting policies selected and applied;
b. The accounting policies selected and applied are consistent with the applicable financial reporting
framework and are appropriate;
c. The accounting estimates made by management are reasonable;
d. The information presented in the financial statements is relevant, reliable, comparable, and
understandable;
e. 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; and
f. The terminology used in the financial statements, including the title of each financial statement, is
appropriate.

When the financial statements are prepared in accordance with a fair presentation framework, the evaluation
shall also include whether the financial statements achieve fair presentation. The auditor’s evaluation as to
whether the financial statements achieve fair presentation shall include consideration of:
a. The overall presentation, structure and content of the financial statements; and
b. Whether the financial statements, including the related notes, represent the underlying transactions
and events in a manner that achieves fair presentation.

The auditor shall evaluate whether the financial statements adequately refer to or describe the applicable
financial reporting framework.

Form of Opinion
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.
If the auditor
a. concludes that, based on the audit evidence obtained, the financial statements as a whole are not free
from material misstatement; or
b. 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 the auditor’s report in accordance with SA 705 - Modifications to the
Opinion in the Independent Auditor's Report

If financial statements prepared in accordance with the requirements of a fair presentation framework
● do not achieve fair presentation,

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● the auditor shall discuss the matter with management and,


● shall determine whether it is necessary to modify the opinion in the auditor’s report in accordance with
SA 705

When the financial statements are prepared in accordance with a compliance framework,
● the auditor is not required to evaluate whether the financial statements achieve fair presentation.
● However, if in extremely rare circumstances the auditor concludes that such financial statements are
misleading,
○ the auditor shall discuss the matter with management and,
■ depending on how it is resolved, shall determine whether, and how, to communicate it in
the auditor’s report.

Auditor’s Report
The auditor’s report shall be in writing.

Elements of Audit Report


Title
The auditor’s report shall have a title that clearly indicates that it is the report of an independent auditor.

Addressee
The auditor’s report shall be addressed, as appropriate, based on the circumstances of the engagement. Law,
regulation or the terms of the engagement may specify to whom the auditor’s report is to be addressed.

The auditor’s report is normally addressed to those for whom the report is prepared, often either to the
shareholders or to those charged with governance of the entity whose financial statements are being audited.

Auditor’s Opinion
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 the auditor expresses an unmodified opinion, it is not appropriate to use phrases such as “with the
foregoing explanation” or “subject to” in relation to the opinion, as these suggest a conditional opinion or a
weakening or modification of opinion.

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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.
(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.

Going Concern
Where applicable, the auditor shall report in accordance with SA 570.

Key Audit Matters


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.

Law or regulation may require communication of key audit matters for audits of entities other than listed
entities.

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Responsibilities for the Financial Statements


The auditor’s report shall include a section with a heading “Responsibilities of Management for the Financial
Statements.”

This section of the auditor’s report shall describe


● Management’s responsibility for:
○ Preparing the financial statements in accordance with the applicable financial reporting
framework,
■ 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;
○ Assessing the
■ entity’s ability to continue as a going concern and
■ whether the use of the going concern basis of accounting is appropriate
■ as well as disclosing, if applicable, matters relating to going concern.

Oversight of the financial reporting process. (Under Mgt. Respo only)


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 diff erent from Management.

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 the entity.

Auditor’s Responsibilities for the Audit of the Financial Statements


The auditor’s report shall include a section with the heading “Auditor’s Responsibilities for the Audit of the
Financial Statements.”

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.

The Auditor’s Responsibilities for the Audit of the Financial Statements section of the auditor’s report shall
further:

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(a) State that, as part of an audit in accordance with SAs, the auditor exercises professional judgment and
maintains professional skepticism throughout the audit; and
(b) Describe an audit by stating that the auditor’s responsibilities are:
(i) To identify and assess the risks of material misstatement of the financial statements, whether
due to fraud or error; to design and perform audit procedures responsive to those risks; and to
obtain audit evidence that is sufficient and appropriate to provide a basis for the auditor’s
opinion.
(ii) To obtain an understanding of internal control relevant to the audit in order to design audit
procedures that are appropriate in the circumstances.
(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 ( based
on the audit evidence obtained), and
■ 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.

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) For audits of financial statements of listed entities,


○ 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 listed entities and any other 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.
○ The auditor describes these matters in the auditor’s report unless law or regulation precludes
public disclosure.

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 shall be included:

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(a) Within the body of the auditor’s report;


(b) Within an appendix to the auditor’s report, in which case the auditor’s report shall include a reference
to the location of the appendix; or
(c) By a specific reference within the auditor’s report to the location of such a description on a website of
an appropriate authority, where law, regulation or national auditing standards expressly permit the
auditor to do so.

Other Reporting Responsibilities


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.

Signature
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 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

Place of Signature
The auditor’s report shall name a specific location, which is ordinarily the city where the audit report is signed.

Date
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:
(a) All the statements that comprise the financial statements, including the related notes, have been
prepared; and
(b) Those with the recognized authority have asserted that they have taken responsibility for those
financial statements.

The date of the auditor’s report informs the user of the auditor’s report that the auditor has considered the
effect of events and transactions of which the auditor became aware and that occurred up to that date.

The auditor’s responsibility for events and transactions after the date of the auditor’s report is addressed in SA
560.

UDIN
It was noticed that financial documents/ certificates attested by third person misrepresenting themselves as CA
Members were misleading the Authorities and Stakeholders.
Unique Document Identification Number.

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Chartered Accountants having full-time Certificate of Practice can register on UDIN Portal and generate
UDIN by registering the certificates attested/certified by them. Accordingly, an auditor is required to mention
the UDIN with respect to each audit report being signed by him, along with his membership number while
signing an audit report.

AUDITOR’S REPORT PRESCRIBED BY LAW OR REGULATION


If the auditor is required by law or regulation 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.
(a) A title.
(b) An addressee, as required by the circumstances of the engagement.
(c) 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.
(d) An identification of the entity’s financial statements that have been audited.
(e) 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.
(f) Where applicable, a section that addresses, and is not inconsistent with, the reporting requirements
relating to going concern as per SA 570 (Revised).
(g) Where applicable, a Basis for Qualified (or Adverse) Opinion section that addresses, and is not
inconsistent with, the reporting requirements relating to going concern as per SA 570 (Revised).
(h) 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.
(i) A description of management’s responsibilities for the preparation of the fi nancial statements and an
identifi cation of those responsible for the oversight of the fi nancial reporting process that addresses,
and is not inconsistent with, the requirements as contained in this SA 700.
(j) A reference to Standards on Auditing and the law or regulation, and a description of the auditor’s
responsibilities for an audit of the fi nancial statements that addresses, and is not inconsistent with, the
requirements as contained in this SA 700.
(k) The auditor’s signature.
(l) The Place of signature.
(m) The date of the auditor’s report.

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Auditor’s Report for Audits Conducted in Accordance with Both Standards on


Auditing issued by ICAI and International Standards on Auditing/ Auditing
Standards of Another 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.

The auditor may refer in the auditor’s report to the audit having been conducted in accordance with both the
Standards on Auditing issued by ICAI as well as the International Standards on Auditing/auditing standards
of another jurisdiction only when
● in addition to complying with the ISAs/ auditing standards of such other jurisdiction,
● the auditor complies with each of the SAs relevant to the audit.

A reference to both Standards on Auditing issued by ICAI and the International Standards on
Auditing/auditing standards of another jurisdiction is not appropriate
● if there is a conflict between the requirements in SAs and those ISAs/ auditing standards of such other
jurisdiction
● that would lead the auditor
○ to form a different opinion or
○ not to include an Emphasis of Matter or Other Matter paragraph as required by SAs.
● In such a case, the auditor’s report refers only to the auditing standards (either Standards on Auditing
issued by ICAI or ISAs/the auditing standards of such other jurisdiction) in accordance with which the
auditor’s report has been prepared.

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.

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Supplementary Information Presented with the Financial Statements

KPI Ltd. is a company on which International Standards on Auditing are applicable along with Standard on Auditing issued by
the ICAI. The company appointed new auditors for the audit of the financial statements for the year ended 31 March 2023 after
doing all appointment formalities. In the auditor’s report, auditor referred the International Standard on Auditing in addition
to the Standard on Auditing issued by the ICAI.
As an expert, you are required to advise the auditor regarding auditor’s report for audits conducted in accordance with both the
Standards.
(RTP, Nov 2019, NA)

MN & Associates, Chartered Accountants have been appointed as statutory Auditors of Cotton Ltd. for the F.Y 2022-2023. The
Company is into the business of yarn manufacturing. For this purpose, cotton ginning is also done within the factory premises.
Raw cotton is purchased from local market and processed in-house. The Company received a notice from the State Government
to deposit market development fee for the last 5 years to the tune of Rs 10.00 crores. The Company and all other organizations
in the same business have not deposited the market development fee, taking shelter of an old circular issued by the
Government. The trade association met with the government officials to resolve the matter and agreed to deposit the same
prospectively. However, the matter relating to payment of development fee for the last 5 years is pending before the
Government as at the end of the financial year. The Company, however, disclosed the same in notes to accounts, as contingent
liability, without quantifying the effect and proper explanation. If the liability is provided in the books of accounts, entire
reserves will be wiped off. Auditor seeks your guidance as to how this disclosure affects them while forming an opinion on
financial statements.
(SA, July 2021, 5 Marks)

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CA S has been appointed as Statutory Auditor of SRT Ltd. for the financial year 2022-2023. The Company while preparing
financial statements for the year under audit prepared one additional profit and loss account that disclosed specific items of
expenditure and included the same as an appendix to the financial statements. CA. S has not been able to understand this as the
additional profit and loss account is not covered under applicable financial reporting framework. Guide him as to how he
should deal with this issue while reporting on the financial statements of SRT Ltd.
(SA, July 2021, 5 Marks)

SA 701 - Communicating Key Audit Matters in the Independent


Auditor’s Report

Scope
This Standard on Auditing (SA) deals with the auditor’s responsibility to communicate key audit matters in
the auditor’s report.

Objective
The objectives of the auditor are
● To determine key audit matters and, having formed an opinion on the financial statements,
● Communicate those matters by describing them in the auditor’s report.

Key audit Matters


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.

Purpose
As per SA 701, “Communicating Key Audit Matters in the Auditor’s Report”, the purpose of communicating key
audit matters is to
● ENHANCE - enhance the communicative value of the auditor’s report by providing greater
transparency about the audit that was performed.
● UNDERSTAND - 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.
● UNDERSTAND - Communicating key audit matters may also assist intended users in understanding
the entity and areas of significant management judgment in the audited financial statements.
● BASIS TO ENGAGE - The communication of key audit matters in the auditor’s report may also provide
intended users a basis to further engage with management and those charged with governance about
○ certain matters relating to the entity,
○ the audited financial statements,
○ or the audit that was performed.

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Applicability
This SA applies to
● audits of complete sets of general purpose financial statements of listed entities and
● circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s
report.
● This SA also applies when the auditor is required by law or regulation to communicate key audit
matters in the auditor’s report.
However, SA 705 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.

Determining Key Audit Matters


The auditor shall determine,
● from the matters communicated with those charged with governance,
● those matters that required significant auditor attention in performing the audit.
● In making this determination, the auditor shall take into account the following
a. Areas of higher assessed risk of material misstatement, or significant risks identified in
accordance with SA 315.
b. Significant auditor judgments relating to areas in the financial statements that involved
significant management judgment, including accounting estimates that have been identified
as having high estimation uncertainty.
c. The effect on the audit of significant events or transactions that occurred during the period.

The auditor shall determine which of the matters so determined above were of most significance in the audit of
the financial statements of the current period and therefore are the key audit matters.

There may be other matters communicated with those charged with governance that required significant
auditor attention and that therefore may be determined to be key audit matters. Such matters may include, for
example, matters relevant to the audit that was performed that may not be required to be disclosed in the
financial statements. For example, the implementation of a new IT system (or significant changes to an existing
IT system) during the period may be an area of significant auditor attention, in particular if such a change had a
significant effect on the auditor's overall audit strategy or related to a significant risk (e.g., changes to a system
affecting revenue recognition).

If an auditor determines that it is necessary to include information about the entity in order to effectively
describe a key audit matter that has not been disclosed by management and management does not agree to
disclose that information, the auditor should reconsider the adequacy of the disclosures.

Circumstances in Which a Matter Determined to Be a Key Audit Matter Is Not


Communicated in the Auditor’s Report
The auditor shall describe each key audit matter in the auditor’s report unless
a. Law or regulation precludes public disclosure about the matter; or
b. In extremely rare circumstances, the auditor determines that the 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. This shall not apply if the entity has
publicly disclosed information about the matter.

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Communicating Key Audit Matters


The auditor shall
● describe each key audit matter,
● using an appropriate subheading,
● in a separate section of the auditor’s report under the heading “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.
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.

Descriptions of Individual Key Audit Matters


The description of each key audit matter in the Key Audit Matters section of the auditor’s report shall include a
reference to the related disclosure(s), if any, in the financial statements and shall address:
a. Why the matter was considered to be one of most significance in the audit and therefore determined to
be a key audit matter; and
b. How the matter was addressed in the audit.

Communicating Key Audit Matters- not a substitute for disclosure in the


Financial Statements etc.
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 an modified opinion when required by the circumstances of a
specifi c audit engagement in accordance with SA 705
c. A substitute for reporting in accordance with SA 570 when a material uncertainty exists relating to
events or conditions that may cast significant doubt on an entity’s ability to continue as a going
concern; or
d. A separate opinion on individual matters.

KAM by Nature
A matter giving rise to a modified opinion in accordance with SA 705 (Revised), or a material uncertainty
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), are by their nature key audit matters.

These matters shall not be described in the Key Audit Matters section of the auditor’s report and the
requirements in Rather, the auditor shall
a. Report on these matter(s) in accordance with the applicable SA(s); and
b. Include a reference to
● the Basis for Qualified (Adverse) Opinion or
● the Material Uncertainty Related to Going Concern section(s) in the Key Audit Matters section.

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If the auditor determines, depending on the facts and circumstances of the entity and the audit, that there are
no key audit matters to communicate or that the only key audit matters communicated are those matters
mentioned above, the auditor shall include a statement to this effect in a separate section of the auditor’s report
under the heading “Key Audit Matters.”

Communication with TCWG


The auditor shall communicate with those charged with governance:
a. Those matters the auditor has determined to be the key audit matters; or
b. If applicable, depending on the facts and circumstances of the entity and the audit, the auditor’s
determination that there are no key audit matters to communicate in the auditor’s report.

Documentation
The auditor shall include in the audit documentation:
a. The matters that required significant auditor attention as determined , and the rationale for the
auditor’s determination as to whether or not each of these matters is a key audit matter.
b. Where applicable, the rationale for the auditor’s determination that there are no key audit matters to
communicate in the auditor’s report or that the only key audit matters to communicate are
i. Modified Opinion
ii. Material uncertainty related to events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern; and
c. Where applicable, the rationale for the auditor’s determination not to communicate in the auditor’s
report a matter determined to be a key audit matter.

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“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 key
factors”. You are required to define key audit matters and briefly discuss the factors determining the key audit matters.
(MTP2, May 2018, 4 Marks)

The property, plant and equipment of ABC Ltd. included Rs. 25.75 crores of earth removing machines of outdated technology
which had been retired from active use and had been kept for disposal after knock down. These assets appeared at residual
value and had been last inspected ten years back. As an auditor, what may be your reporting concern as regards matters
specified above?
(SA, May 2018, 5 Marks)

CA. Amar has come across certain key matters while auditing the accounts of PR Ltd. for the financial year 2022-23. He, being
the associate of your firm, seeks your advice on “Communicating Key Audit Matters” in the Auditor’s report. Guide him.
(SA, Nov 2018 (Old), 5 Marks)

AKY Ltd. is a listed company engaged in the business of software and is one of the largest company operating in this sector in
India. The company’s annual turnover is Rs. 40,000 crores with profits of Rs. 5,000 crores. Due to the nature of the business and
the size of the company, the operations of the company are spread out in India as well as outside India. The company’s
contracts with its various customers are quite complicated and different. During the course of the audit, the audit team spends
significant time on audit of revenue – be it planning, execution or conclusion. This matter was also discussed with management
at various stages of audit. The efforts towards audit of revenue also involve significant involvement of senior members of the
audit team including the audit partner. After completion of audit for the year ended 31 March 2023, the audit partner was
discussing significant matters with the management wherein they also communicated to the management that he plans to
include revenue recognition as key audit matter in his audit report. The management did not agree with revenue recognition to
be shown as key audit matter in the audit report. Comment.
(MTP1, Nov 2019, 4 Marks)

Mr. Hemant Ramsey was appointed as the engagement partner for conducting the audit of Kshetra Lap Ltd. for F.Y. 2022-23, on
behalf of Ramsey and Associates. Mr. Vishay Tyagi was appointed as the engagement quality control reviewer by the firm for
the said audit. During F.Y. 2021-22, there was an implementation of ERP system in a phased manner, in Kshetra Lap Ltd. due to
which some of its business processes got automated. As a result of the implementation of such a system, there was a significant
effect on the auditor's overall audit strategy. Mr. Hemant discussed the implementation of such a system with Mr. Vishay and
also told him that such a matter may be a key audit matter to be reported in the audit report. Mr. Vishay considered the

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significance of such matter but however he was of the opinion that such a matter did not appear to link with the matters
disclosed in the financial statements and there was no need to disclose such matters as a key audit matter. Whether the
contention of Mr. Vishay is proper with respect to the matters to be communicated as a key audit matter?
(RTP, Nov 2021, NA)

While auditing the complete set of consolidated financial statements of Moksh Ltd., a listed company, using a fair presentation
framework, XYZ & Co., a Chartered Accountant firm, discovered that the consolidated financial statements are materially
misstated due to the non-consolidation of one of the subsidiary. The material misstatement is deemed to be pervasive to the
consolidated financial statements. The effects of the misstatement on the consolidated financial statements could not be
determined because it was not practicable to do so. Thus, XYZ & Co. decided to provide an adverse opinion for the same and
further determined that, there are no key audit matters other than the matter to be described in the Basis for Adverse Opinion
section. Comment whether XYZ & Co. needs to report under SA 701 ‘Communicating Key Audit Matters in the Independent
Auditor’s Report’?
(SA, Dec 2021 (Old), 5 Marks) (MTP1, Nov 2022, 5 Marks)

What is the auditor’s responsibility to report a key audit matter for which there are no relevant disclosures in the financial
statements?
(RTP, May 2022, NA)

SA 705 - Modifications to the Opinion in the Independent Auditor's


Report

Nature of Matter Giving Rise to Auditor’s judgment about the Pervasiveness of the Effects or Possible
the Modification Effects on the Financial statements

Material but Not Pervasive Material and Pervasive

❖ Financial Statements are Qualified opinion Material and Pervasive


materially misstated

❖ Inability to obtain SAAE Qualified opinion Disclaimer of opinion

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Objective of the Auditor


As per SA 705 “Modifications To The Opinion In The Independent Auditor’s Report”, 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.

Disclaimer of Opinion - Special Point


The auditor shall disclaim an opinion when,
➢ in extremely rare circumstances involving multiple uncertainties,
➢ the auditor concludes that,
➢ notwithstanding having obtained SAAE regarding each of the individual uncertainties,
➢ it is not possible to form an opinion on the Financial Statements
■ due to potential interaction of the uncertainties and
■ their possible cumulative effect on the Financial Statements

Circumstances when a Modification to the Auditor’s Opinion is Required


● The auditor concludes that based, on the audit evidence obtained, the Financial Statements as a whole
are not free from material misstatement, may be due to following reasons:
○ Inappropriate Accounting Policies;
○ Inappropriate application of selected Accounting Policies;
○ Inappropriate or inadequate disclosures in financial statements.
● The auditor is unable to obtain sufficient appropriate audit evidence to conclude may be due to
following reasons:
○ Limitations imposed by management

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○ Circumstances beyond entity control ( 🔥)


○ Circumstances related to Nature and Timing of auditor’s work

Limitation after the auditor has Accepted the Engagement


As per SA 705, “Modifications to the Opinion in the Independent Auditor’s Report”,
● 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:
1) 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
2) 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:
● Withdraw from the audit, where practicable and possible under applicable law or regulation; or
● If withdrawal from the audit before issuing the auditor’s report is not practicable or possible,
disclaim an opinion on the financial statements.

If the auditor withdraws, 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.

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.

When the auditor modified the opinion on the Financial Statements, the auditor shall, in addition to the
specific elements as required by SA 700:
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.

Language to be Used - Special considerations required for expressing Qualified,


Adverse or Disclaimer Opinion.

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Qualified Opinion
When the auditor expresses a qualified opinion due to a material misstatement in the Financial Statements,
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
● 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 in accordance with applicable FRF).
● When reporting in accordance with a compliance framework
○ the accompanying Financial Statements have been prepared, in all material respects, in
accordance with the applicable FRF.
● When the modification arises from an inability to obtain SAAE, the auditor shall use the phrase
“except for the possible effects of the matter(S) in the Basis for Qualified Opinion section

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 matters described in the Basis for Adverse Opinion section :
● 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 FRF
● When reporting in accordance with a compliance framework
○ the Accompanying Financial Statements have not been prepared, in all material respect in
accordance with (the applicable FRF).

Disclaimer
When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the
auditor shall
● State that the auditor does not express an opinion on the Financial Statements;
● 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 SAAE to provide a basis for an audit opinion on the
financial statements; and
● Amend the statement in the Opinion Section,
○ which indicates that the financial statements have been audited,
○ to state that the auditor was engaged to audit the financial statements.

(Summary of the above paragraph - Auditor does not express opinion, Matter described in Basis of disclaimer of opinion
is significant, Not able to obtain SAAE to provide a basis for audit opinion, Amend the statement in opinion section
FROM FS have been audited to We were engaged to audit FS)

Considerations When the Auditor Disclaims an Opinion on the Financial Statements.


Unless required by law or regulation, when the auditor disclaims an opinion on the financial statements, the
auditor’s report shall not include a Key Audit Matters section in accordance with SA 701.

WHY?
Communication of any key audit matters other than the matter(s) giving rise to the disclaimer of opinion
● may suggest that the financial statements as a whole are more credible then they actually are
● and would be inconsistent with the disclaimer of opinion on the financial statements as a whole.

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Communication with TCWG


When the auditor expects to modify the opinion in the auditor’s report, the auditor shall communicate with
TCWG the circumstances that led to the expected modification and the wording of the modification.

Description of Auditor’s Responsibilities in case of Disclaimer


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 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 by SA 700
(Example of statement about independence - 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.)

SA 706 Emphasis of matter paragraphs & other matter paragraphs in


the independent auditor's report

Objective of the auditor


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 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. 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


When
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 judgement, 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.

EOM and KAM


Provided that When SA 701 applies, the matter communicated in EOM para has not been determined to be a
key audit matter to be communicated in the auditor’s report.
HOW?
When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall

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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 (What is the matter?)
➢ where relevant disclosures that fully describe the matter can be found in the financial
statements. (Where it is disclosed?)
c. Indicate that
➢ the auditor’s opinion is not modified in respect of the matter emphasized.

Emphasis of Matter paragraph is not a substitute


An Emphasis of Matter paragraph is not a substitute for:
a. A modified opinion in accordance with SA 705 (Revised) when required by the circumstances of a
specific audit engagement;
b. Disclosures in the financial statements that the applicable financial reporting framework requires
management to make, or that are otherwise necessary to achieve fair presentation; or
c. 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.

Other Matter paragraph


When
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
judgement,
● 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
○ This is not prohibited by law or regulation

OM and KAM
When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the
auditor’s report.

How?
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.

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

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Standards on Auditing

Placement of Emphasis of Matter Paragraphs and Other Matter Paragraphs in


the Auditor’s Report
The placement of an Emphasis of Matter paragraph or Other Matter paragraph in the auditor’s report
● depends on the nature of the information to be communicated,
● and the auditor’s judgment
○ as to the relative significance of such information
○ With respect to other elements required to be reported in accordance with SA 700

(What is the information, What is the significance w.r.t other elements)

Emphasis of Matter Paragraphs


When the Emphasis of Matter paragraph relates to the applicable financial reporting framework, the auditor
may consider it necessary to place the paragraph immediately following the Basis of Opinion section to
provide appropriate context to the auditor’s opinion.

When a Key Audit Matters section is presented in the auditor’s report,


● an Emphasis of Matter paragraph may be presented
● either directly before or after the Key Audit Matters section,
○ based on the auditor’s judgment.

The auditor may also add further context to the heading “Emphasis of Matter”,
● such as “Emphasis of Matter – Subsequent Event”,
● to differentiate the Emphasis of Matter paragraph from the individual matters described in the Key
Audit Matters section.

(EOM can immediately after Basis of Opinon section, KAM is there before or after KAM, Add further context to
differentiate it from KAM)

Other Matter Paragraphs


When an Other Matter paragraph is included to draw users’ attention to a matter relating to Other Reporting
Responsibilities addressed in the auditor’s report, the paragraph may be included in the Report on Other Legal
and Regulatory Requirements section.

When relevant to all the auditor’s responsibilities or users’ understanding of the auditor’s report, the Other
Matter paragraph may be included as a separate section following the Report on Other Legal and Regulatory
Requirements.

When a Key Audit Matters section is presented in the auditor’s report


● and an Other Matter paragraph is also considered necessary,
● the auditor may add further context to the heading “Other Matter”, such as “Other Matter – Scope of
the Audit”,
● to differentiate the Other Matter paragraph from the individual matters described in the Key Audit
Matters section.

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Standards on Auditing

(OM can be in ORR section, After ORR Section, KAM is there, Add further context to OM, Differentiate it from
KAM)

Enumerate certain important matters which can be included in ‘Emphasis of Matter Paragraph' in an
Auditor’s Report.

Matters which can be included in Emphasis of Matter Paragraph in Auditor’s Report:

As per 706 "Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report” Emphasis of
Matter is a paragraph which is included in auditor’s report to draw users’ attention to important matter(s) which are already
disclosed in Financial Statements and are fundamental to users’ for understanding of Financial Statements.

Specific requirements for the auditor to include Emphasis of Matter paragraphs in the auditor’s report in certain
circumstances. These circumstances 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).

Matters which can be included in ‘Emphasis of Matter Paragraph’ in an Auditor’s Report, may be listed as below:
● An uncertainty relating to the future outcome of an 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 pervasive effect on the financial
statements in advance of its effective date.
● A major catastrophe that has had, or continues to have, a significant effect on the entity's financial position.

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Standards on Auditing

SA 710 "Comparative Information - Corresponding Figures And


Comparative Finacial Statements

Scope
● Deals with the auditor's responsibilities regarding comparative information in an audit of financial
statements.

Objectives
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.
● To report in accordance with the auditor’s reporting responsibilities.

Definitions
Comparative information
● 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.

Corresponding figures
● Comparative information where amounts and other disclosures
○ for the prior period are included as an integral part of the current period financial statements,
and
○ are intended to be read only in relation to the amounts and other disclosures relating to the
current period .

Comparative financial statements


Comparative information where amounts and other disclosures
● for the prior period are included for comparison with the financial statements of the current period
● but, if audited, are referred to in the auditor’s opinion.

Difference between Corresponding Figures and Comparative Financial Statement from


reporting point of view.
● When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding
figures other than in exceptional cases.
● When comparative financial statements are presented, the auditor’s opinion shall refer to each period
for which financial statements are presented and on which an audit opinion is expressed.

Audit Procedures

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Standards on Auditing

Comparative Information Included and Appropriately Classified.


The auditor shall determine
● whether the financial statements include the comparative information required by the applicable
financial reporting framework and
● whether such information is appropriately classified. For this purpose, the auditor shall evaluate
whether
○ The comparative information agrees with the amounts and other disclosures presented in the
prior period; and
○ The accounting policies reflected in the comparative information are consistent with those
applied in the current period or,
■ if there have been changes in accounting policies,
● whether those changes have been
○ properly accounted for and adequately presented and disclosed.

(Summary - CI Included and Apt Classified - Evaluate - CI agree with A & D of PP and AP of PP consistent with CP,
if not changes properly A________, P________, D_______. )

Possible material misstatement in the comparative information.


If the auditor becomes aware of a possible material misstatement in the comparative information while
performing the current period audit,
● the auditor shall perform such additional audit procedures as are necessary in the circumstances to
obtain sufficient appropriate audit evidence to determine whether a material misstatement exists.
● If the auditor had audited the prior period’s financial statements, the auditor shall also follow the
relevant requirements of SA 560

(Summary - Become aware of Poss MMS in CI, AAP SAAE, MMS Exist? / Also follow requirement of SA 560 SE)

Written Representation
In the case of comparative financial statements,
● the written representations are requested for all periods referred to in the auditor’s opinion because
management needs to re-affirm that the written representations it previously made with respect to the
prior period remain appropriate.
In the case of corresponding figures,
● the written representations are requested for the financial statements of the current period only because
the auditor’s opinion is on those financial statements, which include the corresponding figures.

The auditor may requests a specific written representation regarding any prior period item that is separately
disclosed in the current year’s financial statement.

(CFI - All Period ref in opinion, to reaffirmWR appropriate, CF - CP only, may request for any PPI disclosed)

Audit Reporting
Corresponding Figures
Reference to corresponding figures
Audit opinion not to refer to corresponding figures, EXCEPT:

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1. Auditor's report on prior period FS was modified


Auditor's report on prior period FS was modified and the subject of modification is still unresolved
○ Modify current audit report also.

In the Basis for Modification paragraph in the auditor’s report, the auditor shall:
● Refer to both the current period’s figures and the corresponding figures in the description of the matter
giving rise to the modification
○ when the effects or possible effects of the matter on the current period’s figures are material; or
(PP Opinon Modified because of misstatement and CP FS are also affected by the same
misstatement)
● In other cases,
○ explain that the audit opinion has been modified
■ because of the effects or possible effects of the unresolved matter
● on the comparability of the current period’s figures and the corresponding
figures. (PP Opinion is modified, Matter is not relevant/ immaterial to the
current period figures in the financial statements-but comparability is effected )

2. Audit evidence that a material misstatement exists in the prior period financial statements on which
an unmodified opinion has been previously issued
If the auditor
● obtains audit evidence that a material misstatement exists in the prior period financial
statements
● on which an unmodified opinion has been previously issued,
● the auditor shall verify whether the misstatement has been dealt with as required under the
applicable financial reporting framework and,
○ if that is not the case,
○ the auditor shall express a qualified opinion or an adverse opinion in the auditor’s
report on the current period financial statements,
■ modified with respect to the corresponding figures included therein.

Prior Period Financial Statements Audited by a Predecessor Auditor


If the financial statements of the prior period were audited by a predecessor auditor and
● the auditor is permitted by law or regulation to refer to the predecessor auditor’s report on the
corresponding figures and
● decides to do so,
the auditor shall state in an Other Matter paragraph in the auditor’s report:
a. That the financial statements of the prior period were audited by the predecessor auditor;
b. The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons
therefore; and
c. The date of that report.

Prior Period Financial Statements Not Audited


If the prior period financial statements were not audited,
● the auditor shall state in an Other Matter paragraph in the auditor’s report that the corresponding
figures are unaudited.

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● Such a statement does not, however, relieve the auditor of the requirement to obtain sufficient
appropriate audit evidence that the opening balances do not contain misstatements that materially
affect the current period’s financial statements.

Comparative Financial Statements


Reference to each period
When comparative financial statements are presented,
● the auditor’s opinion shall
● refer to each period for which financial statements are presented and on which an audit opinion is
expressed.

Opinion Prior Period FS differ from previous opinion.


If the auditor’s opinion on such prior period financial statements differs from the opinion the auditor
previously expressed, the auditor shall disclose the substantive reasons for the different opinion in an Other
Matter paragraph in accordance with SA 706.

Prior Period Financial Statements Audited by a Predecessor Auditor


If the financial statements of the prior period were audited by a predecessor auditor, in addition to expressing
an opinion on the current period’s financial statements, the auditor shall state in an Other Matter paragraph
a. That the financial statements of the prior period were audited by a predecessor auditor;
b. The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons
therefore; and
c. The date of that report,

If the auditor concludes that a material misstatement exists that affects the prior period financial statements on
which the predecessor auditor had previously reported without modification, the auditor shall communicate the
misstatement with the appropriate level of management and those charged with governance and request that
the predecessor auditor be informed.

If the prior period financial statements are amended, and the predecessor auditor agrees to issue a new
auditor’s report on the amended financial statements of the prior period, the auditor shall report only on the
current period.

Prior Period Financial Statements Not Audited


The auditor shall state in an Other Matter paragraph that the comparative financial statements are unaudited.
Such a statement does not, however, relieve the auditor of the requirement to obtain sufficient appropriate
audit evidence that the opening balances do not contain misstatements that materially affect the current
period’s financial statements.

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Standards on Auditing

SA 720 -The Auditor’s Responsibility in Relation to Other Information

Scope of this SA
This Standard on Auditing (SA) deals with the auditor’s responsibilities relating to other information, whether
financial or non-financial information (other than financial statements and the auditor’s report thereon),
included in an entity’s annual report.An entity’s annual report may be a single document or a combination of
documents that serve the same purpose.

This SA does not apply to


● Preliminary announcements of financial information.
● Securities offering documents, including prospectuses.

Objectives
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.

Definitions
Misstatement of the other information
A misstatement of the other information exists when the other information is incorrectly stated or otherwise
misleading (including because it omits or obscures information necessary for a proper understanding of a
matter disclosed in the other information).

Other information
Financial or non-financial information (other than financial statements and the auditor’s report thereon)
included in an entity’s annual report.

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

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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. and
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.

While reading the other information, 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

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.

Responding When the Auditor Concludes That a Material Misstatement of the


Other Information Exists
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.

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. or
b. Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.

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
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 bring the
uncorrected material misstatement to the attention of users for whom the auditor’s report is prepared.

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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, 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.

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.
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. 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, the auditor shall consider
the implications of the matter giving rise to the modification of opinion for the statement required above.

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.

Documentation
In addressing the requirements of SA 230 as it applies to this SA, the auditor shall include in the audit
documentation
a. Documentation of the procedures performed under this SA; and

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b. The final version of the other information on which the auditor has performed the work required
under this SA.

LMP Associates, Chartered Accountants, conducting the audit of PQR Ltd., a listed Company for the year ended 31st
March 2019 is concerned with the auditor's responsibilities relating to other information, both financial and
non-financial, included in the Company’s annual report. While reading other information, LMP Associates considers
whether there is a material inconsistency between other information and the financial statements. As a basis for the
consideration the auditor shall evaluate their consistency, compare selected amounts or other items in the other
information with such amounts or other items in the financial statements. Guide LMP Associates with examples of
"Amounts" or "other items" that may be included in the "other information" with reference to SA 720. (NOV 19) (CA
Final New Course) (www.icai.org)

As per SA 720 “The Auditor’s Responsibility in Relation to Other Information”, the following are examples of amounts
and other items that may be included in other information. This list is not intended to be exhaustive

Amounts
● Items in a summary of key financial results, such as net income, earnings per share, dividends, sales and other
operating revenues, and purchases and operating expenses.
● Selected operating data, such as income from continuing operations by major operating area, or sales by
geographical segment or product line.
● Special items, such as asset dispositions, litigation provisions, asset impairments, tax adjustments,
environmental remediation provisions, and restructuring and reorganization expenses.
● Liquidity and capital resource information, such as cash, cash equivalents and marketable securities; dividends;
and debt, capital lease and minority interest obligations.
● Capital expenditures by segment or division.
● Amounts involved in, and related financial effects of, off-balance sheet arrangements.
● Amounts involved in guarantees, contractual obligations, legal or environmental claims, and other
contingencies.
● Financial measures or ratios, such as gross margin, return on average capital employed, return on average
shareholders’ equity, current ratio, interest coverage ratio and debt ratio. Some of these may be directly
reconcilable to the financial statements.
Other Items
● Explanations of critical accounting estimates and related assumptions.
● Identification of related parties and descriptions of transactions with them.
● Articulation of the entity’s policies or approach to manage commodity, foreign exchange or interest rate risks,
such as through the use of forward contracts, interest rate swaps, or other financial instruments.
● Descriptions of the nature of off-balance sheet arrangements
● Descriptions of guarantees, indemnifications, contractual obligations, litigation or environmental liability cases,
and other contingencies, including management’s qualitative assessments of the entity’s related exposures.
● Descriptions of changes in legal or regulatory requirements, such as new tax or environmental regulations, that
have materially impacted the entity’s operations or fiscal position, or will have a material impact on the entity’s
future financial prospects.
● Management’s qualitative assessments of the impacts of new financial reporting standards that have come into
effect during the period, or will come into effect in the following period, on the entity’s financial results,
financial position and cash flows.
● General descriptions of the business environment and outlook.
● Overview of strategy.
● Descriptions of trends in market prices of key commodities or raw materials.
● Contrasts of supply, demand and regulatory circumstances between geographic regions.
● Explanations of specific factors influencing the entity’s profitability in specific segments.

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Examples of reports that (subject to law, regulation or custom), are not other information within the scope of this SA,
include

● Separate industry or regulatory reports (for example, capital adequacy reports), such as may be prepared in the
banking, insurance, and pension industries.
● Corporate social responsibility reports.
● Sustainability reports.
● Diversity and equal opportunity reports.
● Product responsibility reports.
● Labour practices and working conditions reports.
● Human rights reports.
● Other regulatory filings with the Government agencies such as the Registrar of Companies.

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.

Some situations where Audit Reports and Certificates are required is given below -
Under the Payment of Bonus Act, 1965, a chartered accountant may be required to issue a ‘report’ on the
computation of bonus payable. The report may be as under:

“We have reviewed the figures in the above computation in comparison with the books and records produced to
us, the audit of which has already been completed by us and report that subject to the notes given on face of the
computation in our opinion, and to the best of our knowledge and belief and according to the information and
explanation given to us, the above computation is in due accordance therewith and has been made on a basis
reasonably consistent with the provisions of the Payment of Bonus Act, 1965.”

Place For X & Co


Date Chartered Accountants

Auditor’s Report in accordance with Regulation 54 of the SEBI (Mutual Fund) Regulations,
1993.
i. All Mutual funds shall be required to get their accounts audited in terms of a provision to that effect in
their trust deeds. The Auditor’s Report shall form a part of the Annual Report. It should accompany the
Abridged Balance Sheet and Revenue Account. The auditor shall report to the Board of Trustees and not
to the unit holders.
ii. The auditor shall state whether
1. He has obtained all information and explanations which, to the best of his knowledge and belief,
were necessary for the purpose of his audit.

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2. The Balance Sheet and the Revenue Account are in agreement with the books of account of the
fund.
iii. The auditor shall give his opinion as to whether:
1. The Balance Sheet gives a true and fair view of the scheme wise state of affairs’ of the fund as at
the balance sheet date, and
2. The Revenue Account gives a true and fair view of the scheme wise surplus/deficit of the fund
for the year/period ended at the balance sheet date.

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Professional Ethics

Chapter 3 Professional Ethics

THE FUNDAMENTAL PRINCIPLES


There are five fundamental principles of ethics for professional accountants
a. Integrity – to be straightforward and honest in all professional and business relationships.
b. Objectivity – not to compromise professional or business judgments because of bias, conflict of interest
or undue influence of others.
c. Professional Competence and Due Care – to
1. 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
2. Act diligently and in accordance with applicable technical and professional standards
d. Confidentiality – to respect the confidentiality of information acquired as a result of professional and
business relationships.
e. Professional Behaviour – to comply with relevant laws and regulations and avoid any conduct that the
professional accountant knows or should know might discredit the profession.

Integrity
● 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.
● A professional accountant shall not knowingly be associated with reports, returns, communications or
other information where the accountant believes that the information:
○ Contains a materially false or misleading statement
○ Contains statements or information provided negligently
○ Omits required information where such omission would be misleading.
● If a professional accountant provides a modified report in respect of such a report, return,
communication or other information, the accountant is not in breach.
● When a professional accountant becomes aware of having been associated with information as decribed
the accountant shall take steps to be disassociated from that information.

Objectivity
● A professional accountant shall comply with the principle of objectivity, which requires an accountant
not to compromise professional or business judgment because of bias, conflict of interest or undue
influence of others.
● A professional accountant shall not undertake a professional activity if a circumstance or relationship
unduly influences the accountant‟s professional judgment regarding that activity.

Professional Competence And Due Care


● A professional accountant shall comply with the principle of professional competence and due care,
which requires an accountant to
○ 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
○ Act diligently and in accordance with applicable technical and professional standards.

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Professional Ethics

● 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.

Confidentiality
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
1. 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
2. Maintain confidentiality of information within the firm or employing organization;
3. Maintain confidentiality of information disclosed by a prospective client or employing organization;
4. 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.
5. 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;
6. 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
7. 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.

Circumstances where professional accountants are or might be required to disclose confidential information
a. Disclosure is required by law, for example
i. Production of documents or other provision of evidence in the course of legal proceedings; or
ii. 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 organization.
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.

Factors to considered in deciding whether to disclose confidential information


● Whether the interests of any parties, 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.
● Whether all the relevant information is known and substantiated, to the extent practicable.
● The proposed type of communication, and to whom it is addressed.
● Whether the parties to whom the communication is addressed are appropriate recipients

Principle of confidentiality after the end of the relationship.


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

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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.

Professional Behaviour
An accountant
● must comply with relevant laws and regulations and
● avoid any conduct that the accountant knows or should know might discredit 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

Conduct that might discredit the profession includes conduct that may lead to a reasonable and informed third
party to conclude that such a conduct adversely affects the good reputation of the profession.

When promoting himself and his work, a professional accountant shall not bring the profession into disrepute.
A professional accountant shall be honest and truthful and shall not make:
a. Exaggerated claims for the services offered by, or the qualifications or experience of, the accountant; 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.

Threats to Compliance with Fundamental Principles


Identifying Threats
The professional accountant shall identify threats to compliance with the fundamental principles.
Threats to compliance with the fundamental principles fall into one or more of the following categories
a. Self-interest threat – the threat that a financial or other interest will inappropriately influence a
professional accountant’s judgment or behaviour;
b. Self-review 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 organization, on which the accountant will rely when
forming a judgment as part of performing a current activity.
c. Advocacy threat – the threat that a professional accountant will promote a client’s or employing
organization’s position to the point that the accountant’s objectivity is compromised;
d. Familiarity threat – the threat that due to a long or close relationship with a client, or employing
organization, a professional accountant will be too sympathetic to their interests or too accepting of
their work; and
e. 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.

Circumstances that may create different types of threat

Threat Circumstances

Self-interest ● Having a direct financial interest in a client


threats ● Undue dependence on total fees from a client.
● Having a close business relationship with a client.

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● Concern about the possibility of losing a client.


● Potential employment with a client.
● Having access to confidential information of the client that might be used
for personal gain.
● Accepting gifts and hospitality from an audit client might create a
self-interest, familiarity or intimidation threat.

Self Review Threat ● Accounting and bookkeeping services - Preparing accounting records or
financial statements for an audit client might create a self-review threat.
● Discussing accounting treatments and proposing adjusting journal entries
are a normal part of the audit process and do not create threats long as the
client is responsible for making decisions in the preparation of the financial
statements.
● The loan of personnel to an audit client might create a selfreview, advocacy
or familiarity threat.

Advocacy threats ● Representing the client in court or in any dispute where the matter is
material to the financial statements.
● Negotiating on the client's behalf for finance.
● Promoting shares in a entity when that entity is a financial statement audit
client.
● Loan of personnel from an audit firm to an audit client.
● Providing valuation services to an audit client.

Familiarity threats ● A member of the engagement team having a close or immediate family
relationship with a director or officer of the client.
● A member of the engagement team having a close or immediate family
relationship with an employee of the client who is in a position to exert
direct and significant influence over the subject matter of the engagement.
● A former partner of the firm being a director or officer of the client or an
employee in a position to exert direct and significant influence over the
subject matter of the engagement.
● Long association of an audit team member with the audit client.

Intimidation ● Being threatened with dismissal or replacement in relation to a client


threats engagement because of a disagreement about a professional matter.
● Being feeling pressured to agree with the judgment of a client because the
client has more expertise on the matter in question.
● Being informed that a planned promotion will not occur unless the
accountant agrees with an inappropriate accounting treatment.

Evaluating Threats
When the professional accountant identifies a threat to compliance with the fundamental principles, the
accountant shall evaluate whether such a threat is at an acceptable level.

Acceptable level
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

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Relevant Factors to be considered in Evaluating the Level of Threats


The existence of various conditions, policies and procedures might also be factors that are relevant in
evaluating the level of threats to compliance with fundamental principles. Examples of such conditions, policies
and procedures include:
1. Corporate governance requirements.
2. Educational, training and experience requirements for the profession.
3. Effective complaint systems which enable the professional accountant and the general public to draw
attention to unethical behaviour.
4. An explicitly stated duty to report breaches of ethics requirements.
5. Professional or regulatory monitoring and disciplinary procedures.

The consideration of qualitative as well as quantitative factors is relevant in the professional accountant's
evaluation of threats, as is the combined effect of multiple threats, if applicable.

Addressing Threats
If 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:
a. Eliminating the circumstances, including interests or relationships, that are creating the threats;
b. Applying safeguards, where available and capable of being applied, to reduce the threats to an
acceptable level; or
c. Declining or ending the specific professional activity.

Safeguards
Safeguards are actions, individually or in combination, that the professional accountant takes that effectively
reduce threats to compliance with the fundamental principles to an acceptable level.

Example of Safeguards
● Ensuring that there is adequate time available for performing the relevant duties will reduce or
eliminate self-interest threat.
● Gifts and hospitality may not be accepted unless the value is trivial and inconsequential.
● A self-interest, familiarity or intimidation threat is created when an immediate family member of an
audit team member is an employee in a position to exert significant influence over the client‟s financial
position, financial performance or cash flows - An example of an action that might eliminate such a
self-interest, familiarity or intimidation threat is removing the individual from the audit team.
● A self-interest, self-review or familiarity threat might be created if, before the period covered by the
audit report, an audit team member:
a. Had served as a director or officer of the audit client
b. Was an employee in a position to exert significant influence over the preparation of the client‟s
accounting records or financial statements on which the firm will express an opinion.
An example of an action that might be a safeguard to address such a self-interest, self-review or
familiarity threat is having an appropriate reviewer review the work performed by the audit team
member.
● Using different partners and engagement teams with separate reporting lines for the provision of
nonassurance services to an assurance client might address self-review, advocacy or familiarity threats.

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● Not giving the loaned personnel audit responsibility for any function or activity that the personnel
performed during the loaned personnel assignment might address a self- review threat.

Distinguish Self-interest threat from self-review threat in an Assurance Engagement.


(SA, May 2018, 5 marks)

A professional accountant in public practice is always subject to various threats in compliance with fundamental
principles of his profession and you, as a professional accountant, are worried about engagement specific threat in
your audit assignment of M/s Soft Ltd. and want to implement some measures to eliminate and reduce the same.
Enumerate some engagement specific safeguards which you may introduce in your work environment to ward off
such threats.
(SA, May 2019, 5 marks)

The audit team is preparing to conduct audit for ABC Company for the period ending 31.3.2020. However, the
audit team has not received its audit fees from ABC Company for its audit concluded for the period ended
31.3.2019. The audit team might be tempted to issue a favorable report so that ABC Company is able to secure a
loan to settle the fees outstanding for their 31.3.2019 audit. The audit team is not complying the fundamental
principles of auditing hence hindering the Auditor's Independence. Explain the types of threats that may hinder
Auditor's Independence while issuing Audit Report.
(SA, Jan 2021, 5 marks)

The professional accountants need to observe certain fundamental principles, which are covered in the Code of
Ethics of the Institute of Chartered Accountants of India. Briefly explain each of the five principles which needs to
be complied by the Chartered Accountants ?
(SA, Nov 2022, 5 Marks)

Relevant Provisions of The Chartered Accountant Act, 1949

Section 2(2) - Members Deemed to be in Practice


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
ii. Offers to perform or performs services 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 relating to accounting procedure or the
recording, presentation or certification of financial facts or data.
iv. Renders such other services as, in the opinion of the Council, are or may be rendered by a chartered
accountant in practice

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Pursuant to Section 2(2)(iv) above, the Council has passed a resolution permitting a Chartered Accountant in
practice to render the entire range of “Management Consultancy and other Services”.
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
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 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 features 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) admedia, (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 the 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).

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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.
xxviii. Administrative Services. 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.
For example, the functions of a GST practitioner
i. furnish the details of outward and inward supplies;
ii. furnish monthly, quarterly, annual or final return;
iii. make deposit for credit into the electronic cash ledger;
iv. file a claim for refund;
v. file an application for amendment or cancellation of registration;

Services related to tax implications


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”.

MCS Does not include


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

Offers to render
The act of setting up an establishment offering to perform accounting services would tantamount to being in
practice even though no client has been served.

Armed forces
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’

Employment- Still Deemed to be in Practice


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 be deemed to be in practice for the limited purpose of the training of
Articled Assistants.

Others
● Becomes administrator, liquidator, receiver, trustee, arbitrator, executor,
● Secretary to the central or state government, however if it is done for salary basis then it is not deemed
to be in practice.

A normal company incorporated for the purpose or any existing company can be used to have a practice in
corporate form. ICAI declared such a company as Management Consultancy Company.Any Company
complies with the Guidelines for Practice in Corporate Form issued by the Institute shall be a Management
Consultancy Company. A Chartered Accountant in practice can also run a Management Consultancy

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Company. This Management Consultancy Company shall have a distinct name which shall be approved by
the Institute.

● 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 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 Company is required to take approval of the name and then apply for registration with the
Institute.

CA Natraj, in practice, accepted an assignment as advisor and consultant to the public issue of shares by his
client M/s Super Ltd. Besides helping the company as an advisor, he also underwrote the public issue of the
company to the extent of 25% at a commission of 1%. Remaining shares were underwritten by banks and
other financial institutions at the same rate of commission. He contends that above assignments are part of
management consultancy work permitted by the council of the Institute. Do you agree with the view of CA
Natraj? Decide in the light of applicable code of conduct.
(SA, May 2019, 4 Marks)

P, a Chartered Accountant in practice provides management consultancy and other services to his clients.
During 2020, 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?
(Study Material of ICAI)

Entry of names in the Register. - Section 4


Any of the following persons shall be entitled to have his name entered in the Register, namely
● any person who has passed such examination and completed such training as may be prescribed for
members of the Institute.
● any person who has passed such other examination and completed such other training without India
as is recognised by the Central Government or the Council as being equivalent to the examination and
training prescribed for members of the Institute:

Provided that in the case of any person who is not permanently residing in India, the Central Government or
the Council, as the case may be, may impose such further conditions as it may deem fit.

Fees - Will be determined by notification, by the council, shall not exceed ₹ 3,000.
Provided that the Council may, with the prior approval of the Central Government, determine the fee exceeding
rupees three thousand, which shall not in any case exceed ₹ 6,000.

Fellows and Associates. - Section 5


5. (1) The members of the Institute shall be divided into two classes designated respectively as associates and
fellows.

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(2) Any person shall, on his name, being entered in the Register, be deemed to have become an associate
member of the Institute and be entitled to use the letters A.C.A. after his name to indicate that he is an
associate member of the Institute of Chartered Accountants.

(3) A member, being an associate


● who has been in continuous practice in India for at least five years, and
● a member who has been an associate for a continuous period of not less than five years and
● who possesses such qualifications as the Council may prescribe 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 five years as a chartered accountant shall,
○ on payment of such fees, as may be determined, by notification, by the Council,
○ which shall not exceed rupees five thousand and
■ on application made and granted in the prescribed manner,
■ be entered in the Register as a fellow of the Institute and shall be entitled to use the
letters F. C. A. after his name to indicate that he is a fellow of the Institute of Chartered
Accountants:

Provided that the Council may, with the prior approval of the Central Government, determine the fee exceeding
rupees five thousand, which shall not in any case exceed rupees ten thousand.

Certificate of practice. Section 6


● 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.
● The certificate of practice obtained may be cancelled by the Council under such circumstances as may
be prescribed.

Regulation 10 - THE CHARTERED ACCOUNTANTS REGULATIONS, 1988 😌


A certificate of practice issued under sub-section (1) of section 6 shall be liable for cancellation, if
● The name of the holder of the certificate is removed from the Register under subsections (1) and (2) of
section 20.
● 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
● a member has ceased to practise
● a member has not paid annual fee for certificate of practice till 30th day of September of the relevant
year.

Regulation 11 - Restoration of certificate of practice


The Council may,
● on an application made in the
○ approved Form and on
○ payment of such fee,
○ as may be determined by the Council,
● restore the certificate of practice 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
certificate of practice and whose application, complete in all respects, together with the fee, is received
by the Secretary before the expiry of the relevant year.

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Mr. Dice, a practicing Chartered Accountant was ordered to surrender his Certificate of Practice and he was
suspended for one year on certain professional misconduct against him. During the period of suspension, Mr.
Dice, designating himself as GST Consultant, did the work of filing GST returns and made appearance as a
consultant before various related authorities. He contended that there is nothing wrong in it as he, like any
other GST consultant, could take such work and his engagement as such in no way violates the order of
suspension inflicted on him. Is he right in his contention?
(SA, May 2018, 5 marks)

Penalty for falsely claiming to be a member, etc. - Section 24


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; or
ii. being a member of the Institute, but not having a certificate of practice, represent that he is in practice
or practises as the chartered accountant, shall be punishable on first conviction with fine which may
extend to one thousand rupees, and on any subsequent conviction with imprisonment which may extend
to six months or with fine which may extend to five thousand rupees, or with both.

Member in Practice Prohibited from using a Designation Other Than Chartered


Accountant - Section 7
Use of The Members of the Institute are permitted to use the word 'CA' as prefix before their
Word CA name irrespective of the fact that they are in practice or not.

Members in A member in practice cannot use any designation other than that of a Chartered
practice Accountant, nor he can use any other description, whether in addition to or in
substitution to “Chartered Accountant”,

Members not A member who is not in practice and does not use the designation of a Chartered
in Practice Accountant may use any other description. (If uses “Chartered Accountant”
nothing else is allowed)

Membership Members are entitled to indicate membership of such other Institute of


of other accountancy, whether in India or elsewhere, as may be recognised in this behalf by
Institute of the Council, or any other qualification that he may possess.
accountancy

Other Points
● Can use letters to indicate other membership or qualification
● 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 / Lawyers. Such members shall, however, not use designation/s of
the aforesaid Institute/s simultaneously with the designation “Chartered Accountant”.
● The members can use “Dr” with Prefix “CA”

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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.

Merchant Banker / Advisor to an issue


● The members can act as “Advisor or Consultant to an issue” after getting the required qualification
from SEBI.
● 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.

Disabilities. - Section 8
A person shall not be entitled to have his name entered in or borne on the Register if he
i. has not attained the age of twenty-one years at the time of his application for the entry of his name in
the Register; or
ii. is of unsound mind and stands so adjudged by a competent court; or
iii. is an undischarged insolvent; or
iv. 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; or
v. has been convicted by a competent Court whether within or without India, of an offence involving
moral turpitude and punishable with transportation or 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
vi. has been removed from membership of the Institute on being found guilty of professional or other
misconduct :

Provided 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.

Register. - Section 19
1. The Council shall maintain in the prescribed manner a Register of the Members of the Institute
2. The Register shall include the following particulars about every member of the Institute, namely,—
a. his full name, date of birth, domicile, residential and professional address;
b. the date on which his name is entered in the Register;
c. his qualifications;
d. whether he holds a certificate of practice; and
e. any other particulars which may be prescribed.
3. The Council shall cause to be published in such manner as may be prescribed, a list of members of the
Institute as on the 1st day of April of each year, and shall, if requested to do so by any such member,
send to him a copy of such list on payment of such amount as may be prescribed.
4. Every member of the Institute shall, on his name being entered in the Register, pay such annual
membership fee as may be determined, by notification, by the Council, which shall not exceed rupees
five thousand:

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Professional Ethics

Provided that the Council may with the prior approval of the Central Government, determine the fee exceeding
rupees five thousand, which shall not in any case exceed rupees ten thousand.

Removal from the Register. - Section 20


The Council may remove from the Register the name of any member of the Institute
a. who is dead; or
b. from whom a request has been received to that effect; or
c. who has not paid any prescribed fee required to be paid by him; or
d. who is found to have been subject to any of the disabilities mentioned in section 8
i. at the time when his name was entered in the Register, or
ii. at any time thereafter or
e. who for any other reason has ceased to be entitled to have his name borne on the Register.

If the name of any member has been removed from the Register becauseof non-payment of fee, on receipt of an
application, his name may be entered again in the Register on payment of the arrears of annual fee along with
such additional fee, as may be determined, by notification, by the Council which shall not exceed rupees two
thousand

Provided that the Council may with the prior approval of the Central Government, determine the fee exceeding
rupees two thousand, which shall not in any case exceed rupees four thousand.

Restoration of Membership - Regulation 19


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 and additional fee determined by the Council under the Act.

The restoration shall be with effect from the date on which the application and fee are received

Provided that where such an application for restoration, complete in all respects, is received within the same
year in which the name was removed, the Council may restore the name on his paying the annual membership
fee due for that year, entrance fee and the additional fee for restoration, with effect from the date on which it
was removed from the Register
Provided further that the restoration of a member's name which was removed under the orders of the Board of
Discipline or the Disciplinary Committee or the Appellate Authority or the High Court shall be affected only in
accordance with such orders.

Companies not to engage in accountancy. - Section 25


● No company, whether incorporated in India or elsewhere, shall practise as chartered accountants.
● the "company" shall include any limited liability partnership which has company as its partner for the
purposes of this section.
● If any company contravenes the above provision then,
○ 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 one thousand rupees, and
■ on any subsequent conviction to five thousand rupees.

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Professional Ethics

Unqualified persons not to sign documents - Section 26


1. 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 such chartered accountants.
2. Any person who contravenes the provisions of sub-section (1) shall be punishable
○ on first conviction with a fine not less than five thousand rupees but which may extend to one lakh
rupees, and
○ in the event of a second or subsequent conviction with imprisonment for a term which may extend to
one year or with fine not less than ten thousand rupees but which may extend to two lakh rupees or
with both.

Maintenance of branch offices. - Section 27


1. Where a chartered accountant in practice or a firm of such chartered accountants has more than one office
in India, each one of such offices shall be in the separate charge of a member of the Institute :

Provided that the Council may in suitable cases exempt any chartered accountant in practice or a firm of such
chartered accountants from the operation of this sub-section.

2. Every chartered accountant in practice or a firm of such chartered accountants maintaining more than one
office shall send to the Council a list of offices and the persons in charge thereof and shall keep the Council
informed of any changes in relation thereto.

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Professional Ethics

Intimation about every branch office must be sent to ICAI. (Decentralised Office), otherwise it will be
considered to be professional misconduct.

CA Final Practice Manual Old - (www.icai.org)


Is there any misconduct on the part of a Chartered Accountant in the following circumstances?
Mr. G, a Chartered Accountant in practice as a sole proprietor has an office in Mumbai near ChurchGate. Due to an
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.

Answer
➔ 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.

CA Final Practice Manual Old - (www.icai.org)


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 kms from the municipal limits, puts up a name-board of the firm in both premises and also
in their respective residences.

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Professional Ethics

Answer
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 and also in their
respective residences.
➔ Thus, the chartered accountants are guilty of misconduct. Distance given in the question is not relevant for
deciding.

Schedules to the Act

First Schedule
First Schedule Part 1- Professional Misconduct in relation to CAs in Practice

A Chartered Accountant in practice is deemed to be guilty of professional misconduct

Clause (1)
If he 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.

CA In Practice (Having COP) and Partner

CA In Practice (Having COP) and Employment

CA In Practice (Having COP) Neither Partner Nor Employee

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Professional Ethics

Others in employment

Others in partnership

Others

CA Bahu, a newly qualified professional with certificate of practice, approached CA Subahu, the auditor of his father's
company Apex Ltd., to allow him to have some practical and professional knowledge and experience in his firm before he
can set up his own professional practice. CA Subahu allowed him to sit in his office for 6 month and allotted a small
chamber with other office infrastructure facility. In the course of his association with CA Subahu' s office, he used to
provide tax consultancy independently to the client of the firm and also filed few IT and GST return and represented
himself before various tax authorities on behalf of the firm although no documents were signed by him. During his
association in CA Subahu's office, he did not get any salary or share of profit or commission but only re-imbursement of
usual expenses like conveyance, telephone etc. was made to him. After the end of the agreed period, he was given a lump
sum amount of Rs 2,50,000 by CA Subahu for his association out of gratitude. Give your comments with reference to the
Chartered Accountants Act, 1949 and Schedules thereto
(MTP1, May 2022, 5 marks)

Clause (2)
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 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.

Regulation 53A: Professional bodies: [same for clause (3) & clause (4)]
● The Institute of Company Secretaries of India established under the Company Secretaries Act, 1980.
● The Institute of Cost & Works Accountants of India established under the Cost & Works Accountants
Act, 1959.
● Bar Council of India established under the Advocates Act, 1961.
● The Indian Institute of Architects established under the Architects Act, 1972.
● The Institute of Actuaries of India established under the Actuaries Act, 2006.

Further, the Council has also prescribed the persons qualified in India, which are as under
● Company Secretary within the meaning of the Company Secretaries Act, 1980;
● Cost Accountant within the meaning of the Cost and Works Accountants Act, 1959;
● Actuary within the meaning of the Actuaries Act, 2006;
● Bachelor in Engineering from a University established by law or an Institution recognised by law;
● Bachelor in Technology from a University established by law or an institution recognised by law;
● Bachelor in Architecture from a University established by law or an institution recognised by law;
● Bachelor in Law from a University established by law or an institution recognised by law;

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Professional Ethics

● Master in Business Administration from Universities established by law or technical institutions


recognised by All India Council for Technical Education.

Fee deducted by Government


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.

% age sharing with article


Paying % age of profits to article as stipend not allowed even if financial condition weak.

Mr. Avin, a practicing Chartered Accountant gave 50% of the audit fees received by him to a nonChartered Accountant,
Mr. Lucky, under the nomenclature of office allowance and such an arrangement continued for a number of years.
Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, Nov 2019, 4 Marks)

CA Ravi, a practising Chartered Accountant, was proprietor of M/s Ravi & Associates. CA Ravi died on 15th September,
2020 due to cardiac arrest. Only family member left behind CA Ravi was his wife, Roohi. On 30th September, 2021, Roohi
sold the practice of her husband to CA Balwan for Rs 25 Lacs along with right to use the firm name i.e., M/s. Ravi &
Associates and requested the Institute to consider the effect of such sale. Give your comments on the following issues
with reference to the Chartered Accountants Act, 1949 and Schedules thereto:
(i) Whether Roohi can sell the practice to CA Balwan?
(ii) Can CA Balwan continue to practice as proprietor in name of M/s Ravi & Associates?
(SA, May 2022, 4 marks)

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Professional Ethics

CA. Vasu started his practice from August 15, 2021. On 16th August 2021, one female candidate approached him for
articleship. In addition to monthly stipend, CA. Vasu also offered her 2 % profits of his CA firm. She agreed to take both
2 % 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 CA. Vasu objecting the payment of 2 % profits. CA. Vasu replies to the ICAI stating that he is
paying 2 % 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 CA. Vasu liable to professional misconduct? Comment with reference to the Chartered
Accountants Act, 1949, and Schedules thereto.
(MTP2, Nov 22, 4 marks)

Clause (3)
If he 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 may be prescribed.

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 a
practice from another member in practice in relation to referring a client to him.

Share in fees of Valuer


CA in Practice will be deemed to be guilty of professional misconduct by virtue of Clause 3, Part I of First
Schedule if he accepts professional fees from a person who is not a member of ICAI. Registered valuers are not
recognised for profit sharing purpose under Regulations 53A and 53B.

Mr. X is a practising Chartered Accountant. Mr. Y is a practising advocate representing matters in the court of law. X
and Y decided to help each other in matters involving their professional expertise. Accordingly, Mr. X recommends Mr.
Y in all litigation matters in the court of law and Y consults X in all matters relating to finance and other related matters,
which come to him in arguing various cases consequently they started sharing profits of their professional work. Is Mr. X
liable for professional misconduct ?
(SA, Nov 2022, 4 marks)

Clause (4)
If he 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,
● whose qualifications are recognized by the Central Government or the Council for the purpose of
permitting such partnerships.

53A - Qualification and Membership For Clause 2 and Clause 3


53A - Qualification for Clause 4 also
53B - Membership for Clause 4. (i.e for partnership)
● ICSI

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Professional Ethics

● ICAI
● Bar Council
● IIA
● IAI
● Engineer, member, The Institution of Engineers, or Engineering from a University established by law or
an institution recognized by law.
● Foreign Professional Bodies (MoU / MRA)

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.

However, partnership between members of the Institute and members of foreign professional bodies are
permissible provided members of such bodies are eligible for the membership of the Institute.

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
Mr. P, a Chartered Accountant in practice entered into a partnership with Mr. L, an advocate for sharing of fees for work
sent by one to the other. However, due to some disputes, the partnership was dissolved after 1 month without any fees
having been received.
(RTP, Nov 2018, NA)

Clause (5)
If he Secure any professional business either through
● the services of a person who is not an employee of such a Chartered Accountant or
● who is not his partner or
● by means which are not open to a Chartered Accountant.
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.
Not applicable to
● Any Chartered Accountant from applying or requesting for or inviting or securing professional work
from another chartered accountant in practice; or
● 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.
NOTE
● 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 restrictions shall not be applicable where the 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.

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Professional Ethics

EMD/Security Deposit
● On a 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.
● The “minimum fee” for this purpose should be such that it commensurates with size, value, volume,
manpower requirement and nature of work.
● The fees quoted by the member shall not be less than the minimum fee mentioned in the tender, if
responding to the tender in areas of service exclusively reserved for chartered accountants.

Other Points related to Clause 6

Advertisement and note ● General Rule - Not allowed


in the press ● Exceptions
○ Changes in partnerships etc
■ 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.
○ Advertisement in the journal/ newsletter of the Institute
■ 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

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Professional Ethics

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.

Application for ● Free to write to the concerned organization with a request to place his
empanelment for name on the panel.
allotment of audit and ● No Roving Enquiries
other professional work ● Quote Fees in Enquiries being received from such bodies.
● Not allowed to send fee structure for services other than enquired

Publication of Name or Question - Whether a member in practice is permitted to have his name
Firm Name by published in the Telephone Directory?
Chartered Accountants ● Yes, a member in practice is permitted to have his name published in
in the Telephone or the Telephone Directory subject to certain conditions :-
other Directories ● The entry should appear in the section/category of “Chartered
published by Telephone Accountants“.
Authorities or Private ● The member/firm should belong to the town/city in respect of which the
Bodies directory is being published.
● The entry should be in normal type of letters. Entry in bolder type or
abnormal type of letters or in a box is not permissible.
● The order of the entries should be alphabetical and logical.
● The entry should not appear in a manner giving the impression of
publicity/advertisement. Entry should not be given in a manner which
gives prominence to it as compared to other entries.
● The payment, if any, for the entry should not be unreasonable.
● 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.
● Subject to the above conditions, the members can also include their
names in trade directories which are published and/or otherwise
available such as electronic media e.g. Internet, telephone services like
“Ask Me Services“ etc.

Specialised Directories ● The name, description and address of a member (or firm) may appear in
for limited circulation 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.

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Professional Ethics

Publication of Books or It is not permissible for a member to mention in a book or an article published
Articles 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.

Issue of greeting cards Designation “Chartered Accountant” as well as the name of the firm may be
or invitations used in
● greeting cards,
● invitations for marriages and religious ceremonies and
● any invitation 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 close friends of the member concerned only.

Soliciting professional Will Tantamount to advertisement and therefore prohibited.


work by making roving
inquiries

Scope of ● Should not be abused to secure needless publicity,


Representation which ● Should not be used directly or indirectly to canvassing or soliciting for
an auditor is entitled to his continuance as an auditor.
make under Section ● The letter should merely set out in a dignified manner how he has been
140(4)(iii) of the acting independently and conscientiously through the term of office and
Companies Act, 2013) may, in addition, indicate if he so chooses his willingness to continue as
auditor if re appointed by the shareholders.

Acceptance of original ● Should not accept the original professional work coming from a client
professional work by a introduced to him by another member.
member coming from ● If any professional work of such client comes to him directly, it should
the client Introduced to be his duty to ask the client that he should come through the other
him by another member dealing generally with his original work
member

Giving public ● Should not result in publicity


Interviews ● ensure that such interviews or details about the members or their firms
are not given in a manner highlighting their professional attainments.

Members and/or firms Prohibited.


who publish
advertisements under
Box numbers

Educational Videos ● While the videos of educational nature may be uploaded on the internet
by members,

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Professional Ethics

● 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.

Sponsoring Activities a. A member in practice or a Firm of Chartered Accountants is not


permitted to sponsor an event. However, such a 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.

Advertisement of CA in Practice also involved in coaching are advised to abstain from advertising
Teaching/Coaching their association with Coaching /teaching activities through hoardings, posters,
activities by members 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.

Television or Movie While sharing name of the member or Firm of Chartered Accountants for
Credits 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

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.

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 the suffix “Chartered Accountants” would not be
permitted.

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Professional Ethics

Guidelines Related to Website - Approved by Council

Free to Create their own Free to create their own Website subject to the overall guidelines laid
Website down by the Council.

Core Principle The details in the Website should be so designed that it does not amount
to soliciting client or professional work.

Adequate Secrecy Website should ensure adequate secrecy of the matters of the clients
handled through Website

Format Not Prescribed

Color No restriction

Model Pull model. Not push model

Circulation of information Only on “Pull” request

Mention the name of the Allowed


website on office stationery

Information allowed ● Name of firm / Member


● Year of establishment
● Address
● Contact no.
● Email ID
● FAX
● Nature of service - Pull Request
● Details of Partners
○ Name
○ Year of Qualification
○ Other Qualification
○ Contact details
○ Areas of Experience “Pull” Request
● Details of Employees
● Vacancies
● Number of Clients
● Nature of assignments
● NOT ALLOWED - Name of the client and fees charged

Name of the client and fees charged can be disclosed if required by a


regulator, only to the extent of requirement of the regulator. It should be
clearly mentioned that the disclosure is in terms of the requirement of
the regulator along with the name of the citation of rule or the statue
under which such disclosure is required.

Logo Not allowed

Photographs Passport size photos are permitted

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Professional Ethics

Articles etc. Articles, professional information, professional updation and other


matters of larger importance or of professional interest are allowed.

Bulletin board Allowed

Chat Room Which permits chatting amongst members of the ICAI and between
Firms and its clients. The confidentiality protocol would have to be
observed.

Social Media 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.

Online Advice Allowed upon request

Listing on search engine Allowed - keywords - “Chartered Accountants” or “CA” or “Indian CA”,
“Indian CPA”, “Indian Chartered Accountant” or any permutation or
combination related thereto.

Advertisement Not allowed

Address The address of the Website can be different from the name of the firm.
But it should not amount to soliciting clients or professional work or
advertisement of professional attainments or services.

The Website should mention the date upto which it is updated and the information should not be at
material variance from the information as per the ICAI’s records.

Intimation to ICAI
● The website address of the member be obtained on an annual basis in the annual form required
to be filed by the member while paying fee and
● the same be taken as entry on record &
● the website address of the member be provided to members as part of the membership record.
● If the member chose not to give his website address, it did not prevent the Institute to take
suitable action against him in case his noncompliance with the guidelines.

No Need to inform while starting the website or upon completion of website or changes in the
particulars of the website.

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 Rs. 50,000 as earnest deposit as part of the terms of the tender.
Comment with reference to the Chartered Accountants Act, 1949.
(MTP1, Nov 2018, 4 marks)

During the opening ceremony of a new branch office of CA. Young, his friend CA. Old introduced to CA. Young, his
friend and client Mr. Rich, the owner of an Export House whose accounts had been audited by CA. Old for more than 15
Years. After few days, Mr. Rich approached CA. Young and offered a certification work which hitherto had been done by
CA. Old. CA. Young undertook the work for a fee which was not less than fee charged by CA. Old in earlier period.
Comment whether CA. Young had done any professional misconduct.

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Professional Ethics

(SA, Nov 2018, 5 marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto. OPAQ & Associates, a firm of
Chartered Accountants responded to a tender issued exclusively for Chartered Accountants by an organisation in the
area of tax audit. However no minimum fee was prescribed in the tender document.
(RTP, May 2020, NA)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
A special notice has been issued for a resolution at 3rd annual general meeting of LED Ltd., providing expressly that CA.
Anoop shall not be re-appointed as an auditor of the· company. Consequently, CA. Anoop submitted a representation in
writing to the company with a request to circulate to the members. In the detailed representation, CA. Anoop included
the contributions made by him in strengthening the control procedures of the company during his association with the
company and also indicated his willingness to continue as an auditor if reappointed by the shareholders of the company.
(SA, Nov 2019, 4 Marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto. ABZ & Co., a firm of Chartered
Accountants, develops a website “abz.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
(RTP, May 2020, NA)

CA. Nikhil, in practice, started project consultancy work as a part of his practice and to advance the same, sent mail to
all the CAs in the country informing them of his services and for securing professional work. Comment with reference to
the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, May 2020, 4 marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
CA. Srishti and CA. Mishti are two partners of the CA firm ‘Srishti Mishti & Associates’. Being very pious, CA. Srishti
organised a religious ceremony at her home for which she instructed her printing agent to add her designation
“Chartered Accountant” with her name in the invitation cards. Later on, the invitations were distributed to all the
relatives, close friends and clients of both the partners.
(RTP, Nov 2020, NA)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto: Mr. Vineet, a chartered
accountant in practice, created his own website in attractive format and highlighted the contents in purple colour. The
website also displayed the nature of assignments handled along with the names of clients without such requirement from
any of the regulator. He also circulated the information contained in the website through e-mail to acknowledge public
at large about his expertise. However, he did not intimate his website address to the Institute.
(SA, Nov 2020, 4 marks)

A letter is sent by Mr. Raja, a Chartered Accountant in practice, to the Ministry of Finance inquiring whether a panel of
auditors is being maintained by the Ministry and if so to include his name in the panel. He also enclosed his CV.
Comment on the above with reference to the Chartered Accountants Act, 1949 and Schedules thereto.
(MTP1, May 2021, 4 marks)

M/s. SR & Associates is one of the three firms shortlisted by ARG Cooperative Bank for assignment of Statutory Audit
for the F.Y 2020-2021. Bank mailed the list of branches to the audit firms along with the maximum fee per branch and
asked them to submit the quotations. SR & Associates responded to the bank and submitted their quotation. Comment
with reference to the provisions of the Chartered Accountants Act, 1949 and schedules thereto.
(SA, July 2021, 4 marks)

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Mr. Avi, 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. Ravi gave
him an idea to start online services and give stock certifications to traders with Cash Credit Limits in Banks. Mr. Avi
started a website with colourful catchy designs and shared the website address on his all social media posts and stories
and tagged 40 traders of his local community with the caption “Simple Online Stock Certification Services”. Besides, Mr.
Avi entered into an agreement with a Digital Marketer to give him 8% commission on each service procured through
him. Discuss if the actions of Mr. Avi are valid in the light of the Professional Ethics and various pronouncements and
guidelines issued by ICAI.
(RTP, May 2022, NA)

CA Praful has recently qualified and has obtained certificate of practice. In the initial years, it is taking time to set up his
clientele base. He is also conducting audit of few entities. Simultaneously, he plans to provide coaching to CA students
online taking advantage of his fresh reservoir of knowledge. Therefore, he advertises his classes on various social media
platforms. Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto
(MTP2, Nov 22, 5 marks)

Question
(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
(Study mat)

Mr. Rival, a Chartered Accountant in practice, delivered a speech in the national conference organized by the Ministry of
Textiles. While addressing the audience, he informed 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 with reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, Nov 2019, 5 Marks)

Mr. Sirish, a Chartered Accountant in practice, delivered a speech in the national conference organized by the Ministry
of Information Technology. While delivering the speech, he told the audience that he is a Cybersecurity Expert and his
firm provides services of cloud accounting, IT governance, risk compliance and information security at reasonable rates.
He also requested the audience to approach his firm of chartered accountants for these services and at the request of the
audience he also distributed his business cards and telephone number of his firm to those in the audience. Comment in
the light of professional Code of Ethics
(SA, May 2022, 4 marks)

Clause (7)
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
● 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

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■ 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.

A member empanelled as Insolvency Professional or Registered Valuer can mention “Insolvency Professional”
or “Registered Valuer” respectively on his visiting card and letterhead.

Guidelines of the Council of ICAI w.r.t Clause 7

Income-tax Consultant or a Cost Not allowed


Consultant or a Management
Consultant.

Date of setting up the practice by a Not Allowed


member or the date of
establishment of the firm on the
letterheads and other professional
documents

Publication of photographs and Allowed, provided no payment is made for such publication and
brief particulars of members in there is no advertisement of professional attainments
magazines.

Photograph on their visiting cards Not permissible for the chartered accountants in practice to print
their photograph on their visiting cards.

Quick Response Code (QR Code) Allowed to print Quick Response Code (QR Code) on the visiting
Card, provided that the Code does not contain information that is
not otherwise permissible to be printed on a visiting Card.

Advertisement Specified Purpose


● Advertisements for recruiting staff in the members’ own
office.
● Advertisements inserted on behalf of clients requiring staff
or wishing to acquire or dispose of business or property.

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● Advertisement for the sale of a business or property by a


member acting in a professional capacity as trustee,
liquidator or receiver.
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.
● Avoid the expression such as “a well known firm”
● 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.

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.
● Some biographical information may be included.
● The rule 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.

Appearance on TV / Films / Radio / Members may appear on television, films and Internet and agree to
Lectures at Forums 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 for appointments to Permitted, reference to the professional firm of the member should
positions of local or national not be given
importance or for the views of
members on matters of similar
importance

Holding training courses, seminars Prominence should not be given to the name of the professional
etc. for his staff, clients and others accountant in any booklet or document issued in connection
therewith.

Writing articles or letters to the May give their names and use the description Chartered
press on subjects connected with Accountants.
the profession

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Professional Ethics

Sign Board Use of glow signs or lights on large sized boards as is used by
traders or shop-keepers would not be proper.

Directorship in a Company ● Members should take necessary steps to ensure that


○ such prospectus or public announcements or public
communications do not advertise his professional
attainments.
○ descriptions about his expertise, specialization and
knowledge in any particular field are not published
with his name.
● Use of judgement is suggested

Logo ● Use of logo is not allowed


● Common logo is allowed

Name of Multiple CA Firms in ● Allowed


which he/she is a partner

Use of ICAI’s Monogram ● Not allowed

Vision. Mission and Value ● No, will fall under clause 6

Information for the purpose of ● Not allowed, as it would result in claiming superiority of
ranking one firm over other

Members of the Institute in practice who are otherwise eligible may practice as advocates subject to the
permission of the Bar Council but in such case, they should not use the 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.

Q. Can a Chartered Accountants firm give advertisement in relation to Silver, Diamond, Platinum or
Centenary celebration of the firm?

Yes, while considering the implications of Clause (6) & (7) of Part I of the First Schedule of the Chartered
Accountants Act, 1949 in relation to such advertisements and also the need of interpersonal
socialisation/relationship of the members through such get together occasions, the advertisement for Silver,
Diamond, Platinum and Centenary celebrations of the firms has been permitted to be published in any
newspaper or in the newsletters.

It is not permitted to advertise the events organised by a Firm of Chartered Accountants.

ELECTED MEMBERS
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 - Follow the guidelines of ICAI.

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Professional Ethics

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
A Chartered Accountant in practice, empanelled as IP (Insolvency Professional) has mentioned the same on his visiting
cards, letter heads and other communications also. Mr. A, who is residing in his neighborhood has filed a complaint for
professional misconduct against the said member for such mention of insolvency professional on circulations
(RTP, Nov 2018, NA)

A practising Chartered Accountant uses a visiting card in which he designates himself, besides as Chartered Accountant,
as (i) Tax Consultant (ii) Cost Accountant. Advise on above with reference to the Chartered Accountants Act, 1949, and
Schedules thereto.
(MTP1, Nov 2018, 5 marks)

Mr. M, a Chartered Accountant in practice, has printed visiting cards which besides other details also carries a Quick
Response (QR) code. The visiting card as well the QR code contains his name, office and residential address, contact
details, e-mail id and name of the firm's website. Comment with reference to the Chartered Accountants Act, 1949 and
schedules thereto.
(MTP1, Nov 2018, 4 marks) (RTP, May 2019, NA)

Clause (8)
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
● accepts a position as auditor
● previously held by another chartered accountant
● without first communicating with him in writing.

Other Points
● 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, internal audit, concurrent audit or any
other kind of audit if the previous auditor is a chartered accountant.
● The mandatory communication with the previous auditor being a Chartered Accountant is required
even in a case where the previous auditor happens to be an auditor for a year other than the
immediately preceding year.

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Professional Ethics

Conditional Acceptance
● 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.

Relation with Section 140


● Section 140 of the Companies Act, 2013 gives the right to company to remove the auditor subject to the
procedure prescribed, also the same section gives right to the auditor to resign. We have also seen
various SAs guide the auditor to withdraw from engagement in specified circumstances.

Why to change auditor


● Why client might change auditor
○ Change of place
○ Temperament clash
○ Not-satisfied with the services
○ Dispute regarding fees

Reasons for new auditor for not accepting


● Professional reasons for new auditor for not accepting an audit could be
○ Non-compliance of the provisions of Sections 139, 140 and 142 read with Section 141 of the
Companies Act, 2013.
○ 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 or various other statutes; and
○ Issuance of a qualified report.

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.

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Professional Ethics

The incoming auditor should in appropriate circumstances use his influence in favour of his predecessor to
have the disputes as regards the fees settled.

Read only
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-emphasized.

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)

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Professional Ethics

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.

Some Case Laws (Read them once)


A Chartered Accountant commenced the work of audit on the very day he sent a letter to the ‘previous auditor -
Held, he was guilty of professional misconduct under the clause. The appointment could be accepted only when
the outgoing auditor does not respond within a reasonable time. [S.N. Johri vs. N.K. Jain (1973)]

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Professional Ethics

A Chartered Accountant sent a registered letter to the previous auditor after the commencement of the audit by
him. Held he was guilty of professional misconduct under the clause. [Radhey Shyam vs. K.S. Dubey (1974)]

A chartered accountant had sent a communication to the previous auditor under certificate of posting without
obtaining any acknowledgment thereof. The Council held the member guilty in terms of this Clause. On an
appeal made by the member, the High Court observed that the expression “in communication with” when read
in the light of the instructions contained in the booklet “Code of Conduct” could not 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 had reached his hands. Certificate of Posting of a letter could not in the circumstances
be taken as positive evidence of its delivery to the addressee. [M.L. Agarwal vs. J.S. Bhati (1975)]

The provision of Clause (8) requiring a communication with the previous auditor is absolute and applicable
even in respect of an appointment by the Government agencies and even in cases where the member is aware
that the previous auditor had been made aware of the appointment. [Rajeev Kumar vs. R.K. Agrawal (1988)]

CA. T, in practice, was appointed to carry out internal audit of a stock broker, listed with BSE. However, he failed to
intimate his appointment to the statutory auditors of the company. The statutory auditor feels this is violation of
professional ethics. Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, May 2019, 5 marks)

Vineet & Associates have been offered Statutory Audit of TLP Ltd. As a part of ethical requirements of the Institute of
Chartered Accountants, CA V, partner of the firm, communicated with the previous auditor enquiring as to whether any
professional reason exists for which he should not accept the audit assignment. Previous auditor informed that he issued
a qualified report, so management is changing the auditor. Comment with reference to the provisions of the Chartered
Accountants Act, 1949 and schedules thereto as to whether Vineet & Associates can accept the audit.
(SA, July 2021, 4 marks)

Clause (9)
A Chartered Accountant in practice 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
139, 140 and 142 read with Section 141 of the Companies Act, 2013 are duly complied with.

Other Points
● 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.
● Auditor must verify the relevant records
● Company is not allowing to verify the relevant records - Auditors should not accept the audit
assignment.

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Professional Ethics

This clause helps the Auditor to be assured that no shareholder or retiring auditor may, at a later date,
challenge the validity of such appointment.

The following guidelines have been issued for looking into the cases of Removal of Auditors
● 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.
● 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.
● The Ethical Standards Board, on a review of the communications referred above, 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.
● The above procedure is also followed in the case of removal of auditors by the government and other
statutory authorities.

Give your comments with reference to the Chartered Accountants Act, and schedules thereto - Mrs. Walecha is a
Director of Inder Private Limited, having 25% share -holdings in the company. During 20XX, the company
appointed C.A. Mr. Adi , Mrs. Walecha's spouse, as its statutory auditor.

Answer
Expressing an Opinion on Financial Statements where Director is a Relative:
➔ 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 Sections 139 and 140 read with Section
141 of the Companies Act, 2013, in respect of such appointment have been duly complied with.
➔ As per Section 141(3)(f) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor
of a company whose relative is a director or is in the employment of the company as a director or key managerial
personnel. The definition of ‘Relative’ includes husband and wife
➔ In this case Mrs. Walecha is a Director of Inder Private Limited and the company has appointed Mr. Adi,
Chartered Accountant, Mrs. Walecha's spouse, as its statutory auditor. Mr. Adi should not accept the
appointment as statutory auditor of the company, where his wife Mrs. Walecha is director. This is a
contravention of section 141(3)(f) of the Companies Act, 2013.
➔ Therefore, Mr. Adi is liable for misconduct as per Clause (9) of Part I of the First Schedule to the Chartered
Accountants Act, 1949.

CA Mehta was appointed as the Auditor of CS Ltd. for the year 2020-21 in the place of retiring auditor CA Gupta. CA
Mehta accepted the appointment after obtaining a certificate from the management that the provisions of the Sections
139 and 140 of the Companies Act, 2013 have been complied with. Comment with reference to the Chartered
Accountants Act, 1949 and schedules thereto.
(SA, Dec 2021, 4 marks)

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Professional Ethics

Clause (10)
A Chartered Accountant in practice is 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 (Example of Contingent - No Fee will be charged
unless a specific finding or result is obtained)
■ results of such employment,
○ except as permitted under any regulations made under this Act.

Other Points
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 -
● “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;
● 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;
● 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;
● 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;
● In the case of certain fundraising services, the fees may be based on a percentage of the fund raised;
● In the case of debt recovery services, the fees may be based on a percentage of the debt recovered;
● In the case of services related to cost optimisation, the fees may be based on a percentage of the benefit
derived; and
● Any other service or audit as may be decided by the Council.
Following activities have been decided by the Council :-(i) Acting as Insolvency Professional;(ii) Non-Assurance
Services to Non-Audit Clients.

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto. Agarwal Pvt Ltd. approached
CA. Prem, a Chartered Accountant in practice, for debt recovery services. CA Prem accepted the work and insisted for
fees to be based on 2% of the debt recovered.
(RTP, May 2020, NA)

Mr. Vinod a practicing chartered accountant acting as liquidator of XYZ & Co. charged his professional fees on
percentage of the realization of assets. Comment with reference to the Chartered Accountants Act, 1949, and Schedules
thereto.
(MTP1, May 2020, 4 marks)

Clause (11)
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he
● Engages in any business or occupation

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Professional Ethics

○ 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.

In simple words, he can be a director (Not MD or WTD) but he or his partner must not be interested in the
company.

Whether the auditor of a Subsidiary Company can be a Director of its Holding Company-
Public conscience is expected to be ahead of the law
“It is not possible to define “independence” precisely. Rules of professional conduct dealing with independence
are framed primarily with a certain objective. The rules themselves cannot create or ensure the existence of
independence. Independence is a condition of mind as well as personal character. It should not be confused
with the superficial and visible standards of independence which are sometimes imposed by 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.

Permission of Council
All the activities (Other than the profession of a Chartered Accountant ) in which a CA in Practice can be
engaged, which are permitted by council can be divided into 2 parts
● Generally permitted.
● Permitted with Prior Permission.

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.

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. etc
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.

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Professional Ethics

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

Specific and Prior approval is required


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.
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).
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 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.

Private Tutorship
● The Council has 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.

Interest in family business


● A member of the Institute can acquire interest in family business in any of the following manner:
○ as a proprietary firm
○ as a partnership firm
○ 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 to 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.

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
CA. Raj is a leading income tax practitioner and consultant for derivative products. He resides in Bangalore near to the
XYZ commodity stock exchange and does trading in commodity derivatives. Every day, he invests nearly 50% of his time

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Professional Ethics

to settle the commodity transactions, though he has not taken any permission for this. Is CA. Raj liable for professional
misconduct?
(RTP, May 2018, NA)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto. CA. Moni is practicing since
2009 in the field of company audit. Due to her good practical knowledge, she was offered editorship of a ‘Company Audit’
Journal which she accepted. However, she did not take any permission from the Council regarding such editorship.
(RTP, Nov 2020, NA)

CA AB, a practicing chartered accountant, is a promoter director of ABG Pvt. Ltd. and moreover he is also a sleeping
partner in his family business of garments manufacturing firm. Is CA. AB liable for professional misconduct as per
Chartered Accountant Act 1949?
(SA, Jan 2021, 4 marks)

C.A. Bahubali is Special Executive Magistrate. He also took over as the executive chairman of Software Company on
1.4.2021. He is also a leading income tax practitioner and consultant for derivative products. He resides in Chennai near
to the ION commodity stock exchange and does trading in commodity derivatives. Every day, he invests nearly 38% of his
time to settle the commodity transactions. He has not taken any permission for becoming Special Executive Magistrate.
However, he has got special permission of Council of ICAI for becoming executive chairman and for trading in
commodity derivatives. Is C.A. Bahubali liable for professional misconduct? Comment with reference to the Chartered
Accountants Act, 1949, and Schedules thereto.
(MTP2, Nov 2021, 5 marks) (MTP1, Nov 22, 5 marks)

M/s SS limited is a partly owned subsidiary of M/s HH limited. For the upcoming financial year, M/s DD & Co., Chartered
Accountants, were appointed as the statutory auditors of SS limited. The CEO of the holding company was impressed
with the knowledge and experience of Mr. D, one of the partners of the firm and hence, he offered Mr. D to take up the
position of Director (not MD/ wholetime director) of HH limited. At the same time, Mr. D’s friend approaches him with
an assignment to act as a Recovery Consultant for a bank. Mr. D is now confused whether to accept or reject the offers.
He approaches you and seeks your advice on the same. Advise what Mr. D about what he can do with the offers with
reference to the Chartered Accountants Act, 1949 and Schedules thereto.
(MTP1, May 2021, 5 marks)

CA R, a Chartered Accountant in practice is specializing in the field of Information Systems Audit. He is considered to
be one of the experts of this field because of his command over the subject. HKC Limited, a Company engaged in
rendering management consultancy offered him to appoint as its managing director. CA R accepted the position of
managing director without obtaining prior permission from the Institute. One of his friends , CA S informed him that
now he cannot retain full time certificate of practice, thus cannot do attest function and train articled assistants.
Comment with reference to the provisions of the Chartered Accountants Act, 1949 and schedules thereto.
(SA, July 2021, 4 marks)

Sanyam, a chartered accountant in practice is owner of three agriculture lands. He lost his father due to Covid Pandemic.
After death of his father, he started carrying out agricultural activities. His neighbour Raja who is a farmer, filed a
complaint against him to ICAI that being a member he is carrying out agricultural activities, therefore, he is liable for
misconduct. You are required to examine the same with reference to the Chartered Accountants Act, 1949 and Schedules
thereto.
(MTP2, May 2022, 4 marks)

Clause (12)
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

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Professional Ethics

○ to sign on his behalf or


○ on behalf of his firm,
○ any balance sheet, profit and loss account, report or financial statements.
NOTES
● The subject matter of the report should be the expression of a professional opinion whether, financial or
non-financial.
● The financial statements and the reports 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:
● Issue of audit queries during the course of audit.
● Asking for information or issue of questionnaire.
● Letter forwarding draft observations/financial statements.
● Initiating and stamping of vouchers and of schedules prepared for the purpose of audit.
● Acknowledging and carrying on routine correspondence with clients.
● Issue of memorandum of cash verification and other physical verification or recording the results
thereof in the books of the clients
● Issuing acknowledgements for records produced.
● Raising of bills and issuing acknowledgements for money receipts.
● Attending to routine matters in tax practice, subject to provisions of Section 288 of Income Tax Act.
● Any other matter incidental to the office administration and routine work involved in practice of
accountancy.

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
(RTP, Nov 2019, NA) (Study mat)

Mr. 'K’, a practicing Chartered Accountant is the proprietor of M/s K & Co. since 1995. He went abroad in the month of
December 2018. He delegated the authority to Mr. ‘Y’ a Chartered Accountant, his employee for taking care of the
important matters of his office. During his absence Mr. 'Y' has conducted the undermentioned jobs in the name of M/s K
& Co.
(i) He issued Net worth certificate to a client for furnishing to a Bank.
(ii) He attended the GST proceedings for a client as authorized representative before GST Authorities.
Please comment on eligibility of Mr. 'Y' for conducting such jobs in name of M/s K & Co. and liability of Mr. 'K’ under
the Chartered Accountants Act, 1949.
(SA, Nov 2019, 5 Marks)

CA. Intelligent, a practicing Chartered Accountant was on Europe tour between 15-09-20 and 25-09-20. On 18-09-20 a
message was received from one of his clients requesting for a stock certificate to be produced to the bank on or before
20-09-20. Due to urgency, CA. Intelligent directed his assistant, who is also a Chartered Accountant, to sign and issue the
stock certificate after due verification, on his behalf. Comment with reference to the Chartered Accountants Act, 1949,

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Professional Ethics

and Schedules thereto.


(MTP1, Nov 2021, 4 marks)

First Schedule Part II- Professional Misconduct in relation to CAs in Service


Clause (1)
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-
● pays or allows or
● agrees to pay directly or indirectly
○ to any person
○ any share in the emoluments
■ of the employment undertaken by him.
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.

Clause (2)
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-
● 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.

Mr. 'C', a Chartered Accountant employed as Senior executive in charge of Tax in a company, and not holding certificate
of practice recommends a particular lawyer to his employer in respect of a case. The lawyer, out of the professional fee
received from the employer of Mr. 'C' paid a particular sum as referral fee to Mr. 'C'. Comment with reference to the
Chartered Accountants Act, 1949 and schedules thereto.
(SA, Nov 2019, 5 Marks)

First Schedule Part III- Professional Misconduct in relation Members 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 (3)
● while inviting professional work from another chartered accountant or

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Professional Ethics

● 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.

XYZ Associates, a Chartered Accountants Firm is having a relationship with a multinational accounting firm in India.
The ICAI required that all firms having networking relationship with any other entity need to furnish information online
within the stipulated time. XYZ Associates failed to respond. Comment on this with reference to Professional
misconduct, if any.
(SA, Nov 2018, 4 marks)

Mr. Shanti, a Chartered Accountant, employed as a paid Assistant with a Chartered Accountant firm, leaves the services
of the firm on 31st December, 2020. Despite many reminders from ICAI he fails to reply regarding the date of leaving the
services of the firm. Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, May 2022, 4 marks)

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
● If imprisonment tenure exceeds six months, this case will be covered in the Part Ill of Second Schedule.
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.

CA. X, a practicing Chartered Accountant, failed to return the books of account and other documents of ABC Ltd.
despite many reminders from the company. The company had settled his entire fees dues also. Comment with reference
to the Chartered Accountants Act, 1949.
(MTP2, Nov 2018, 4 marks)

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.
(MTP1, May 2019, 4 marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto. Ms. Preeto, a CA, had an
account with a bank. The normal balance in this account remained at a level below Rs 5,000. The bank inadvertently
credited this account with a cheque of Rs 2,70,000 belonging to another account holder. When CA. Preeto came to know
about this she withdrew the amount of Rs 2,75,000 and closed the bank account. After 1 year the bank noticed the
mistake and claimed Rs 2,75,000 with interest. CA. Preeto contested this claim. Can the bank approach the Institute of
Chartered Accountants of India for disciplinary action against CA. Preeto?
(RTP, Nov 2020, NA)

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Professional Ethics

THE SECOND SCHEDULE


Part I - Professional Misconduct in relation to Chartered Accountant in practice
Clause (1)
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.

Mr. B, a Chartered Accountant in practice was invited to deliver a seminar on GST which was attended by professionals
as well as by representatives of various Industries. One section of audience raised a particular issue unique to the
industry to which it pertains. Mr. B enthusiastically explained the issue and elaborated how he actually solved this, for
his client facing the same issue with worked out examples from the computer storage device using the actual data of one
of his clients with full identification of client details being displayed to the group for the sake giving clarity on a topic in
a real life situation. Comment his acts in the light of Code of Conduct.
(SA, May 2018, 5 marks)

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?
(Study material)

Clause (2)
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.

Points to remember
● As per section 26, No person other than a member of ICAI shall sign the document on behalf of a CA or
a firm.
● Clause 12 of Part I of First Schedule - CA in Practice - Allows a person other than Member + COP +
Partner.
● A CA can rely on work of another CA
○ SA 299
○ SA 600
Mr. B, a chartered accountant in practice certifies the report on physical verification of the inventory of the client, The
report was neither examined by him, his partner or employee of the firm or by any other CA. Comment his acts in the
light of code of conduct.
(For Self Practice)

An employee of a CA Firm signed the audit report of the client, it was not examined by anyone in the firm. Discuss

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Professional Ethics

(For Self Practice)

Clause (3)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct,
● 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.

Points to be noted.
● The Council has issued Standard on Assurance Engagements (SAE) 3400, “The Examination of
Prospective Financial Information”
● In any circumstances CA in practice shall not vouch for the accuracy of the forecast.
● 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
○ he does not vouch for the accuracy of the forecasts.

Lily, a chartered accountant prepares and certifies projected financial statements of his client Amazon Ltd. Amazon Ltd.
forwarded the same to their banks to secure some loans and bank, on that basis sanctioned a loan. Comment with
reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP1, Nov 2018, 5 marks)

Give your comments with reference to Chartered Accountants Act, 1949 and Schedules thereto: Mr. 'PK', a practicing
Chartered Accountant, was requested by one of his client to prepare a projection for next 3 years and also a report on the
same. Mr. 'PK' after having prepared the same stated in his report the sources of information, the basis of forecasts and
also the major assumptions made in arriving at the forecasts. He also stated that he does not vouch for the accuracy of
the forecasts.
(For Self Practice)

Clause (4)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct,
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.
NOTES
Independence
● 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.
● 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.

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Professional Ethics

Points to be kept in Mind for maintaining Independence


● A member should not audit financial statements of such business or enterprise of which the member is
either an owner or a partner.
● The member must refrain from undertaking the audit of financial statements of such business or
enterprise where the partner or relative of a member has substantial interest.
● The member must refrain from undertaking the audit of financial statements of such business or
enterprise where the member or his partner or relative
○ is a director or
○ in the employment of an officer or
○ an employee of the company.
● The Council has clarified that the members are not permitted to write books of account of their auditee
clients.
● A statutory auditor of a company cannot also be its internal auditor, as it will not be possible for him to
give independent and objective report.
● 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.
○ 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.
● The Council has also decided that a Chartered Accountant should not by himself or in his firm name:-
○ accept the Auditorship of a college, if he is working as a part-time lecturer in the college.
○ accept the Auditorship of a Trust where his partner is either an employee or a trustee of the
Trust.
● Internal auditor not to be the Tax auditor simultaneously
● Chartered Accountant in employment NOT 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. (He can do so if required by law)

Applicability on All type of Attest Fuctions


● 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.
● This would not, however, apply to cases where such statements are prepared by members in
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.
● 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.

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.

Section 141(3)
(3) The following persons shall not be eligible for appointment as an auditor of a company, namely:—
(a) a body corporate other than a limited liability partnership registered under the Limited Liability Partnership Act,
2008 (6 of 2009);

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Professional Ethics

(b) an officer or employee of the company;


(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(d) a person who, or his relative or partner—
(i) is holding any security of or interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company:
Provided that the relative may hold security or interest in the company of face value not exceeding one thousand rupees or
such sum as may be prescribed (Not exceeding Rs. 1 lakh)
In the event of acquiring any security or interest by a relative, above the threshold prescribed (Rs. 1,00,000), the
corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of such acquisition
or interest.
(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such
holding company, in excess of such amount as may be prescribed (Not exceeding Rs. 5 lakh) ; or
(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to
the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding
company, for such amount as may be prescribed; (Not exceeding Rs. 1 lakh.)
(e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or its
subsidiary, or its holding or associate company or subsidiary of such holding company or associate company of
such nature as may be prescribed;
For the purpose of clause (e) of sub-section (3) of section 141, the term "business relationship" shall be construed as any
transaction entered into for a commercial purpose, except -
i. commercial transactions which are in the nature of professional services permitted to be rendered by an
auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and the rules or the
regulations made under those Acts;
ii. commercial transactions which are in the ordinary course of business of the company at arm's length price
-like sale of products or services to the auditor, as customer, in the ordinary course of business, by
companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other
similar businesses.
(f) - a person whose relative
- is a director or
- is in the employment of the company as a
- director or key managerial personnel;
(g) - a person who is in full time employment elsewhere or
- a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the
date of such appointment or reappointment holding appointment as auditor of more than twenty
companies other than one-person Company, dormant companies , small companies and private
Companies having paid up capital less than 100 Crores which has not committed default in filing it’s
financial statements u/s 137 or annual return u/s 92 of companies act with the registrar.
(h) a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed
from the date of such conviction.
(i) a person who, directly or indirectly, renders any service referred to in section 144 to the company or its holding
company or its subsidiary company.

Mr. Dhawal, a practicing CA, is appointed as a Director Simplicitor in Gautam Pvt. Ltd. After three year of appointment,
Mr. Dhawal resigned as the Director and accepted the Statutory Auditor position of the Company. Is Mr. Dhawal right in
accepting the auditor position? Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto
(MTP2, May 2021, 4 marks)

CA Dev started practice in Punjab in the year 2019. CA Dev issued ‘Turnover Certificate’ for M/s. ASAUS Traders to be
forwarded to the Bank for the purpose of availing cash credit facility and machinery term loan. Brother of CA Dev was
proprietor of M/s. ASAUS Traders.
(RTP, Nov 2022, NA)

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Professional Ethics

A firm of Chartered Accountants was appointed by a company to evaluate the costs of the various products
manufactured by it. One of the partners of the firm was a Director of the company. Comment with reference to the
Chartered Accountants Act, 1949 and Schedules thereto.
(Self- Practice)

Clause (5)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he
● 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.

Mr. Sheetal, a Chartered Accountant during the course of audit of SS Ltd. came to know that the company has taken a
loan of Rs 12 lakh from Employees Provident Fund. The said loan was not reflected in the books of account. However,
the auditor ignored this information in his report. Comment with reference to the Chartered Accountants Act, 1949, and
Schedules thereto
(MTP1, Nov 2021, 4 marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto:
CA Dice had signed the Balance sheet of QR Ltd. for the year ended 31st March, 2019 which failed to give disclosure of
the charge created for Rs 4.35 crores against the Corporate Guarantee given in favour of a Group Company. The Balance
Sheet size of the company filed with the Registrar of Companies was Rs 26.12 crores.
(SA, Nov 2020, 4 marks)

NOTES
● 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 employers in the normal course of their duties and not
meant to be submitted to any outside authority.

Clause (6)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, 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.

Misstatement – A difference between the amounts, classification, presentation, or disclosure of a reported


financial statement item and the amount, classification, presentation, or disclosure that is required for the item
to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or
fraud.

Example
1. A Company did not provide for depreciation as required by Section 205 and Section 350 of the
Companies Act, 1956 (now Section 123 read with Schedule III of the Companies Act, 2013) and although

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the Chartered Accountant was aware that the Company had underprovided depreciation, he did not
bring out this fact in his report- Held the Chartered Accountant was guilty of professional misconduct
under the clause. He had failed to disclose a material fact known to him but disclosure of which was
necessary to make the financial statement not misleading.

2. The CA failed to give disclosure of Contingent Liabilities in the Financial Statements for the period
ending in 2012 against the Corporate Guarantee given in favour of a Group Company. In this context,
the CA should have verified the charges created on the basis of material available with the Company
and Registrar of Companies. The charge of ₹4.35 crores against the Balance Sheet size of ₹ 26.12 crores
was significant. Hence, omission of such information from the Financial Statements makes them
misleading and thereby reflects gross negligence on the part of the Respondent in conducting audit and
failing to report material misstatement in the financial statements of the said period.

Mr. Tarun, a Chartered Accountant in practice was appointed by Fake Limited to represent its cases before Income
Tax Authorities. In the course of proceedings, he submitted certain statements - written as well as oral - which later
found to be false and materially misleading. Comment this in the light of Professional Code.

Submitting Information as Authorized 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 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 Income Tax 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.

➔ Hence Mr. Tarun would not be held liable for professional misconduct.

Clause(7) (No Due Diligence or Gross Negligence)


A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct,
● does not exercise due diligence,
● or is grossly negligent in the conduct of his professional duties.

NOTES
● “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.”

Some examples of Gross Negligence or Not exercising Due Diligence.


● Relying entirely on the documents and representations provided by the client.

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● Not completing the work on a timely basis.


● Signing the documents or reports without examination
● Failure to check the balances in the bank from the pass book and obtaining confirmations form banks.
● A certificate issued by a Chartered Accountant to a proprietor of a firm in respect of the turnover of
betel nuts to enable the firm, which was not dealing in betel nuts, to obtain import license without
checking the books and documents himself, but relying on his articled clerk for its correctness. Held he
was guilty of gross negligence.

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
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.
(RTP, Nov 2018, NA)

Mr. Yuvi, a Chartered Accountant in practice, is the auditor of Prime Ltd. He advised the Managing Director of the
company to include ‘orders under negotiation’ in sales, to reflect higher profit and better financial position for obtaining
bank loans in future. Mr. Yuvi, thereafter, gave clean reports on the balance sheet prepared accordingly without
examining the accounts. Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto
(MTP1, May 2020, 5 marks)

Nam & Co., conducted Stock Audit of DEF Ltd. as per instructions issued by HEG Bank. However instead of visiting the
site where the stock was lying, the firm relied on the Management Information Systems report along with inspections
reports and photographs of Stock taken by the employees of DEF Ltd. The photographs were also carrying the date and
time printed on them. Comment with reference to the Chartered Accountants Act, 1949 and its schedules thereto
(SA, Jan 2021, 4 marks)

The Cashier of a company committed a fraud and absconded with the proceeds thereof. The Chief Accountant of the
company also did not know when the fraud had occurred. In the course of the audit, the auditor failed to discover the
fraud. After the audit was completed, however, the fraud was discovered by the Chief Accountant. Investigation made at
that time indicates that the auditor did not exercise proper skill and care and performed his work in a desultory and
haphazard manner. With this background, the Directors of the company intend to file disciplinary proceedings against
the auditor. Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
(SA, Dec 21, 4 marks)

Comment with reference to the with reference to the Chartered Accountants Act, 1949 and Schedules thereto. Aagam
Private Limited requested CA Sheetal, a practicing Chartered Accountant, to digitally sign the form related to
resignation of Mr. Rohit, one of the Director of Aagam Private Limited, along with the copy of Resignation Letter to be
uploaded on the website of Registrar of Companies. The signature of Mr. Rohit was simply copied and pasted by another
Director of Aagam Private Limited. CA Sheetal, without verifying the genuineness of the resignation letter, digitally
signed the form and the said form was uploaded on the website of Registrar of Companies.
(RTP, Nov 2022, NA)

Clause (8)
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 (exception/qualification of/in expression of opinion)
○ are sufficiently material
○ to negate the expression of an opinion.

NOTES
● Negate = to state that something is not true or does not exist, खंडन करना; नकारना; अस्वीकार करना

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● When the situation demands disclaimer (NEGATE), why you are giving an exception - WHY
SITUATION demands NEGATION - Because exception is MATERIAL
● The exceptions (qualification) in opinion are material enough to negate the expression of an opinion and
auditor gives opinion he will be guilty of professional misconduct.
● Example
○ Where a Chartered Accountant relying on the work of the internal auditor of a company
qualified his report that the books of account and the supporting vouchers had been examined
by the internal auditor of the company, the Council taking the view that the qualification
amounted to an exception sufficiently material to negate the expression of an opinion, found
him guilty, of misconduct under the latter part of Clause (8)

For your ready reference- Clause (2) of Part I of Second Schedule


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.

Question
CA. Prakash, a practicing 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 printer’s bills
and by not caring to ascertain how many copies were sold and paid for. Is CA. Prakash liable to professional
misconduct? Comment with reference to the Chartered Accountants Act, 1949, and Schedules thereto.
(MTP2, Nov 22, 4 marks)

Answer
As per Clause (2) of Part I of Second Schedule to the Chartered Accountants Act, 1949 a chartered accountant is held
guilty of professional misconduct if he certifies or submits 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 employee in his firm or
any other chartered accountant in practice.

Clause (7) of Part I of Second Schedule to the Chartered Accountants Act, 1949 also applies to this case which states that
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.

Clause (8) of Part I of Second Schedule to the Chartered Accountants Act, 1949 states that if a Chartered Accountant in
practice fails to obtain sufficient information to warrant the expression of an opinion or his exceptions are sufficient
material to negate the expression of an opinion, the chartered accountant shall be deemed to be guilty of a professional
misconduct.

In the given case Mr. Prakash, a practicing 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
printer’s bills and by not caring to ascertain how many copies were sold and paid for. He did not exercise due diligence

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and is grossly negligent in conduct of his professional duties.

The chartered accountant should not express his opinion before obtaining the required data and information. As an
auditor, Mr. Prakash ought to have verified the basic records to ensure the correctness of circulation figures.

Conclusion: CA Prakash will be held guilty of Professional Misconduct under Clause (2), clause (7) and clause (8) of Part I
of Second Schedule to the Chartered Accountants Act, 1949.

Mr. Anil, a Chartered Accountant was the auditor of 'A Limited'. During the financial year 2015-16, the investment
appeared in the Balance Sheet of the company of Rs. 10 lakhs and was the same amount as in the last year. Later on, it
was found that the company's investments were only Rs. 25,000, but the value of investments was inflated for the purpose
of obtaining higher amount of Bank loan.
(MTP2, Nov 2018, 5 marks)

Clause (9)
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.

NOTES
● 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.
● 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.

CA K qualified as Chartered Accountant and started practice as proprietor in the name of M/s K & Associates in the year
2015-16. LST Limited, a listed entity, appointed M/s K & Associates as Statutory Auditor for the year ended 31st March,
2022. CA K signed the balance sheet of LST Limited for the year ended 31st March, 2022 on 14th May, 2022. M/s K &
Associates never subjected themselves to the Peer Review process of the Institute since its inception of practice.
Comment with reference to the Chartered Accountants Act, 1949 and Schedules thereto
(SA, May 2022, 4 marks)

Clause (10)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he

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● 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 this connection the Council has considered some practical difficulties of the members and the following
suggestions have been made to remove these difficulties:
1. 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.
2. 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.
3. 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.
4. Moneys received by a Chartered Accountant, in his capacity as trustee, executor liquidator, etc. must be
put in a separate bank account immediately.

A film artist who was going abroad for long shooting, deposited a sum of Rs 20 lakhs with his tax consultant Mr. G, a
practising Chartered Accountant for payment of Goods and Service Tax monthly when they were due, Mr. G duly
remitted all but one instalments. He utilised the amount of instalment which he did not pay, to remit his own advance
income tax. However, while filing return of GST of the film artist, he duly remitted on her behalf the tax payable with
interest due for late payment of GST out of money lying with him. He also bore for himself the interest due to shortfall in
remittance of tax of his client. Comment on the above in the light of Code of Conduct.
(SA, May 2018, 5 marks)

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
M/s Amudhan & Co., a firm of Chartered Accountants, received Rs 2.8 lakhs in January, 2019 on behalf of one of their
clients, who has gone abroad and deposited the amount in their Bank account, so that they can return the money to the
client in July, 2019, when he is due to return to India.
(RTP, Nov 2019, NA)

CA N was appointed as an auditor of JAL Ltd. The company has branches all over the state of Haryana. CA N, in
consultation with management, decided to Visit 6 out of 10 branches. Management decided to pay him advance of Rs
2.00 Lacs against the estimated expenses of Rs 2.50 Lacs on visits to be conducted as a part of services rendered. As
agreed, Rs 2.00 Lacs was transferred in his bank account from which he met all the expenses. Comment with reference to
Chartered Accountants Act, 1949 whether the action of CA N of receiving the advance money in his saving accounts and
not keeping it in separate bank account is valid
(SA, Jan 2021, 4 marks)

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Part II - Professional misconduct in relation to members of the Institute


generally

Clause (1)
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 thereunder or
● any guidelines issued by the Council.

Some regulations related to articles

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● Taking loan from an entity in which the article or his parents are having interest in lieu of providing
articleship or continuance of it.
● Premium to provide articleship
● Security deposit from article’s father for Articleship.
● Register article without COP or without the availability of seat / vacancy
● During the working hours, the articled assistant is not permitted to attend college/other institutions for
pursuing any course including graduation. Accordingly, college timings of such courses should not be
such (after taking into account the time required to commute) which clashes with the normal working
hours of the article training.
● Payment of stipend must be by an account payee cheque, it should be paid monthly.

Comment with reference to the Chartered Accountants Act, 1949 and schedules thereto.
The manager of ZedEx (P) Ltd. approached CA. Vineet in the need of a certificate in respect of a consumption statement
of raw material. Without having certificate of practice (CoP), CA. Vineet issued the certificate to the manager of the
company, acting as a CA in practice and applied for the CoP to the Institute on very next day to avoid any dispute.
(RTP, May 2018, NA) (RTP, May 2019, NA)

Clause (2)
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.

Clause (3)
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct,
if he
● 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.

Other points
● Informing wrong number of partners or wrong partners
● False information about the timing or courses pursued by articles (if known)

A Chartered Accountant in practice certified in requisite Form that an articled assistant was undergoing training with
him, whereas, he was also employed in a company between 10 a.m. and 6 p.m. on a monthly salary of Rs. 17,000 and

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attended the office of the Chartered Accountant thereafter until 7 p.m. The Chartered Accountant pleaded that the
articled assistant was on audit of the company. Comment with reference to the Chartered Accountants Act, 1949.
(MTP2, Nov 2018, 4 marks) (MTP1, Nov 2019, 4 Marks)

Clause (4)
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct,
if he
● 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 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.

Council General 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
Applicable to all the Members of the Institute whether in practice or not

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.

Connections - As per Clause (2) of Part I of Second Schedule to the Chartered Accountants Act, 1949 a
chartered accountant is held guilty of professional misconduct if he certifies or submits 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 employee in his firm or any other chartered accountant in practice.

Clause (7) of Part I of Second Schedule to the Chartered Accountants Act, 1949 states that 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.

As per Clause (1) of Part II of Second Schedule to 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 contravenes
any of the provisions of this Act or the regulations made thereunder or any guidelines issued by the Council.

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
1. a Cash Book;
2. a Ledger.

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Chapter VI Tax Audit assignments under Section 44 AB of the Income-tax Act,


1961
● 60 Tax Audit per CA in all capacities
● Audits conducted under Section 44AD, 44AE, 44ADA - shall not be taken into account for the
purpose of reckoning the "specified number of tax audit assignments"
● The audit of the head office and branch offices of a concern shall be regarded as one tax audit
assignment.
● 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.
● Part time practicing partner - shall not be taken into account for the purpose of reckoning the tax
audit assignments of the firm.
● Sign- Any partner on behalf of firm
● Maintenance of record - A Chartered Accountant in practice shall maintain a record of the tax audit
assignments accepted by him in each financial year in the format as may be prescribed by the Council
● Clarification - 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.

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

What is undisputed audit fee?


● 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".

What is sick unit?


For this purpose, "sick unit" shall mean a unit registered for not less than five ears, which has at the end of any
financial year accumulated losses equal to or exceeding its entire net worth.

Chapter VIII Specified number of audit assignments


● A member of ICAI in practice shall not hold at any time appointment of more than“specified number of
audit assignments” of Companies under Sec 141 of the Companies Act 2013.
● For this purpose, the "specified number of audit assignments" means - 30 Audit per CA in all capacities
● with the exception of OPC and dormant companies.
● Number of partners on date of acceptance to be considered.

Chapter IX Appointment as Statutory auditor


A member of the Institute in practice

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● shall not accept the appointment as statutory auditor of


○ Public Sector Undertaking/ Government Company/Listed Company and other Public Company
having turnover of ₹ 50 crores or more in a year
● where he accepts an other work(s) or assignment(s) or service(s) in regard to the same Undertaking(s)/
Companie(s) on a 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.

Other work excludes


● audit under any other statute.
● certification work required to be done by statutory auditors; and
● any representation before an authority

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/-

If 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.

Limit as per Cos. Act for indebtness is 5 Lakhs & for guarantee or security is 1 Lakhs

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 auditors 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
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

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notified through the various announcements published on the website of ICAI www.icai.org at the relevant
times.

Chapter XV Guidelines for Networking


Concept
Network
Where larger structure is
● aimed at co-operation and
● entities within structure share significant part of
● professional resources,
○ Common systems that enable firms to exchange information such as client data, billing
and time records
○ Partners and staff
○ Technical departments
○ Audit methodology or audit manuals
○ Training courses and facilities
● profits,
● common ownership, control or management,
● common quality control policies,
● common business strategy, it is deemed to be a network.

Network Firm
Means a firm or entity that belongs to a network.

Other Points
● 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
● 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 cannot be termed as network.
● 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.
● 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

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.

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● 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’ .
2. 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.
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 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, the Institute shall reserve such name for a period of 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


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.

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.

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 network firm 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

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a. For a Network firm who is doing statutory audit, it shall be the same as mentioned in the said
notification; and
b. 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 firms constituting the network are permitted to use the words “Network Firms” on their
professional stationery.

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:
1. 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.
2. Administration of the network
3. Contribution of membership fees to meet the cost of the administration of the network.
4. Identifying a partner of any of the member firms of the network to be responsible for the assignment
(engagement partner)
5. Dispute settlement procedures through arbitration and conciliation
6. Development of training materials for members of the network
7. Issue of News-letters for staff and clients
8. Development of software for different types of assignments
9. Development and maintenance of databases relevant for different types of assignments
10. Library
11. Appointment of a technical director.
12. Determining the methodology for drawing resources from each member firm
13. Determining compensation to member firms for resources to be drawn from them
14. Peer review of the member firms

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 Affilates LLP
c. If the network is a limited company
➢ AB Affiliates P. Ltd/Limited

Chapter XVI Logo Guidelines


The logo consists of the 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

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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 it 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, Wholetime 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, Wholetime
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 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.

No audit practice can be done in Corporate Form.

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Ethical Compliance
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: -
1. 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.
2. 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.
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.

Recommended Self- Regulatory Measures

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 more important of these recommendations are as under

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.
1. where the accounting records of the branches are maintained at the head office of the respective
companies, and
2. where significant operations of an undertaking or a company are carried out at its branch office.

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.

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.

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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.

KYC requirements for a Chartered Accountant’s practice

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 the Chartered Accountancy profession in India, the Council
of ICAI thought it necessary to issue such norms to be observed by the members of the profession who
are in practice.
● 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 attest 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 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
■ Company Identification No.
■ Directors’ Names & Addresses
■ Directors’ Identification No.
3. Where Client is a Non-Corporate Entity
a. General Information
■ Name and Address of the Entity
■ Copy of PAN
■ 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

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Professional Ethics

Write a short note on: Importance of KYC requirements for a Chartered Accountant’s practice.
Answer - Importance of KYC requirements for a Chartered Accountant’s 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 the Chartered Accountancy profession in India, the Council
of ICAI recommended such norms to be observed by the members of the profession who are in
practice.
➔ These Know Your Client (KYC) Norms are also important in order to ensure a healthy growth of the
profession and an equitable flow of professional work among the members and would also further
enhance the prestige of the profession in the society.

Summary of Schedules to the Act and Clauses


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
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.

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.

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Professional Ethics

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 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 139, 140 read with Section 141 of the Companies Act, 1956, in respect of such
appointment have been duly complied with.

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.

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Professional Ethics

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.

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:

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.

(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.

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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.

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.

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Professional Ethics

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 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.

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.

Sections Related to Disciplinary Actions


Disciplinary Directorate. - Section 21
(1) The Council shall, by notification, establish a Disciplinary Directorate headed by an officer of the Institute
designated as Director (Discipline) and such other employees for making investigations in respect of any
information or complaint received by it.

(2) On receipt of any information or complaint along with the prescribed fee, the Director (Discipline) shall
arrive at a prima facie opinion on the occurrence of the alleged misconduct.

(3) Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other
misconduct mentioned in the First Schedule, he shall place the matter before the Board of Discipline and 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 Schedules, he shall place the matter before the Disciplinary
Committee.

(4) In order to make investigations under the provisions of this Act, the Disciplinary Directorate shall follow
such procedure as may be specified.

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Professional Ethics

(5) Where a complainant withdraws the complaint, the Director (Discipline) shall place such withdrawal before
the Board of Discipline or, as the case may be, the Disciplinary Committee, and the said Board or Committee
may, if it is of the view that the circumstances so warrant, permit the withdrawal at any stage.

Board of Discipline - Section 21A


1. The Council shall constitute a Board of Discipline consisting of—
a. a person with experience in law and having knowledge of disciplinary matters and the
profession, to be its Presiding Officer;
b. two members one of whom shall be a member of the Council elected by the Council and the
other member shall be nominated by the Central Government from amongst the persons of
eminence having experience in the field of law, economics, business, finance or accountancy;
c. the Director (Discipline) shall function as the Secretary of the Board.
2. The Board of Discipline shall follow summary disposal procedure in dealing with all cases before it.
3. Where the Board of Discipline is of the opinion that a member is guilty of a professional or other
misconduct mentioned in the First Schedule, it shall afford to the member an opportunity of being
heard before making any order against him and may thereafter take any one or more of the following
actions, namely: —
a. reprimand the member;
b. remove the name of the member from the Register up to a period of three months;
c. impose such fine as it may think fit, which may extend to rupees one lakh.
4. The Director (Discipline) shall submit before the Board of Discipline all information and complaints
where he is of the opinion that there is no prima facie case and the Board of Discipline may, if it agrees
with the opinion of the Director (Discipline), close the matter or in case of disagreement, may advise the
Director (Discipline) to further investigate the matter.

Disciplinary Committee. - Section 21B


1. The Council shall constitute a Disciplinary Committee consisting of the President or the
Vice-President of the Council as the Presiding Officer and two members to be elected from amongst the
members of the Council and two members to be nominated by the Central Government from amongst
the persons of eminence having experience in the field of law, economics, business, finance or
accountancy:
Provided that the Council may constitute more Disciplinary Committees as and when it considers necessary.
2. The Disciplinary Committee, while considering the cases placed before it shall follow such procedure as
may be specified.
3. Where the Disciplinary Committee is of the opinion that a member is guilty of a professional or other
misconduct mentioned in the Second Schedule or both the First Schedule and the Second Schedule, it
shall afford to the member an opportunity of being heard before making any order against him and may
thereafter take any one or more of the following actions, namely: —
a. reprimand the member;
b. remove the name of the member from the Register permanently or for such period, as it thinks
fit;
c. impose such fine as it may think fit, which may extend to rupees five lakhs.
4. The allowances payable to the members nominated by the Central Government shall be such as may be
specified.

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Authority, Disciplinary Committee, Board of Discipline and Director (Discipline)


to have powers of civil court. - Section 21C
For the purposes of an inquiry under the provisions of this Act, the Authority, the Disciplinary Committee,
Board of Discipline and the Director (Discipline) shall have the same powers as are vested in a civil court under
the Code of Civil Procedure, 1908 (5 of 1908), in respect of the following matters, namely: —
a. summoning and enforcing the attendance of any person and examining him on oath;
b. the discovery and production of any document; and
c. receiving evidence on affidavit.
Explanation.—For the purposes of sections 21, 21A, 21B, 21C and 22, "member of the Institute" includes a
person who was a member of the Institute on the date of the alleged misconduct although he has ceased to be a
member of the Institute at the time of the inquiry.

Appeal to Authority. - Section 22G


1. Any member of the Institute aggrieved by any order of the Board of Discipline or the Disciplinary
Committee imposing on him any of the penalties referred to in sub-section (3) of section 21A and
sub-section (3) of section 21B, may within ninety days from the date on which the order is
communicated to him, prefer an appeal to the Authority:

Provided that the Director (Discipline) may also appeal against the decision of the Board of Discipline or the
Disciplinary Committee to the Authority, if so authorised by the Council, within ninety days:

Provided further that the Authority may entertain any such appeal after the expiry of the said period of ninety
days, if it is satisfied that there was sufficient cause for not filing the appeal in time.

2. The Authority may, after calling for the records of any case, revise any order made by the Board of
Discipline or the Disciplinary Committee under sub-section (3) of section 21A and sub-section (3) of
section 21B and may—
a. confirm, modify or set aside the order;
b. impose any penalty or set aside, reduce, or enhance the penalty imposed by the order;
c. remit the case to the Board of Discipline or Disciplinary Committee for such further enquiry as
the Authority considers proper in the circumstances of the case; or
d. pass such other order as the Authority thinks fit:
Provided that the Authority shall give an opportunity of being heard to the parties concerned before passing
any order.

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Professional Ethics

Updates by ICAI
Fees Disclosure requirement

When the total fees generated from an audit client by the firm expressing the audit opinion represent a large
proportion of the total fees of that firm, the dependence on that client and concern about losing the client
create a self-interest or intimidation threat.

An example of an action that might be a safeguard to address such a self-interest or intimidation threat is
increasing the client base in the firm to reduce dependence on the audit client.

Disclosure requirements:
● 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.
● 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.

The firms shall - Disclose to the Institute

Exemption from applicability of the provision


● where total Fees received by Firm does not exceed 20 lacs of rupees.
● in the case of audit of government Companies, public undertakings, nationalised banks, public financial
institutions, regulators where appointments of auditors are made by the Government.

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Due Diligence, Investigation & Forensic Audit

Chapter 4 - Due Diligence, Investigation & Forensic Audit

Overview
● 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.
● Due Diligence is required to be performed in cases of acquisition of a business, corporate restructuring,
venture capital financing, lending, leveraged buyouts, public offerings, disinvestment, corporatisation,
etc.
● 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.

Difference Between Due Diligence And 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 confirm all material facts
of the prospective business opportunity.

Importance Of Due Diligence (Homework)


There are many reasons for carrying out due diligence including:
1. To confirm that the business is what it appears to be;
2. To identify potential ‘deal killer’ defects in the target company and avoid a bad business transaction;
3. To gain information that will be useful for valuing assets, defining representations and warranties,
and/or negotiating price concessions; and
4. To verify that the transaction complies with investment or acquisition criteria.

Classification Of Due-diligence
Due Diligence can be sub-classified into discipline-wise exercises in following manner
1. Commercial/Operational Due Diligence Evaluation from commercial, strategic and operational
perspectives. For example, whether the proposed merger would create operational synergies.
2. 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.
3. Tax Due Diligence: It is generally included in the financial due diligence. The accountant has to look at
the tax effect of the merger or acquisition.
4. Information Systems Due Diligence: It pertains to all computer systems and related matter of the
entity.
5. Legal Due Diligence: This may be required where legal aspects of functioning of the entity are
reviewed.
6. Environmental Due Diligence: It is carried out in order to study the entity’s environment, its flexibility
and adaptiveness to the acquirer entity.
7. 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.

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Due Diligence, Investigation & Forensic Audit

For your Reading - 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.

Aspects to be covered in Financial due diligence


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

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 the
target's business products, markets, suppliers, expenses, operations. This could, inter alia, include the following

● Nature of business(es)
● Location of production facilities, warehouses, offices.
● Employment
● Products or services and markets
● History of the business with important suppliers of goods and services
● Inventories
● 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

Accounting policies -
The accountant should study the accounting policies being followed by the target company and ascertain
whether any accounting policy is inappropriate.

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Due Diligence, Investigation & Forensic Audit

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.

Review of Financial Statements -


Preparation of Financial Statements
Before commencing the review of each of the aspects 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 warrants an inclusion in the final report on due diligence.

Operating Results
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.

Extraordinary Item
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.

Comparison with budgets


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.

Past year results and trend


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.

Similar Companies
The normal operating profits should further be benchmarked against other similar companies.

Under and over valuation


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 overvalued
assets.

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.

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Due Diligence, Investigation & Forensic Audit

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?

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.

Management and Employees -


● Problem of extra work force
● Workforce to be retained
● New requirements
● Possible litigation from workforce and its impact
● The assumptions regarding increase in salaries, interest rate, retirement etc. have to be gone into to see
if they are reasonable.
● Pay packages of the key employees as this can be a crucial factor in future costs.
● Employees Stock Option Plans
● 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.

Statutory Compliance -
● During a due diligence this is one aspect that has to be investigated in detail.
● A list of applicable laws and regulations must be there.
● Penalty levied or to be levied must be considered.

Work Approach To Due Diligence


The purchase of business in many instances is the largest and most expensive asset purchase in life time and
therefore some caution should be exercised through the due diligence process. Therefore, assessing the
businesses fair value passes through.
1. Reviewing and reporting on the financials submitted by the target company.
2. Assessing the business first hand by a site visit (if applicable).

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Due Diligence, Investigation & Forensic Audit

3. Working through the due diligence process with the acquisitioning company or investor by defining the
key areas.
4. Helping prepare an offer based on completion of due diligence.
There is no rule of thumb for when it comes to the approach of due diligence.

Conducting 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.
● Talking 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.

Contents Of A Due Diligence Report


The contents of a due diligence report will always vary with individual circumstances. Following headings are
illustrative:
● 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 unforeseen and
undetected contingent liabilities

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● Suggestions on various aspects to be taken care of before and after the proposed merger/acquisition.

KDK Bank Ltd., received an application from a pharmaceutical company for take over 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.[May 2018(New)]

Answer
Major areas to examine in course of Due Diligence Review:
➔ 'Due Diligence' is a term that is often heard in the corporate world these days in relation to corporate
restructuring. The purpose of due diligence is to assist the purchaser or the investor in finding out all he can,
reasonably 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.
➔ Due diligence is an all pervasive exercise to review all important aspects like financial, legal, commercial, etc.
before taking any final decision in the matter. As far as any hidden liabilities or overvalued assets are concerned,
this shall form part of such a review of Financial Statements. Normally, cases of hidden liabilities and overvalued
assets are not apparent from books of accounts and financial statements. Review of financial statements does
not involve examination from the view point of extraordinary items, analysis of significant deviations, etc.
However, in order to investigate hidden liabilities, the auditor should pay his attention to the following areas:
❖ 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.
❖ Contingent liabilities not shown in books.
Regularly Overvalued Assets:
The auditor shall have to specifically examine the following areas:
❖ 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.
❖ 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.

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❖ Intangibles of no value.

Question
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?
[May 2013(Old)]

Answer
Factors to be Considered in Assessing Future Maintainable 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?

Investigation
Audit and Investigation

Audit
An Audit is
● independent examination of
● Financial information of
● any entity, whether profit oriented or not , and irrespective of its size or legal form, when such an
examination is conducted
● with a view to expressing an opinion thereon.

Investigation
● It implies systematic, critical and special examination of the records of a business for a specific purpose.
● The examination conducted under investigation is intensive as well as exhaustive so far as the activities
or areas of accounting is concerned.
● Investigation requires a concentrated focus on the subject matter of inquiry & related matters.

Difference between Audit and Investigation

Basis of Investigation Audit


Difference

Objective An investigation aims at establishing a The main objective of an audit is to verify


fact or a happening or at assessing a whether the financial statements display a
particular situation. true and fair view of the state of affairs and
the working results of an entity.

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Scope The scope of investigation may be The scope of audit is wide and in case of
governed by statute or it may be non- statutory audit the scope of work is
statutory determined by the provisions of relevant law.

Periodicity The work is not limited by rigid time The audit is carried on either quarterly,
frame. It may cover several years, as the half-yearly or yearly
outcome of the same is not certain.

Nature Requires a detailed study and Involves tests checking or sample technique
examination of facts and figures. to draw evidences for forming a judgement
Investigation is voluntary in nature. and expression of opinion. It is mandatory
for companies

Inherent No inherent limitation owing to its Audit suffers from inherent limitation.
Limitations nature of engagement.

Evidence It seeks conclusive evidence. Audit is mainly concerned with prima- facie
evidence

Observance It is analytical in nature and requires a Is governed by compliance with generally


of thorough mind, capable of observing, accepted accounting principles, audit
Accounting collecting and evaluating facts procedures and disclosure requirements.
Principles

Appointing Even third party can appoint Auditor is appointed by owner/ shareholders
Agency Investigator of company/ enterprise

Reporting The outcome is reported to the person(s) The outcome is reported to the owners of the
on whose behalf investigation is carried business entity.
out.

Steps in Investigation
Step 1: Determination of objectives and establishment of scope of investigation
● The investigator should be absolutely clear about what is sought to be achieved by the investigation.
● He should obtain clearly written instructions covering the object,the scope and purpose of
investigations, period to be covered and the issues incidental thereto.

Step 2: Formulation of the investigation programme


● It is not possible to draw up one programme to serve different types of investigations
● Investigation programme should be drawn up having regard to
○ The nature of the business
○ The structure of business organization
○ The instructions from the client embodying the objectives and scope of work
○ The consequent scope and depth of investigation
○ The necessity to extend the investigation into books and records belonging to others.
○ The investigator should concentrate on areas considered relevant rather than to undertake a
wide-ranging verification.

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● 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.

Step 3: Collection of Evidence


● An investigator checks if something is true by looking at papers and asking people questions.
● They need to find the best evidence to show what really happened, and can get help from other people if
needed, but they must not disrupt the normal work of the person they are checking for.

Step 4 - Analysis and Interpretation of Findings


● Before an investigator can come to a conclusion, they need to carefully analyze and compare facts and
figures.
● The conclusion should be based on solid evidence and supported by proper records.
● The investigator must analyze the data objectively and consider various factors, such as politics and
competition. The interpretation should be brief, clear, and not doubtful.

Step 5: Reporting of findings


Nature of the report to be submitted by investigator is governed mainly by two factors
a. the instructions given by the client, and
b. findings of the investigation.

Issues to be kept in mind while preparing the report


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.

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SPECIAL ISSUES IN INVESTIGATION


Whether an investigator is required to undertake a cent per cent verification approach or
whether he can adopt selective verification
● How an investigator investigates depends on the specific situation they are investigating.
● Extent of Investigation example
○ If the investigator is trying to find missing money, they will need to look at all the records, but if
they are checking a company's profitability, they can look at only some transactions as long as
they are careful not to miss anything important.
● It's better to use statistically recognized sampling methods than just check a few things here and there.

Whether the investigator can put reliance on the already audited statement of account
Following process may be carried out
1. 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.
2. 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.
3. 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.

Whether the investigator can put reliance on the already audited statement of account
● No reliance if doubts in audited statement of account in investigation
● Investigator can rely on audited materials if requested to establish value of business, share or goodwill
unless audit carried on casually or terms require fresh tests during verification.

Whether an investigator necessarily requires assistance of expert


It would be proper for the investigator to get the written general consent of his client, to refer special matters
for views of different experts.

Investigation out of disputes and conflicting claims


● Cases for investigation can arise from disputes and conflicting claims
● Investigator must remain impartial and alert to the possibility of biased information or documents
● Client may try to influence reports, requesting favorable or lower price
● Investigator must remain professional and consider the interest of all parties

Basis of opinion of an investor


● Investigator should avoid speculative opinions
● Opinion should be based on established facts
● If facts are not clear, investigator should not express opinion or clearly state reasons if opinion is given
● Incomplete books and records can cause difficulty in establishing facts and may lead to qualified
opinions

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Whether an investigator can make futuristic statements – Even if the appointing authority is
willing to obtain a futuristic statement
● Investigator should not be futuristic
● Established trend may be assumed to continue in near future
● Projection of trend into future years to establish value not permitted

Whether to retain working papers or not


● Investigator should retain full notes, copies of schedules, and working papers
● Working papers should link book figures to final figures produced
● Representation letter should be taken from appointing authority if required these will help to explain
figures in court when accountant is challenged
● Retaining notes and working papers helps correlate facts and events and draft report.

Special Aspects In Connection With Business Investigations


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:
1. the amount required for the replacement of assets when these would become worn out or obsolete;
2. 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:
1. Trend: Whether in the past sales have been increasing consistently or they have been fluctuating. A
proper study of this phenomenon should be made.
2. Marketability: Is it possible to extend the sales into new markets or that these have been fully exploited?
Product wise estimation should be made.
3. 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?
4. 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
When assessing future working capital needs, consider these things:
● Has the ratio of inventory to turnover been increasing? Is it temporary or continuing?
● Are trade payables being paid on time, or is there a backlog that needs to be addressed?
● What happens to inventory, trade receivables, and trade payables if turnover increases or new products
are introduced?

Estimating Future Maintainable Profits


● Examine profits for fluctuations and adjust for extraneous factors

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● Determine if factors causing fluctuations are temporary or likely to recur.


● Stable or increasing percentage of profits before taxation to capital indicates continued profitability
● Falling percentage with no evidence of chance of improvement indicates inadvisable further investment

Types Of Investigation

Investigation on behalf of an Incoming Partner


Approach
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.

Incoming partner interests


● Reasonable terms: based on business nature, profit records, capital distribution, existing partners'
capabilities, socio-economic setting
● Capability to derive continuing benefit: return on capital, remuneration for services, considering overall
economic conditions and personal factors
● Capital safety and useful application

Broadly, the steps involved are the following:


i) Ascertainment of the history of the inception and growth of the firm. [Inception and growth history]

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ii) 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.
[Provisions of Partnership Deed]
iii) 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. [Profitability record]
iv) 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, patents, etc. impending
liabilities including contingent liabilities and those for pending 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. [Asset and
liability position]
v) Position of orders at hand and the range and quality of clientele should be thoroughly examined, which
the firm is presently operating. [Orders and clientele]
vi) 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 should be studied. [Loan finance
terms]
vii) 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. [Key personnel quality]
viii) 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 import of such standing agreements would be gauged
before a final decision is reached. [Contractual and Legal obligations]
ix) 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.[Admission reason]
x) 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. [Capital
employed, return of return]
xi) It would be useful to have a first hand knowledge about the specialisation, if any, attained by the firm in
any of its activities. [Firm specialization]
xii) Manner of computation of goodwill on admission as also on retirement, if any, should be ascertained.
[Goodwill computation (Manner)]
xiii) 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. [Special admission clauses]
xiv) Whether the incomplete contracts which will be transferred to the reconstituted firm will be a liability
or a loss. [Incomplete contracts impact]

1. Inception and growth history


2. Deed of partnership provisions
3. Profitability record
4. Asset and liability position
5. Orders and clientele
6. Loan finance terms

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7. Key personnel quality


8. Contractual and legal obligations
9. Admission reason
10. Capital employed, return
11. Firm specialization
12. Goodwill computation (Manner)

13. Special admission clauses


14. Incomplete contracts impact

Other points to be considered


● Personal considerations crucial in partnerships
● Assess firm's standing, partner reliability, reputation, and goodwill
● Investigating accountant devises unique considerations for each case
● Service-rendering firms: profit, business record, goodwill emphasized
● Industrial firms: customer network, scatter, and size relevant

Investigation for Valuation of Shares in Private Companies


Valuation of Shares in Private Companies:
1. Importance in Valuation should be given to
● Various purposes for valuation
● Different valuation bases
● Economic factors affecting price determination
2. Necessity for Valuation:
● Private company shares have restricted transfer, no free market to determine prices
3. Valuation Methods for Equity Shares:
● Net worth method: Value determined by net worth, including goodwill and non-trading assets
● Yield method: Average profit over preceding years, capitalized at a reasonable rate of interest
4. Valuation of Preference Shares:
● Based on yield of similar companies, adjusted for factors like transferability restrictions and
average rate of earnings
5. Special Features of different methods
● Net Worth Basis:
● Revaluation of assets based on utility to the business
● Estimation of goodwill value based on super-profit and future expectations
● Yield Basis:
● Present value of future dividends
● Projecting profit trends and dividend policies
● Capitalization rate considering various risk factors
● Consideration of Social and Political Factors:
➢ Impact on company profitability
➢ Comparison with shares of companies in similar trades
● Valuation of Control:
➢ Separate value for control in cases where it passes with share transfer
● Added to the value obtained from net worth or yield basis

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Investigation on Behalf of the Bank for Advances


Why?
● Purpose of the loan
● Repayment sources
● Security for loan default

Investigating accountant's role


Collect information on
1. Loan purpose and investment plan
2. Assess repayment schedule, assumptions, and cash availability for loan repayment
a. Lenders focus on annual profits, losses, and mortgaged asset values
3. Directors' and officers' financial standing and business integrity
4. Company authorization for borrowing in Memorandum or Articles of Association
5. Company's growth, development, and 5-year performance history
6. Impact of economic, political, and social changes on company during loan period

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) Income Statement
● Create condensed 5-year income statement
● Show income, expenses, gross and net profits, and taxes paid annually
● Determine maintainable profits
● Account for profit increase from borrowed fund investment.
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:
● Sales to Average Inventories held.
● Sales to Fixed Assets.
● Equity to Fixed Assets.
● Current Assets to Current Liabilities.
● Quick Assets (the current assets that are readily realisable) to Quick Liabilities.
● Equity to Long Term Loans.
● Sales to Book Debts.
● 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.

Verification of assets and liabilities included in the Balance Sheet of the borrower
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

1. Fixed assets: description, gross value, depreciation, encumbrances, revaluation


2. Inventory: value, types, valuation basis, slow-moving/obsolete items, pledged inventory
3. Trade Receivables: composition, credit period, bad debts, provision, recovery
4. Investments: purchase date, cost, nominal/market value, pledged investments
5. Secured Loans: debentures, outstanding amounts, due dates, collateral, asset pledge

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6. Provision of Taxation: tax assessment years, shortfall in provision


7. Other Liabilities: disclosure, trade payables analysis, trade credit reliance
8. Insurance: policy schedule, risks, premium dates, coverage adequacy
9. Contingent Liabilities: undisclosed liabilities, direct inquiries

Investigate other loan applications to other banks or financial institution and their outcomes

Investigation of Frauds
● Companies Act, 2013 defines fraud in Sections 143(12) and 447.
● Fraud is an intentional act involving deception for unjust or illegal advantage.

Types of Frauds:
1. Fraud for Personal Gains:
● Bribery: offering money or gifts for dishonest actions.
2. Corporate Frauds/ Irregularities:
● Advance Billing: booking fictitious sales to misrepresent revenue.
● Shell/Dummy Company Schemes: using fictitious companies to transfer funds or profits.
● Money-Laundering Activities: converting illegal money into legal money through the banking
system.
3. Fraud at Operational Level Employees:
● Tampering of Cheques/Drafts/On-line payments/receipts.
● Off Book Frauds: misappropriating cash before it's recorded in the books.
● Cash Misappropriation: stealing cash after it's recorded in the books.
● Teeming and Lading: overlapping cash deposits or collections to divert funds.
● Fraudulent Disbursements: issuing false bills or inflating refunds.
● Expense Reimbursement Schemes: claiming personal expenses as business expenses.
● Payroll Fraud: paying non-existent employees or inflating manpower resources.
● Commission Schemes: exaggerating sales or altering prices to earn higher commissions.

Procedure for Investigation of Fraud:


1. Ascertain the suspected person's duties, relationships, and circumstances surrounding the fraud.
2. Study the financial and accounting structure of the organization.
3. Examine the line of responsibility between staff members.
4. Review the internal control system for weaknesses.
5. Direct the inquiry towards aspects where there is excessive control or inherent weakness.

Some of the way in which money can be embezzled and their investigation procedures
Cash Receipts
Methods
1. Issuing a receipt to the payee for the full amount collected and entering only a part of the amount on
the counterfoil.
2. Showing a larger cash discount than actually allowed.
3. Adjusting a fictitious credit in the account of a customer for the value of goods returned by him.
4. Adjusting a cash sale as a credit sale, and raising a debit in the account of the customer.
5. Writing off a good debt as bad and irrecoverable to cover up the amount collected which has been
misappropriated.

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Verification of Cash Receipts


1. Scrutinize evidence of income received from various sources, such as inventory, sales summaries, rental
registers, customer correspondence, salesman advices, and receipt counterfoils.
2. Examine carbon copies of receipts marked 'duplicate' to confirm they are copies of earlier issued
receipts.
3. Compare cash deposit details on bank paying-in-slips with those in the Cash Book.
4. Investigate records of scrap sales, rent collections, refunds from utilities or government authorities to
detect potential misappropriation.
5. Vouch cash sales in detail and check recoveries from customers and parties against receipt copies.
6. Review cash discount deductions and ensure all bank withdrawals correspond to entries in the bank
pass book.

Inflating cash payment


Methods
Cash payment frauds may be in the form of
1. Making double payment of an invoice or paying a false invoice.
2. Paying personal expenses out of the business by falsifying details. e.g., showing betting losses as
advertisement charges.
3. Withdrawing unclaimed credit balances of customers or amounts falsely credited in the accounts of
parties.
4. Falsely adjusting a refund in the account of a customer and withdrawing the credit balance.
5. Wrong totalling of the wage sheets and misappropriating the excess amount withdrawn from the bank
for payment of wages.

Verification of Cash Payments:


1. Scrutinize evidence of cash payments, including acknowledgements from parties receiving payments.
2. Confirm actual amounts paid when receipts show erasures or alterations.
3. Examine all payments made by bearer cheques.
4. Review the wage recording system for over-totalling or dummy workmen entries.
5. Assess the system of ordering and receiving goods to ensure no payments for unreceived supplies.
6. Obtain confirmations from partners or directors for amounts paid to them.
7. Vouch and total the Petty Cash Book, paying special attention to salary and wage payments.
8. Confirm with management that all salary and wage payments were made to actual employees.
9. Check bank withdrawals by referencing entries in the bank's pass book.
10. Verify bills receivable and payable by cross-checking with the Bills Books.

Frauds through suppliers’ ledger


Methods
1. 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.
2. Suppressing the Credit Notes issued by suppliers and withdrawing the corresponding amounts not
claimed by them.
3. Withdrawing amounts unclaimed by suppliers, for one reason or another by showing that the same have
been paid to them.
4. Accepting purchase invoices at prices considerably higher than their market prices and collecting the
excess amount, paid in cash, from the suppliers.

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Verification of Balances in Suppliers' Ledger:


1. Vouch Purchase Journal with Goods Inward Book and suppliers' invoices to confirm accurate credits to
suppliers' accounts.
2. Request statements from all suppliers to verify outstanding balances and ensure correct adjustments for
allowances and rebates.
3. Examine the internal control system for purchase orders and identify potential collusion with suppliers.

Customers’ ledger
Methods
1. 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.
2. 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.
3. 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:


1. Pay special attention to allowances, adjustments, and bad debt write-offs.
2. Cross-check Order Book entries with Sales Day Book to confirm accurate debits for supplied goods.
3. Obtain customer confirmations for outstanding account balances.
4. Request customers with zero balances to verify the accuracy of their account statements and ensure
genuine entries.

Inventory Frauds
Methods
Inventory frauds are many and varied but here we are concerned with misappropriation of goods and their
concealment.
1. Employees may simply remove goods from the premises.
2. Theft of goods may be concealed by writing them off as damaged goods, etc.
3. Inventory records may be manipulated by employees who have committed theft so that book quantities
tally with the actual quantities of inventories in hand.
4. Inflating the quantities issued for production is another way of defalcating raw materials and store
items.
5. Stocks actually dispatched but not entered in sales/ debtor’s account.

Verification Procedure for Defalcation of Inventory:


1. Review the entire system of receipts, storage, and dispatch to identify weaknesses.
2. Determine defalcated items and quantities by physically checking inventory and comparing with
Inventory Book.
3. Ascertain the duties of personnel handling stocks and identify excessive control by a single person
without supervision. (Check for lack of segregation of duties)
4. Verify Inventory Book receipts and issues with Goods Inward and Outward Registers and purchase/sale
documents.
5. Verify raw materials, stores, and tools issued for production, and manufactured goods received in the
godown.

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Due Diligence, Investigation & Forensic Audit

6. Investigate potential management defalcations by analyzing inflated production wastage and excessive
material issued for production.
7. Consult an engineer to determine the extent of inflated shortages and verify the adequacy of materials
issued for production.

Indicators of Fraud
Indicators of Fraud:
1. Discrepancies in Accounting Records:
● Non-recording, partial recording, incorrect recording, or delayed recording of amounts.
● Misclassifications.
2. Conflicting or Missing Evidence:
● Missing documents, altered documents.
● Significant unexplained items in reconciliations.
● Discrepancies between entity's records and confirmations received.
3. Unacceptable Management Responses:
● Denial of access to records, facilities, or employees.
● Undue time pressure to resolve complex issues.
● Unusual delays in providing requested information.
● Denial for the use of Computer Assisted Audit Techniques.
● Unwillingness to address identified deficiencies in internal control.
4. Other Indications:
● Accounting policies in variance with industry norms.
● Frequent changes in accounting estimate

Responses to Fraud
1. Auditor's Response to Assessed Risks (SA 330 & SA 240z):
● Assign and supervise personnel, considering their knowledge, skill, and ability.
● Evaluate the selection and application of accounting policies by the entity.
● Incorporate unpredictability in the selection of audit procedures' nature, timing, and extent.
2. Response to Management Override of Controls:
● Test the appropriateness of journal entries and adjustments in Financial Statements.
● Review accounting estimates for biases.
● Review significant transactions outside the normal course of business or appearing unusual.
3. Assess Fraud Risk Factors:
● Evaluate incentives/pressures, opportunities, and attitudes/rationalizations for material
misstatement or asset misappropriation.
4. Communication and Documentation:
● Communicate with management and those charged with governance.
● Communicate with regulatory and enforcement authorities when necessary.
● Document the assessment of risks of material misstatement and response to fraud.

Auditor’s ability to detect fraud


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

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● the seniority of those individuals involved.

Investigation on behalf of an Individual or Firm Proposing to Buy a Business


Investigation for Buying a Business:
1. Scope of investigation:
● Similar to valuation of shares
● Determine whether buying the business is worthwhile and at what price
2. Additional matters for proprietary concerns or partnerships:
● Reasons for sale and effect on turnover and profits
● Lease terms and prospects of renewal or extension
● Unexpired period of patents owned by vendors
● Age of managerial staff and prospects under new ownership
● Liability for pensions or gratuities for old or retrenched employees
● Impact of loss of key customers on profitability
● Valuation of goodwill
3. Additional matters for limited companies:
● Authorized and issued capital
● Uncalled liability on shares
● Rights attached to different classes of shares
● Dividend history and arrears on cumulative preference shares
● Mortgages or charges on company assets, search in Register of Charges
● Price at which shares are being offered and valuation of shares for purchase

Investigation in Connection with Review of Profit/Financial Forecasts


1. Purpose of investigation:
● Required for general investigations into business purchases
● Required by banks and financial institutions for loan applications and project appraisals
2. Challenges in forecasting:
● Forecasts depend on the nature of the business and involve numerous uncertainties
● Forecasts cannot be verified in the same way as financial statements for completed accounting
periods
3. Special review considerations:
● These situations differ from the auditor's traditional role of expressing opinions on past events
● The investigation should focus on the reasonableness of assumptions, methodology, and
potential risks in the forecasts
● The investigating accountant should evaluate the historical performance, trends, and market
conditions to assess the reliability of the forecasts

Forensic Audit
Introduction
● “Forensic” means “suitable for use in the court of law”. Forensic Accountants have to work to the
standard that their outcome must be suitable for use in the court of law.
● Forensic Accounting: The blend of accounting, auditing and investigative skills to look into theft,
fraud or other similar situations.

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Due Diligence, Investigation & Forensic Audit

● A forensic audit is an examination and evaluation of financial records to derive evidence that can be
used in a court of law or legal proceeding.
● Forensic audits require the expertise of accounting and auditing procedures as well as expert
knowledge about the legal framework of such an audit.

AUDIT V/S. FORENSIC ACCOUNTING/FORENSIC AUDIT


Basis Forensic Audit Financial Audit

Meaning A forensic audit is an examination and Examination of Financial Information so as to


evaluation of financial records to derive express an opinion on true and fair view of state
evidence that can be used in a court of law of affairs and financial results.
or legal proceeding.

Techniques Investigative and Substantive Compliance and Substantive

Checking Detailed Test Checking is Used

Period / Timing No Specified Timing. Period is decided as Generally for a financial year and can be
per the situation and requirement concluded only when financial statements are
prepared in full

Objective To establish a fact, generally whether To express an opinion on true and fair view.
fraud was conducted or not

Reliance on No. Independent verification is conducted Yes. They are considered as audit evidence, but
Management not sufficient and appropriate evidence.
Certificates etc

Thought Process Investigative Professional Skepticism

FORENSIC AUDITOR Involvement


A Forensic Auditor is often involved in (Why we need Forensic Audit?)

Fraud Detection
● Investigating and analyzing financial evidence,
● Detecting financial frauds and
● Tracing misappropriated funds

Computer Forensics
Developing computerized applications to assist in the recovery, analysis and presentation of financial evidence;

Fraud Prevention
● Reviewing internal controls to verify their adequacy
● Providing consultation in the development and implementation of an internal control framework
aligned to an organization's risk profile.

Providing Expert Testimony


● Assisting in legal proceedings,

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● Testifying in court as an expert witness and


● Preparing visual aids to support trial evidence.

Importance of Forensic Auditors


They can resolve the matters by combining accounting knowledge & experience with respect to:
● Fraud Prevention
● Fraud Detection
● Risk Management
● Internal Controls Implementation and Review
● Evidence Collection and Analysis

Areas in which forensic auditor can provide services


The services rendered by the forensic accountants are in great demand in the following areas
1. Criminal Investigation
2. Professional Negligence cases
3. Arbitration services
4. Fraud Investigation and Risk/Control Reviews
5. Settlement of insurance claims
6. Dispute Settlement

Services rendered by Forensic Auditors


● Crafting questions to be posed
● Responding to questions posed
● Identifying documents to be requested and/or subpoenaed
● Identifying individuals to be most knowledgeable of facts
● Conducting research relevant to facts of the case
● Identifying and preserving key evidence
● Evaluating produced documentation and information for completeness
● Analysing produced records and other information for facts
● Identifying alternative means to obtain key facts and information
● Providing questions for deposition and cross examination of fact and expert witnesses

PROCESS OF FORENSIC ACCOUNTING


Step 1. Initialization
Meet The Client
● To obtain an understanding of the important facts, issues at hand.
● Will help in understanding the need of the client and resources required.
● Will help in preparing a detailed plan.

Step 2. Develop Plan


● This plan will take into account the knowledge gained by meeting with the client.
● will help is determining the
○ objectives to be achieved and
○ the methodology to be utilized to accomplish them.

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Step 3. Obtain Relevant Evidence


● Locating documents, economic information, assets, a person or company, another expert or proof of
the occurrence of an event.
● Understanding the fraud and how it is committed will impact the evidence required.

Step 4. Perform the analysis


The actual analysis performed will be dependent upon the nature of the assignment and may involve:
● Using computers and computer based technique
● Tracing of transactions
● Processing of huge volume of transactions
● Calculating economic damages;
● Creating Maps and Diagrams to understand and present the flow used for fraud.
● Use of Statistics and other related techniques

Step 5. Reporting
● Will Include Various Sections / Parts Explaining Relevant Details of the assignment such as
○ Scope
○ Approach
○ Limitations (if any)
○ Findings
■ How fraud was conducted
■ Person(s) responsible
■ Amount Involved
■ Why systems failed.
○ Summary
○ Conclusions
○ Schedules, Diagrams, Annexures etc.

Step 6. Court proceedings


● The investigation is likely to lead to legal proceedings against the suspect(s).
● The team of forensic audit must be ready to describe the evidence in front of court and all other
details mentioned in the report by the forensic auditor.

FORENSIC AUDIT TECHNIQUES


Some of the techniques that a forensic auditor may use are listed below:

Reperforming / Replicate the (alleged) fraud


● This technique requires you to attempt to put yourself in the shoes and think like your suspect.

Statistical & Mathematical Techniques:


● Trend Analysis -Careful review of the subject organization's historical norms is necessary in order for
you to be able to isolate the exceptional events and transactions
● Ratio Analysis - Another useful fraud detection technique is the calculation of data analysis ratios for
key numeric fields. Like financial ratios that give indications of the financial health of a company, data
analysis ratios report on the fraud health by identifying possible symptoms of fraud.

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Technology based /Digital Forensics Techniques


● Every transaction leaves a digital footprint in today's computer-driven society. Close scrutiny of
relevant emails, accounting records, phone logs and target company hard drives is a requisite facet of
any modern forensic audit.
● Before taking steps such as obtaining data from email etc. the forensic auditor should take appropriate
legal advice so that it doesn’t amount to invasion of privacy.
● Digital investigations can become quite complex and require support from trained digital investigators.
● Many open-source digital forensics tools are now available to assist you in this phase of the
investigation.
● Examples are

(i) Cross Drive Analysis (vi) EnCase

(ii) Live Analysis (vii) MD5

(iii) Deleted Files (viii) Tracking Log Files

(iv) Stochastic Forensics (ix) PC System Log

(v) Steganography (x) Free Log Tools

Computer Assisted Auditing Techniques (CAATs):


● Computer Assisted Auditing Techniques and computer programs are developed to audit electronic data
● It will increase the accuracy of audit tests; and
● Perform audit tests more efficiently, which in the long-term will result in a more cost effective audit.
● Example - Audit Command Language (ACL), Interactive Data Extraction and Analysis (IDEA) and
Panaudit.

Common Software Tool (CST):


● They are common softwares, not specifically created for audit but are used for auditing.
● Spreadsheets (like MS Excel, Lotus, etc.), RDBMS (like MS Access, etc.) and Report writers (like Crystal
reports, etc.) are few examples of CSTs.
● Advantage
○ Low Cost
○ Standardised
○ No dependent on Operating System
○ Easy access and Retrieval
○ Simple and easy to use

Data Mining Techniques: (technique to be used for identifying any hidden patterns in the
information)
● Data mining technique is a set of assisted techniques designed to automatically mine large volumes of
data for new, hidden or unexpected information or patterns.
● It discovers the unusual knowledge or patterns in data, without a predefined idea or hypothesis about
what the pattern may be, i.e. without any prior knowledge of fraud.
● It explains various affinities(similarties), association, trends and variations in the form of conditional
logic.

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Due Diligence, Investigation & Forensic Audit

● Data mining techniques are categorized in three ways: Discovery, Predictive modeling and Deviation
and Link analysis

Laboratory Analysis of Physical and Electronic Evidences


Few Example
● hard disk imaging
● E-mail analysis
● search for erased files
● analyse use & possible misuse of data
● computer software to analyze data

FORENSIC AUDIT REPORT


Forensic Audit Report is statements of observation gathered & considered while providing conclusive evidence.
It will be based on the findings of the investigation.

Points to be kept in mind.

Clear thinking ● To whom the report is directed.


● Purpose and aim of investigation.
● logical presentation.

Importance must be ● Translate technical matters to easy to understand language.


given to the reader ● To give information from the user / reader’s point of view.

Unbiased approach ● To mention the view point of the auditee

Impact of the report ● What is the probable reaction to reporting whether action or decision will
follow in the quickest possible time or to be treated as of academic interest
only?
● To remember the universal saying - "don't jump to conclusions"

Sequences and ● Facts and figures to be in proper sequences and suggestions to prevent
Suggestions fraud in future.

The main factors to be considered for the various ways of presentations of written reports are
1. Nature of business of the organization
2. Nature of subject or aspect appraised
3. For whom the report is intended
4. Purpose for which the report is prepared
5. Management attitude, directives and needs
6. Forensic auditor's approach and calibre
7. Extent of details required by auditee and management.

Broad areas of information to be incorporated in the report of Forensic auditor -


Issuing an audit report is the final step of a fraud audit. 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.

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Due Diligence, Investigation & Forensic Audit

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.

The forensic auditor should have active listening skills which will enable him to summarize the facts in the
report. It should be kept in mind that the report should be based on the facts assimilated during the process
and not on the opinion of the person writing the report

Annexure
Definition of Red Flag
Red flags are indicators or warnings of any impending danger or inappropriate behavior. Red flags do 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.

What points should be kept in mind by the management while appointing a forensic auditor
Characteristics of Forensic Auditor
● Out of the Box Thinking
● Strong Visualization and Imagination
● Curiosity
● Persistence
● Detail-oriented
● Inquisitiveness
● Creativity
● Discretion
● Skepticism
● Confidence and
● Sound professional judgement
● Objectivity and credibility

Skills - Forensic Auditor should possess


● Auditing standards, related methodologies procedures and
● Accounting systems & Business reporting
● Information Technology
● Data Analytics
● Criminology
● Legal Framework
● Litigation processes & procedures
● Investigative Techniques
● Evidence gathering
● Network of professional contacts in related fields' viz. enforcement, regulatory bodies, law, industry,
peers etc.

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Sample Table of Contents of a Forensic Audit Report may include the following
1. Title of the report
2. Executive Summary
3. Engagement Details
a. Background
b. Objective
c. Approach
4. Risk Analysis
a. Internal
■ Customer
■ Supplier
■ Human Resources
b. External
■ Political and Legal
■ Technology
■ Market Conditions
5. Audit Process
6. Evidence of Risk Events
7. Audit Recommendation
8. Implementation of Recommendations
a. Budget consideration
b. Stakeholder view point and conflict (if any), conflict resolution (if required)
9. Various Annexures, Schedules, Diagrams etc. (If required)

ABC Ltd. is a listed company having turnover of Rs 50 crores & plans expansion by installation of new machines at new
building-having total additional project cost of Rs 20 crore

Rupees (In crore) Purpose

10.0 - for Building


8.5 - for Machinery
1.5 - for Working Capital

20 cr

Project gets implemented in 2017-18 and one of the accountants points out to Managing Director that something wrong
has happened in the purchase of building material.
On hearing this, the management is planning to appoint Forensic Auditor. Advise management that how is a forensic
accounting analysis is different from an audit.
(RTP, May 2018, NA) (ICAI study mat)

OR
Explain how a Forensic Audit differs from an Assurance Engagement
(SA, May 2018, 4 marks)

OR
Shipra recently qualified as a Chartered Accountant and started her own practice. One of her friends told her that
Forensic Audit is a new area and has a lot of potential in terms of professional opportunities and remuneration. Seema

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Due Diligence, Investigation & Forensic Audit

said that there is nothing new in this as ultimately forensic audit is also like other audits. Do you agree with the views of
Seema? Support your answer with relevant explanation
(RTP, May 2022, NA)

OR
You have been requested to carry out a forensic audit of a listed entity by the Board of Directors, based on a whistle
blower complaint received. Before the commencement of the forensic audit, you and your team, are discussing the
various aspects relating to the scope and the procedures to be carried out. What would be the items of discussion with
respect to the differences between forensic audit and other audit?
(SA, Nov 2022, 4 marks)

ACT Silk Industries is a leading textile manufacturing listed company. In the course of evidence collection and analysis,
it was observed that the company is involved in siphoning of funds through payments to shell companies. Hence, SEBI
appointed B & S As sociates, Chartered Accountants, as forensic auditors of the company. Enumerate in brief the steps to
be taken by B & S Associates in forensic audit process.
(SA, Dec 2021, 5 marks)

You have been appointed as a forensic accountant in M/s Secure Ltd. to carryout various analysis as a part of your
assignment to arrive at a particular result. Specify the various analysis which might have to be carried out by you to
arrive at your result.
(SA, May 2019, 5 marks)

CA Robo has been appointed as Forensic Auditor by BMY Bank Limited for one of its borrowal accounts WRONG Ltd.
CA Robo started the audit by first reviewing the transactions of the borrower in Bank statement as per Bank records to
identify any hidden patterns in that information. She had to review huge volume of data, as the number of transactions
per day were in hundreds and the data was to be reviewed for the last three years. So, she was stuck up as to how to
proceed further to identify any hidden patterns in information, if any. Guide CA Robo, suggesting which technique to be
used for identifying any hidden patterns in the information.
(SA, Nov 2020, 4 marks)

M/s GSB Limited is into the business of construction for the past 25 years. Management of the Company came to know
that building material sent to construction sites are of substandard quality whereas the payment released by the accounts
department of the Company are on the higher side. Forensic Auditor was asked to carry out detailed investigation.
Forensic auditor completed his investigation and now preparing his report. What are the broad areas of information that
needs to be incorporated in the report of forensic auditor?
(SA, July 2021, 4 marks)

BR Construction was into the business of building roads and other infrastructure facilities for government contracts. Mr.
Tiwari, one of the senior official, was looking after the procurement of cement required at the construction sites. There
was a substantial increase in the price of cement bags bought as compared to those bought prior to the appointment of
Mr. Tiwari. The management of the company decides to get a forensic audit done for the transactions handled by Mr.
Tiwari. What points should be kept in mind by the management while appointing a forensic auditor?
(MTP2, May 2022, 4 marks) (ICAI study mat)

TQR Limited is engaged in the business of garment manufacturing having registered office at Mumbai and branches
across India. Mr. Shyam, one of the senior Managers was involved in creating false documents and legitimate documents
were altered to support fictitious transactions. Consequently, the management appointed you to get forensic audit done
based on the digital foot-print of transactions handled by Mr. Shyam. The use of sound techniques will enable to discover
the defalcations on a timely basis. As a forensic auditor how will you deal and suggest Technology based/Digital forensic
techniques.
(SA, May 2022, 5 marks)

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Write a short note on: Services rendered by Forensic Auditors


(RTP, Nov 2022, NA)

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Chapter-5 Company Audit


CHAPTER X- AUDIT AND AUDITORS

Section Particulars

139 Appointment of auditors

140 Removal, resignation of auditor and giving of special notice

141 Eligibility, qualifications and disqualifications of auditors.

142 Remuneration of auditors.

143 Powers and duties of auditors and auditing standards

144 Auditor not to render certain services.

145 Auditor to sign audit reports, etc.

146 Auditors to attend general meetings.

147 Punishment for contravention.

148 Central Government to specify audit of items of cost in respect of certain companies

Companies (Audit and Auditors) Rules, 2014


Rule No. Particulars

1 Short title and commencement

2 Definitions

3 Manner and procedure of selection and appointment of auditors

4 Conditions for appointment and notice to Registrar

5 Class of Companies

6 Manner of rotation of auditors by the companies on expiry of their term.

7 Removal of the auditor before expiry of his term

8 Resignation of auditor

9 Omitted

10 Internal financial controls

11 Other matters to be included in auditors report

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12 Duties and powers of the company's auditor with reference to the audit of the branch
and the branch auditor.

13 Reporting of frauds by auditor and other matters.

14 Remuneration of the Cost Auditor

FORM ADT 1 Information to the registrar by the company for appointment of auditor

FORM ADT 2 Application for removal of auditor(s) from his / their office before expiry of term

FORM ADT 3 Notice of resignation by auditor

FORM ADT 4 Report of the central government

Companies (Cost Records and Audit) Rules, 2014


Rule No. Particulars

1 Short title and commencement

2 Definitions

3 Application of Cost Records.

4 Applicability for cost audit.

5 Maintenance of records

6 Cost audit

7 Omitted

FORM CRA 1 Form in which cost record shall be maintained

FORM CRA 2 Form for intimation of appointment of cost auditor by the company to Central
Government

FORM CRA 3 Form of the cost audit report

FORM CRA 4 Form for filing cost audit report with central government

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Appointment of auditors - 139

Appointment of Subsequent Auditor other than Government Company - 139. (1)


Subject to the provisions of this Chapter,
● every company
● shall,
● at the first annual general meeting,
● appoint an individual or a firm as an auditor
● who shall hold office
○ from the conclusion of that meeting till the conclusion of its sixth annual general meeting
○ And the manner and procedure of selection of auditors by the members of the company at such
meeting shall be such as may be prescribed.

Provided further that


● before such appointment is made,
● the written consent of the auditor to such appointment, and
● a certificate from him or it
○ that the appointment,
○ if made,
○ shall be in accordance with the conditions as may be prescribed, shall be obtained from the
auditor:

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Provided also that the certificate shall also indicate whether the auditor satisfies the criteria provided in section
141

Provided also that the company shall inform the auditor concerned of his or its appointment, and also file a
notice of such appointment with the Registrar within fifteen days of the meeting in which the auditor is
appointed.

Recommendation of Audit Committee - 139 (11)


Where a company is required to constitute an Audit Committee under section 177, all appointments, including
the filling of a casual vacancy of an auditor under this section shall be made after taking into account the
recommendations of such committee.

Manner and procedure of selection and appointment of auditors - Rule 3


3. (1) In case of a company that is required to constitute an Audit Committee under section 177, the committee,
and, in cases where such a committee is not required to be constituted, the Board, shall take into consideration
the qualifications and experience of the individual or the firm proposed to be considered for appointment as
auditor and whether such qualifications and experience are commensurate with the size and requirements of
the company:

Provided that while considering the appointment, the Audit Committee or the Board, as the case may be, shall
have regard to any order or pending proceeding relating to professional matters of conduct against the
proposed auditor before the Institute of Chartered Accountants of India or any competent authority or any
Court.

(2) The Audit Committee or the Board, as the case may be, may call for such other information from the
proposed auditor as it may deem fit.

(3) Subject to the provisions of sub-rule (1), where a company is required to constitute the Audit Committee, the
committee shall recommend the name of an individual or a firm as auditor to the Board for consideration and
in other cases, the Board shall consider and recommend an individual or a firm as auditor to the members in the
annual general meeting for appointment.

(4) If the Board agrees with the recommendation of the Audit Committee, it shall further recommend the
appointment of an individual or a firm as auditor to the members in the annual general meeting.

(5) If the Board disagrees with the recommendation of the Audit Committee, it shall refer back the
recommendation to the committee for reconsideration citing reasons for such disagreement.

(6) If the Audit Committee, after considering the reasons given by the Board, decides not to reconsider its
original recommendation, the Board shall record reasons for its disagreement with the committee and send its
own recommendation for consideration of the members in the annual general meeting; and if the Board agrees
with the recommendations of the Audit Committee, it shall place the matter for consideration by members in
the annual general meeting.

(7) The auditor appointed in the annual general meeting shall hold office from the conclusion of that meeting
till the conclusion of the sixth annual general meeting, with the meeting wherein such appointment has been
made being counted as the first meeting.

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Conditions for appointment and notice to Registrar - Rule 4


4. (1) The auditor appointed under rule 3 shall submit a certificate that -
a. the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for
appointment under the Act, the Chartered Accountants Act, 1949 and the rules or regulations made
thereunder;
b. the proposed appointment is as per the term provided under the Act;
c. the proposed appointment is within the limits laid down by or under the authority of the Act;
d. the list of proceedings against the auditor or audit firm or any partner of the audit firm pending with
respect to professional matters of conduct, as disclosed in the certificate, is true and correct.

(2) The notice to Registrar about appointment of auditor under fourth proviso to sub-section (1) of section 139
shall be in Form ADT- 1

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Rule 3 Charts

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Subsequent Auditor Government Company - 139(5)


(5) Notwithstanding anything contained in sub-section (1), in the case of
● a Government company or
● any other company
○ owned or controlled,
○ directly or indirectly,
○ by the Central Government, or by any State Government or Governments, or partly by the
Central Government and partly by one or more State Governments,

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● the Comptroller and Auditor-General of India shall,


○ in respect of a financial year,
○ appoint an auditor duly qualified to be appointed as an auditor of companies under this Act,
○ within a period of one hundred and eighty days from the commencement of the financial year,
who shall hold office till the conclusion of the annual general meeting.

Section 2(45) - Government Company - Government company" means any company in which
● not less than fifty-one percent of the paid-up share capital is held by the Central Government,
● or by any State Government or Governments,
● or partly by the Central Government and partly by one or more State Governments,
● and includes a company which is a subsidiary company of such a Government company

First Auditor Other than Government Company - 139(6)


(6) Notwithstanding anything contained in sub-section (1),
● the first auditor of a company, other than a Government company,
● shall be appointed by the
○ Board of Directors within thirty days from the date of registration of the company and
○ in the case of failure of the Board to appoint such auditor,
■ it shall inform the members of the company,
■ who shall within ninety days at an extraordinary general meeting
■ appoint such auditor and such auditor shall hold office till the conclusion of the first
annual general meeting.

First Auditor Government Company - 139(7)


(7) Notwithstanding anything contained in sub-section (1) or sub-section (5), in the case of
● a Government company or any other company owned or controlled, directly or indirectly, by the Central
Government, or by any State Government, or Governments, or partly by the Central Government and
partly by one or more State Governments,
● the first auditor shall be appointed by the
○ Comptroller and Auditor-General of India within sixty days from the date of registration of the
company and in case the Comptroller and Auditor-General of India does not appoint such
auditor within the said period, the Board of Directors of the company shall appoint such auditor
within the next thirty days; and in the case of failure of the Board to appoint such auditor within
the next thirty days, it shall inform the members of the company who shall appoint such auditor
within the sixty days at an extraordinary general meeting, who shall hold office till the
conclusion of the first annual general meeting.

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139(8) - Casual Vacancy


Any casual vacancy in the office of an auditor shall—
● in the case of a company other than a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India,
○ be filled by the Board of Directors within thirty days,
○ but if such casual vacancy is as a result of the resignation of an auditor, such appointment shall
also be approved by the company at a general meeting convened
○ within three months of the recommendation of the Board and he shall hold the office till the
conclusion of the next annual general meeting;
● in the case of a company whose accounts are subject to audit by an auditor appointed by the
Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India
within thirty days:

Provided that in case the Comptroller and Auditor-General of India does not fill the vacancy within the said
period, the Board of Directors shall fill the vacancy within next thirty days.

139(2) - Rotation
No listed company or a company belonging to such class or classes of companies as may be prescribed, shall
appoint or re-appoint—
a. an individual as auditor for more than one term of five consecutive years; and
b. an audit firm as auditor for more than two terms of five consecutive years

Cooling period
Provided that—
● an individual auditor who has completed his term under clause (a) shall not be eligible for
re-appointment as auditor in the sa me company for five years from the completion of his term;

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● an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as
auditor in the same company for five years from the completion of such term:

Firm having common partner or partner


Provided further that as on the date of appointment no audit firm having a common partner or partners to the
other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be
appointed as auditor of the same company for a period of five years

Provided also that, nothing contained in this sub-section shall prejudice


● the right of the company to remove an auditor or
● the right of the auditor to resign from such office of the company.

139(3)
Subject to the provisions of this Act, members of a company may resolve to provide that—
a. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as
may be resolved by members; or
b. the audit shall be conducted by more than one auditor

139(4)
The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors
in pursuance of sub-section (2).

Section 139(2) - Super Summary For Understanding

For listed and prescribed companies


● An Individual cannot be appointed as auditor for more than one term of 5 consecutive years.
● A Firm cannot be appointed as auditor for more than 2 terms of 5 consecutive years.

Individual or firm as the case may be once completes the term (1 term of 5 CY or 2 term of 5CY) as mentioned
above will not be eligible to be reappointed as auditor in the same company for 5 years from the completion
of such term.

Not only individual or the firm the following will also be not eligible to be appointed as the auditor of such a
company
● Partner of the outgoing firm
● Firm having common partner as on the date of appointment.
● Incoming auditor associated with outgoing auditor.
● Incoming auditor and outgoing auditor belongs to same network.
● Firm joined by partner who certified the financial statements.

Any break in 1 term of 5CY or 2 terms of 5CY will be considered as a break only if it is of 5 years or more.

Individual is auditor in a company specified under Section 139(2), the auditor resigned after 4 years. Can The
same auditor be reappointed after 1 year for another 5 years. NO.

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This Rule 5 (Provisions related to rotation) will not be applicable on


● OPC (One Person Company)
● Small Company

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139(9) Reappointment of retiring auditor


Subject to the provisions of sub-section (1) and the rules made thereunder, a retiring auditor may be
re-appointed at an annual general meeting, if—
a. he is not disqualified for re-appointment;

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b. he has not given the company a notice in writing of his unwillingness to be re-appointed; and
c. a special resolution has not been passed at that meeting appointing some other auditor or providing
expressly that he shall not be re-appointed.

139(10) - No auditor is appointed or reappointed


Where at any annual general meeting, no auditor is appointed or reappointed, the existing auditor shall
continue to be the auditor of the company.

Section 143 Powers and duties of auditors and auditing standards


143. (1) Every auditor of a company shall have a
● right of access
○ at all times
○ to the books of account and vouchers of the company,
○ whether kept at the registered office of the company or at any other place and
● shall be entitled to require
○ from the officers of the company
○ such information and explanation as he may consider necessary for the performance of his
duties as auditor and
● amongst other matters inquire into the following matters, namely:—
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:

Provided that the auditor of a company which is a holding company shall also have the right of access to the
records of all its subsidiaries and associate companies insofar as it relates to the consolidation of its financial
statements with that of its subsidiaries and associate companies.

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Right of Access to Minute Book (Important)


● Section 143(1) of the Companies Act, 2013 grants powers to the auditor that every auditor has a right
of access, at all times, to the books of account and vouchers of the company for conducting the audit.
● Further, he is also entitled to require from the officers of the company such information and
explanations which he considers necessary for the proper performance of his duties as Auditor.
Therefore, he has a statutory right to inspect the directors’ minute book.
● In order to verify actions of the company and to vouch and verify some of the transactions of the
company, it is necessary for the auditor to refer to the decisions of the shareholders and/or the
directors of the company.
● It is, therefore, essential for the auditor to refer to the Minute Book. In the absence of the Minute
Book, the auditor may not be able to vouch/verify certain transactions of the company.

Whether powers of the Statutory Auditors can be restricted by shareholders?


● Section 143(1) of the Companies Act, 2013 provides that an auditor of a company shall have right of
access at all times to the books and accounts and vouchers of the company whether kept at the Head
Office or other places and shall be entitled to require from the offices of the company such
information and explanations as the auditor may think necessary for the purpose of his audit.
● These specific rights have been conferred by the statute on the auditor to enable him to carry out his
duties and responsibilities prescribed under the Act, which cannot be restricted or abridged in any
manner.
● Hence, any such resolution even if passed by the entire body of shareholders is ultra vires and
therefore void.

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Comment on Matters Contained under Section 143(1) of the Companies Act, 2013
● Section 143(1) of the Act deals with duties of an auditors requiring the auditor to make an enquiry in
respect of specified matters.
● The matters in respect of which the enquiry has to be made by the auditor include relating to loans
and advances, transactions represented merely by book entries, investments sold at less than cost
price, loans and advances shown as deposits, etc.
● Since the law requires the auditor to make an enquiry,
○ the Institute opined that 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 the auditor is satisfied as a result of the enquiries, he has no further duty to report that he is so
satisfied.

Section 2(13)
Books of account" includes records maintained in respect of—
i. all sums of money received and expended by a company and matters in relation to which the receipts
and expenditure take place;
ii. all sales and purchases of goods and services by the company;
iii. the assets and liabilities of the company; and
iv. the items of cost as may be prescribed under section 148 in the case of a company which belongs to
any class of companies specified under that section;
The phrase ‘books, accounts and vouchers’ includes all books which have any bearing, or are likely to have
any bearing on the accounts, whether these be the usual financial books or the statutory or statistical books;
memoranda books, e.g., inventory books, costing records and the like may also be inspected by the auditor.

Similarly the term ‘voucher’ includes all or any of the correspondence which may in any way serve to vouch
for the accuracy of the accounts.

The auditor of a holding company shall also have the right of access to the records of all its subsidiaries and
associate companies so far as it relates to the consolidation of its financial statements with that of its
subsidiaries and associate companies.

2(59) - Officer
"officer" includes any director, manager or key managerial personnel or any person in accordance with whose
directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to
act;

143(2) Report To Members


The auditor shall
● make a report
● to the members of the company
● on the accounts examined by him and on every financial statements which are required by or under this
Act to be laid before the company in general meeting and
● the report shall after taking into account
○ the provisions of this Act,
○ the accounting and

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○ auditing standards and


○ matters which are required to be included in the audit report under the provisions of this Act or
○ any rules made thereunder or
○ under any order made under sub-section (11) and
○ to the best of his information and knowledge,
● the said accounts, financial statements give a true and fair view of the state of the company's affairs at
the end of its financial year and profit or loss and cash flow for the year and such other matters as may
be prescribed.

143(3) - Report on Other Elements


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; (Books of accounts and return from
branches)
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 auditor 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;
g. whether any director is disqualified from being appointed as a director under sub-section (2) of 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.
j. such other matters as may be prescribed

Reporting under clause(i) of Sec. 143(3) shall not apply to a private company:
● Which is a one-person company or a small company ; or
● Which has turnover less than Rs 50 crores as per latest audited financial statement And Which has
aggregate borrowings from banks or financial institutions or any body corporate at any point of time
during the financial year less than Rs 25 Cr.

Other Matters Prescribed-Rule 11 of Companies (Audit & 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 provisions, as required under any law or accounting standards, for
material foreseeable losses, if any, on long term contracts including derivative contracts;

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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.
a. 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;
b. 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
c. 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 misstatement.
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,
● in respect of financial years commencing on or after the 1st April, 2022,
● 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.

143(4) - Reasons
Where
● any of the matters required to be included in the audit report
● under this section
● is answered in the negative
● or with a qualification,
● the report shall state the reasons therefor.

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(5) In the case of a Government company or any other company owned or controlled, directly or indirectly, by
the Central Government, or by any State Government or Governments, or partly by the Central Government
and partly by one or more State Governments, the Comptroller and Auditor­General of India shall appoint the
auditor under sub­section (5) or sub­section (7) of section 139 and direct such auditor the manner in which the
accounts of the company are required to be audited and thereupon the auditor so appointed shall submit a copy
of the audit report to the Comptroller and Auditor ­General of India which, among other things, include the
directions, if any, issued by the Comptroller and Auditor General of India, the action taken thereon and its
impact on the accounts and financial statement of the company.

(6) The Comptroller and Auditor ­General of India shall within sixty days from the date of receipt of the audit
report under sub­section (5) have a right to,—

(a) conduct a supplementary audit of the financial statement of the company by such person or persons as he
may authorise in this behalf; and for the purposes of such audit, require information or additional information
to be furnished to any person or persons, so authorised, on such matters, by such person or persons, and in such
form, as the Comptroller and Auditor­General of India may direct; and

(b) comment upon or supplement such audit report:

Provided that any comments given by the Comptroller and Auditor­General of India upon, or supplement to,
the audit report shall be sent by the company to every person entitled to copies of audited financial statements
under sub­section (1) of section 136 and also be placed before the annual general meeting of the company at the
same time and in the same manner as the audit report.

(7) Without prejudice to the provisions of this Chapter, the Comptroller and Auditor ­General of India may, in
case of any company covered under sub­section (5) or sub­section (7) of section 139, if he considers necessary, by
an order, cause test audit to be conducted of the accounts of such company and the provisions of section 19A of
the Comptroller and Auditor­General's (Duties, Powers and Conditions of Service) Act, 1971 (56 of 1971), shall
apply to the report of such test audit.

Section 19A - Laying of reports in relation to accounts of Government companies and corporation

Branch Audit
(8) Where a company has a branch office, the accounts of that office shall be audited either by the auditor
appointed for the company (herein referred to as the company's auditor) under this Act or by any other person
qualified for appointment as an auditor of the company under this Act and appointed as such under section 139,
or where the branch office is situated in a country outside India, the accounts of the branch office shall be
audited either by the company's auditor or by an accountant or by any other person duly qualified to act as an
auditor of the accounts of the branch office in accordance with the laws of that country and the duties and
powers of the company's auditor with reference to the audit of the branch and the branch auditor, if any, shall
be such as may be prescribed

Provided that the branch auditor shall prepare a report on the accounts 89 of the branch examined by him and
send it to the auditor of the company who shall deal with it in his report in such manner as he considers
necessary.

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Duties and powers of the company's auditor with reference to the audit of the branch and the branch auditor. -
Rule 12

12. (1) For the purposes of sub­section (8) of section 143, the duties and powers of the company's auditor with
reference to the audit of the branch and the branch auditor, if any, shall be as contained in sub­sections (1) to
(4) of section 143.

(2) The branch auditor shall submit his report to the company's auditor.

(3) The provisions of sub­section (12) of section 143 read with rule 12 hereunder regarding reporting of fraud
by the auditor shall also extend to such branch auditor to the extent it relates to the concerned branch.

(9) Every auditor shall comply with the auditing standards.

(10) 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 (38 of 1949), in consultation with and after examination of the recommendations made
by the National Financial Reporting Authority:

Provided 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.

LATER With CARO


(11) The Central Government may, in consultation with the National Financial Reporting Authority, 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

Reporting of Fraud
(12) Notwithstanding anything contained in this section, 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:

Provided that in case of a fraud involving lesser than the specified amount, 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:

Provided further that the companies, whose auditors have reported frauds under this sub­section 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.

(13) 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 referred to in sub-section (12) if it is done in good faith.

(14) The provisions of this section shall mutatis mutandis apply to—
a. the cost accountant conducting cost audit under section 148; or

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b. the company secretary in practice conducting secretarial audit under section 204.

(15) - If any auditor, cost accountant, or company secretary in practice does not comply with the provisions of
sub-section (12), he shall,—
a. in case of a listed company, be liable to a penalty of five lakh rupees; and
b. in case of any other company, be liable to a penalty of one lakh rupees.]

Rule 13 - Reporting of frauds by auditor and other matters.

13. (1) 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
rupees one 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.

(2) The auditor shall report the matter to the Central Government as under:—
a. the auditor shall report the matter to the Board or the Audit Committee, as the case may be,
immediately but not later than two days of his knowledge of the fraud, seeking their reply or
observations within forty­five 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 fifteen 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 forty ­five days, he shall forward his report to the Central Government
along with a note containing the details of his report that was earlier forwarded to the Board or the
Audit Committee for which he has not received any reply or observations;
d. the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered
Post with Acknowledgement Due or by Speed Post followed by an e­mail in confirmation of the same;
e. the report shall be on the letter­head of the auditor containing postal address, e­mail 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 ADT­4.

(3) In case of a fraud involving lesser than the amount specified in sub­rule (1), the auditor shall report the
matter to Audit Committee constituted under section 177 or to the Board immediately but not later than two
days of his knowledge of the fraud and he shall report the matter specifying the following:—
a. Nature of Fraud with description;
b. Approximate amount involved; and
c. Parties involved

(4) The following details of each of the fraud reported to the Audit Committee or the Board under sub­rule
(3) during the year shall be disclosed in the Board's Report:—
a. Nature of Fraud with description;
b. Approximate Amount involved;
c. Parties involved, if remedial action not taken; and
d. Remedial actions taken.

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(5) The provision of this rule 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.]

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Reporting of Fraud Etc.

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Section 141- eligibility, qualifications and disqualifications of auditors


Eligibility for Appointment
141. (1) A person shall be eligible for appointment as an auditor of a company
● only if he is a chartered accountant
● Provided that a firm whereof
○ majority of partners practising in India are qualified for appointment as aforesaid
○ may be appointed by its firm name to be auditor of a company.

Chartered Accountant
● 2(17) "chartered accountant" means a chartered accountant as defined in clause (b) of sub­section (1) of
section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a valid certificate of practice
under sub­section (1) of section 6 of that Act
● 2(1)(b) of The Chartered Accountants Act, 1949- chartered accountant” means a person who is a member
of the Institute

141(2) - Signature
(2) Where a firm including a limited liability partnership is appointed as an auditor of a company,
● only the partners who are chartered accountants shall be authorised to act and sign on behalf of the
firm.

141(3) - Persons Not Eligible


(3) The following persons shall not be eligible for appointment as an auditor of a company, namely:—
(a) a body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008 (6 of 2009);
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;

141(3)(d) - Security / Indebtedness / Guarantee


(d) a person who, or his relative or partner—
(i) is holding any security of or interest in the company or its subsidiary, or of its holding or
associate company or a subsidiary of such holding company:
Provided that the relative may hold security or interest in the company of face value not exceeding one
thousand rupees or such sum as may be prescribed (Not exceeding Rs. 1 lakh)

In the event of acquiring any security or interest by a relative, above the threshold prescribed (Rs.
1,00,000), thecorrective action to maintain the limits as specified above shall be taken by the auditor
within 60 days of such acquisition or interest.

(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary
of such holding company, in excess of such amount as may be prescribed (Not exceeding Rs. 5
lakh) ; or

(iii) has given a guarantee or provided any security in connection with the indebtedness of any
third person to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, for such amount as may be prescribed; (Not exceeding Rs.
1 lakh.)

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(e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or
its subsidiary, or its holding or associate company or subsidiary of such holding company or associate
company of such nature as may be prescribed;

For the purpose of clause (e) of sub-section (3) of section 141, the term "business relationship" shall be
construed as any transaction entered into for a commercial purpose, except -

i. commercial transactions which are in the nature of professional services permitted to be


rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and
the rules or the regulations made under those Acts;
ii. commercial transactions which are in the ordinary course of business of the company at arm's
length price -like sale of products or services to the auditor, as customer, in the ordinary course
of business, by companies engaged in the business of telecommunications, airlines, hospitals,
hotels and such other similar businesses.

(f) - a person whose relative


➢ is a director or
➢ is in the employment of the company as a
➢ director or key managerial personnel;

(g)
➢ a person who is in full time employment elsewhere or
➢ a person or a partner of a firm holding appointment as its auditor, if such persons or
partner is at the date of such appointment or reappointment holding appointment as
auditor of more than twenty companies
○ other than one-person Company,
○ dormant companies ,
○ small companies and
○ private Companies having paid up capital less than 100 Crores which has not
committed default in filing it’s financial statements u/s 137 or annual return u/s
92 of companies act with the registrar.

(Maximum Audit Per Person Qualified to be an Audtor is 20 in all capacities)


This limit of 20 company audits is per person. For example in the case of an audit firm having 5
partners, the overall ceiling will be 5 × 20 = 100 company audits. Some times, a Chartered Accountant is
a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor
will be together entitled to 20 company audits on his account.

(h) a person who has been convicted by a court of an offence involving fraud and a period of ten years has
not elapsed from the date of such conviction.

(i) a person who, directly or indirectly, renders any service referred to in section 144 to the company or its
holding company or its subsidiary company.

Explanation.—For the purposes of this clause, the term "directly or indirectly" shall have the meaning assigned
to it in the Explanation to section 144.

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(4) Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in 141(3)
after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a
casual vacancy in the office of the auditor.

Meaning of Relative : The term “relative” as defined under the Companies Act, 2013, means anyone who is
related to another as members of a HUF; husband and wife; Father (including step-father), mother (including
stepmother), Son (including step-son), Son’s wife, Daughter, Daughter’s husband, Brother (including
step-brother), sister (including step-sister).

Chapter VIII of Council General Guidlines Specified number of audit assignments


● A member of ICAI in practice shall not hold at any time appointment of more than“specified number of
audit assignments” of Companies under Sec 141 of the Companies Act 2013.
● For this purpose, the "specified number of audit assignments" means - 30 Audit per CA in all capacities
● with the exception of OPC and dormant companies.
● Number of partners on date of acceptance to be considered

Chapter VI Tax Audit assignments under Section 44 AB of the Income-tax Act, 1961
● 60 Tax Audit per CA in all capacities

144 - Auditor not to render certain services.


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

(a) accounting and book keeping services;


(b) internal audit;
(c) design and implementation of any financial information system;
(d) actuarial services;
(e) investment advisory services;
(f) investment banking services;
(g) rendering of outsourced financial services;
(h) management services; and
(i) any other kind of services as may be prescribed :

Explanation.—For the purposes of this sub­section, the term "directly or indirectly" shall include rendering of
services by the auditor

i. in case of auditor being an individual,


○ either himself or
○ through his relative or
○ any other person connected or associated with such individual or
○ through any other entity, whatsoever, in which such individual has significant influence or
control,
○ or whose name or trade mark or brand is used by such individual;
ii. in case of auditor being a firm,

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○ either itself or
○ through any of its partners or
○ through its parent, subsidiary or associate entity or
○ through any other entity, whatsoever, in which the firm or any partner of the firm has
significant influence or control, or
○ whose name or trademark or brand is used by the firm or any of its partners.

Examples and Question

AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the relative of Mr. B, is holding securities having
face value of ₹ 2,00,000 in XYZ Ltd. AB & Co. is qualified for being appointed as an auditor of XYZ Ltd.

Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be appointed as an auditor of a
company if his relative is holding any security of or interest in the company of face value exceeding ₹1 lakh.

Therefore, AB & Co. shall be disqualified for being appointed as an auditor of XYZ Ltd. as Mr. C, the relative of Mr. B
who is a partner in AB & Co., is holding securities in XYZ Ltd. having face value of ₹2 lakh.

A Chartered Accountant holding securities of S Ltd. having face value of ₹950 is qualified for appointment as an
auditor of S Ltd.

Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be appointed as an auditor of a
company if he is holding any security of or interest in the company.

As the chartered accountant is holding securities of S Ltd. having face value of ₹950, he is not eligible for appointment as
an auditor of S Ltd.

Mr. N, a member of the Institute of Chartered Accountants of England and Wales, is qualified to be appointed as
auditor of Indian Companies.

Incorrect: A person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant.

It may be noted that a firm whereof majority of partners practicing in India are qualified for appointment as aforesaid
may be appointed by its firm name to be auditor of a company.

Thus, Mr. N is disqualified to be appointed as an auditor of Indian Companies.

M/s R & Co., a firm of Chartered Accountants, was appointed as statutory auditors of Ramesh Company Ltd. Ramesh
Company Ltd. holds 51% shares in Suresh Company Ltd. Mr. R, one of the partners of M/s R & Co., owed ₹1,500 as on
the date of appointment to Suresh Company Ltd. for goods purchased in normal course of business. Comment.

Indebtedness to the Subsidiary Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person who, or his
relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of its
holding company, for an amount exceeding ₹5,00,000, then he is not qualified for appointment as an auditor of a
company.

Where an auditor purchases goods or services from a company audited by him or its subsidiary, or its holding or
associate company, or a subsidiary of its holding company, whether in normal course of business, he is definitely

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indebted to the company and if the amount outstanding exceeds ₹5,00,000, he is disqualified for appointment as an
auditor of the company. In such a case, he becomes indebted to the company and consequently he has deemed to have
vacated his office.

In the given case, M/s R & Co., a firm of Chartered Accountants, was appointed as statutory auditors of Ramesh
Company Ltd. where the company holds 51% shares in Suresh Company Ltd. Mr. R, one of the partners of M/s R & Co.
owed ₹ 1,500 as on the date of appointment to Suresh Company Ltd. for goods purchased.

Accordingly, the partner, Mr. R, is not disqualified to be appointed as auditor of the company as he is indebted to the
company for an amount not exceeding ₹ 5,00,000.

Due to this, M/s R & Co. is not disqualified to be appointed as an auditor of Ramesh Company Ltd.

ABC Ltd. appointed CA Prem as an auditor of the company for the current financial year. Further the company
offered him the services of investment banking, rendering of outsourced financial services and management services
which was also approved by the Board of Directors. State the services which the auditor is restrained from rendering
and then advise accordingly. (For Answer Please refer Section 144)

An auditor purchased goods worth ₹ 510,200 on credit from a company being audited by him. The company allowed
him one month's credit, which it normally allowed to all known customers.

Purchase of Goods on Credit by the Auditor: Section 141(3)(d)(ii) of the Companies Act, 2013 specifies that a person shall
be disqualified to act as an auditor if he is indebted to the company for an amount exceeding five lakh rupees.

Where an auditor purchases goods or services from a company audited by him on credit, he is definitely indebted to the
company and if the amount outstanding exceeds rupees five lakh, he is disqualified for appointment as an auditor of the
company.

It will not make any difference if the company allows him the same period of credit as it allows to other customers on the
normal terms and conditions of the business.

The auditor cannot argue that he is enjoying only the normal credit period allowed to other customers. In fact, in such a
case he has become indebted to the company and consequently he has deemed to have vacated his office.

Mr. A, a chartered accountant has been appointed as auditor of Laxman Ltd. in the Annual General Meeting of the
company held in September, 2018. Subsequently in January, 2019 he joined Mr. B, another chartered accountant, who is
the Manager Finance of Laxman Ltd., as partner.

Disqualifications of an Auditor: Section 141 (3)(c) of the Companies Act, 2013 prescribes that any person who is a partner
or in employment of an officer or employee of the company will be disqualified to act as an auditor of a company.
Sub-section (4) of Section 141 provides that an auditor who incurs any of the disqualifications mentioned in sub-section
(3) after his appointment, he shall vacate his office as such auditor.

In the present case, Mr. A, an auditor of Laxman Ltd., joined as partner with Mr. B, who is Manager Finance of Laxman
Limited, has attracted sub-section (3)(c) of Section 141 and, therefore, he shall be deemed to have vacated office of the
auditor of Laxman Limited.

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If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of a company, every partner of a firm shall
be authorized to act as an auditor.

Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm including a limited liability partnership (LLP)
is appointed as an auditor of a company, only the partners who are Chartered Accountants shall be authorized to act and
sign on behalf of the firm.

KBC & Co. a firm of Chartered Accountants has three partners, namely, Mr. K, Mr. B & Mr. C. Mr. K is also in whole
time employment elsewhere. The firm is offered the audit of ABC Ltd. and is already holding audits of 40 companies.

Ceiling on Number of Company Audits: Section 141 (3)(g) of the Companies Act, 2013 states that the following persons
shall not be eligible for appointment as an auditor of a company i.e. a person who is in full time employment elsewhere;
or a person, or a partner of a firm holding appointment as its auditor, if such person, or partner is at the date of such
appointment, or reappointment holding appointment as auditor of more than twenty companies.

In the given case, Mr. K, a partner in the firm KBC & Co., is in whole-time employment elsewhere, therefore, he will be
excluded in determining the number of company audits that the firm can hold. If Mr. B and Mr. C do not hold any audits
in their personal capacity or as partners of other firms, the total number of company audits that can be accepted by KBC
& Co., is 40, and in the given case company is already holding 40 audits, therefore, KBC & Co. can't accept the offer for
audit of ABC Ltd.

Ram and Hanuman Associates, Chartered Accountants in practice have been appointed as Statutory Auditor of
Krishna Ltd. for the accounting year 2014-2015. Mr. Hanuman holds 100 equity shares of Shiva Ltd., a subsidiary
company of Krishna Ltd.

Auditor Holding Securities of a Company: As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along
with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an
auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its
subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative
may hold security or interest in the company of face value not exceeding ₹ 1 lakh.
Also, as per sub-section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a
company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office
as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100
equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd.

Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory auditor of
Krishna Ltd., which is the holding company of Shiva Ltd., because one of the partners Mr. Hanuman is holding equity
shares of its subsidiary.

Preksha, a member of the ICAI, does not hold a Certificate of practice. Is her appointment as an auditor valid?

Qualifications of an Auditor: A person shall be qualified for appointment as an auditor of a company, only if one is a
Chartered Accountant within the meaning of the Chartered Accountants Act, 1949. Under the Chartered Accountants
Act, 1949, only a Chartered Accountant holding the certificate of practice can engage in public practice. Preksha does
not hold a certificate of practice and hence cannot be appointed as an auditor of a company.

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'B' owes ₹ 5,01,000 to 'C' Ltd., of which he is an auditor. Is his appointment valid? Will it make any difference, if the
advance is taken for meeting-out travelling expenses?

Indebtedness to the Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person who, or his relative or
partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of its holding
company, for an amount exceeding ₹ 5,00,000/- then he is not qualified for appointment as an auditor of a company.
Accordingly, B's appointment is not valid and he is disqualified as the amount of debt exceeds ₹ 5,00,000.

Even if the advance was taken for meeting out travelling expenses particularly before commencement of audit work, his
appointment is not valid because in such a case also the auditor shall be indebted to the company. The auditor is entitled
to recover fees on a progressive basis only.

Mr. Aditya, a practicing chartered accountant is appointed as a "Tax Consultant" of ABC Ltd., in which his father
Mr. Singhvi is the Managing Director.

Appointment of a Practicing CA as 'Tax Consultant': A chartered accountant appointed as an auditor of a company,


should ensure the independence in respect of his appointment as an auditor, else it would amount to "misconduct" under
the Chartered Accountants Act, 1949 read with Guidance Note on Independence of Auditors.

In this case, Mr. Aditya is a "Tax Consultant" and not a "Statutory Auditor" or "Tax Auditor" of ABC Ltd., hence he is
not subject to the above requirements.

PBS & Associates, a firm of Chartered Accountants, has three partners P, B and S. The firm is already having audit of
45 companies. The firm is offered 20 company audits. Decide and advise whether PBS & Associates will exceed the
ceiling prescribed under Section 141(3)(g) of the Companies Act, 2013 by accepting the above audit assignments?

Ceiling on Number of Audits: Before appointment is given to any auditor, the company must obtain a certificate from
him to the effect that the appointment, if made, will not result in an excess holding of company audit by the auditor
concerned over the limit laid down in section 141 (3)(g) of the Act which prescribes that a person who is in full time
employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is
at the date of such appointment or reappointment holding appointment as auditor of more than 20 companies.

In the case of a firm of auditors, it has been further provided that 'specified number of companies' shall be construed as
the number of companies specified for every partner of the firm who is not in full time employment elsewhere.

If Mr. P, B and S do not hold any audits in their personal capacity or as partners of other firms, the total number of
company audits that can be accepted by M/s PBS & Associates is 60. But, the firm is already having audit of 45
companies. So the firm can accept the audit of 15 companies only, which is well within the limit, specified by Section
141(3)(g) of the Companies Act, 2013.

Mr. Fat, auditor of Thin Ltd., has his office and residence in the building owned by Thin Ltd. Mr. Fat has been given
10% concession in rent by the company as compared to other tenants.

Independence of Auditor: As per SA 200, "Overall Objectives of the Independent Auditor and the conduct of an audit in
accordance with standards on auditing", In the case of an audit engagement it is in the public interest and, therefore,
required by the Code of Ethics, that the auditor be independent of the entity subject to the audit.

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The Code describes independence as comprising both independence of mind and independence in appearance. The
auditor's independence from the entity safeguards the auditor's ability to form an audit opinion without being affected
by influences that might compromise that opinion. Independence enhances the auditor's ability to act with integrity, to
be objective and to maintain an attitude of professional skepticism.

In the instant case, Mr. Fat has his office and residence in the building owned by Thin Ltd. who are subject to audit by
Mr. Fat. Giving 10% concession in rent may be due to some other reasons other than holding the auditor ship of Thin
Ltd. It may be due to being a very old tenant or due to office and residence in the same building or Mr. Fat might have
carried out major renovations and so on.

Thus in the instant case unless and until there is direct proof, giving 10% concession in rent does not affect
independence of the auditor in expressing his opinion on the audit of Thin Ltd.

Under what circumstances the retiring Auditor cannot be reappointed? (झकास)


Answer Circumstances where Retiring Auditor Cannot be Reappointed: In the following circumstances, the retiring
auditor cannot be reappointed-

1. A specific resolution has not been passed to reappoint the retiring auditor.
2. A resolution has been passed in AGM appointing somebody else or providing expressly that the retiring auditor
shall not be reappointed.
3. The proposed auditor suffers from the disqualifications under section 141(3), 141(4) and 144 of the Companies
Act, 2013.
4. He has given the company a notice in writing of his unwillingness to be reappointed.
5. The auditor proposed to be reappointed does not possess the qualification prescribed under section 141 of the
Companies Act, 2013.
6. A written certificate has not been obtained from the proposed auditor to the effect that the appointment or
reappointment, if made, will be in accordance within the limits specified under section 141 (3)(g) of the
Companies Act, 2013.

Mr. Amar, a Chartered Accountant, bought a car financed at ₹ 7,00,000 by Chaudhary Finance Ltd., which is a
holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd. and continues to be to
even after taking the loan.

Indebtedness to the Holding Company: According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not
eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or
associate company or a subsidiary of such holding company, in excess of ₹ 5 lakh.

In the given case Mr. Amar is disqualified to act as an auditor under section 141 (3)(d) (ii)) as he is indebted to M/s
Chaudhary Finance Ltd. for more than ₹ 5'00'000. Also according to Section 141(3)(d)(ii), he cannot act as an auditor of
any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd. Therefore, he has
to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately and Das Ltd
must have to appoint any other CA as an auditor of the company.

Question (Imp Question) Mr. Y was appointed as an auditor of PQR Ltd. for the year ended 31.3.20 _ _ at the Annual
General Meeting held on 16.08.20 _ _ . Mr. Y has been indebted to the company for sum of Rs. 5,10,000 as on 01.04.20

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_ _ , the opening date of accounting year which has been subject to his audit. However, Mr. Y having come to know
that he might be appointed as auditor, he repaid the amount on 10.8.20 _ _ . One of the shareholders, complains that
the appointment of Mr. Y as an auditor was invalid because he incurred disqualification u/s 141 of the Companies
Act, 2013. Comment.

Indebtedness to the Company: According to the section 141(3)(d)(ii) of the Companies Act, 2013, a person who is indebted
to the company for an amount exceeding ₹ 5,00,000 shall be disqualified to act as an auditor of such company and he
should vacate his office of auditor when he incurs this disqualification subsequent to his appointment.

However, where the person has liquidated his debt before the appointment date, there is no disqualification to be
construed for such appointment.

In the given case, Mr. Y was appointed as an auditor of PQR Ltd. for the year ended 31.03.20 _ _ at the Annual General
Meeting held on 16.08.2014. He repaid the loan amount fully to the company on 10.8.20 _ _ i.e. before the date of his
appointment.

Hence, the appointment of Mr. Y as an auditor is valid and the shareholder's complaint is not acceptable.

“RAJUL & Co.” is an Audit Firm having partners “Mr. R”, “Mr. A”, “Mr. J”, “Mr. U” and “Mr. L”, Chartered
Accountants. “Mr. R”, “Mr. A”, “Mr. J”, “Mr. U” and “Mr. L” are holding appointment as an Auditor in 4, 5, 6, 10 and
15 Companies respectively.
I. Provide the maximum number of Audits remaining in the name of “RAJUL & Co.”
II. Provide the maximum number of Audits remaining in the name of individual partner i.e. “Mr. R”, “Mr. A”,
“Mr. J”, “Mr. U” and “Mr. L”.
III. Can RAJUL & Co. accept the appointment as an auditor in 80 private companies having paidup share capital
less than Rs. 100 crore which has not committed default in filing its financial statements under section 137
or annual return under section 92 of the Companies Act with the Registrar, 2 small companies and 1
dormant company?
IV. Would your answer be different, if out of those 80 private companies, 65 companies are having paid-up share
capital of Rs. 115 crore each?
(MTP2, May 2021, 6 marks)

Fact of the Case:


In the instant case, Mr. R is holding appointments in 4 companies, Mr. A is holding appointments in 5 companies, Mr. J
is holding appointments in 6 companies, whereas Mr. U is having appointments in 10 Companies and Mr. L is having
appointments in 15 Companies. In aggregate all five partners are having 40 audits.

Provisions and Explanations:


Section 141(3)(g) of the Companies Act, 2013 states that the following persons shall not be eligible for appointment as an
auditor of a company i.e. a person who is in full time employment elsewhere; or a person, or a partner of a firm holding
appointment as its auditor, if such person, or partner is at the date of such appointment, or reappointment holding
appointment as auditor of more than twenty companies other than one person companies, dormant companies, small
companies and private companies having paid-up share capital less than Rs 100 crore, which has not committed a default
in filing its financial statements under section 137 or annual return under section 92 with the Registrar

As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 5 partners, the
overall ceiling will be 5 × 20 = 100 company audits. Some times, a Chartered Accountant is a partner in a number of
auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company
audits on his account.

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Conclusion:
I. RAJUL & Co. can hold appointment as an auditor of 60 more companies: Total Number of Audits available to
the Firm = 20*5 = 100 Number of Audits already taken by all the partners In their individual capacity =
4+5+6+10+15 = 40 Remaining number of Audits available to the Firm = 60
II. (1) Mr. R can hold: 20 - 4 = 16 more audits. (2) Mr. A can hold: 20 - 5 = 15 more audits. (3) Mr. J can hold: 20 - 6 =
14 more audits. (4) Mr. U can hold 20-10 = 10 more audits and (5) Mr. L can hold 20-15 = 5 more audits.
III. In view of above discussed provisions, RAJUL & Co. can hold appointment as an auditor in all the 80 private
companies having paid-up share capital less than Rs. 100 crore (private company which has not committed a
default in filing its financial statements under section 137 of the said Act or annual return under section 92 of
the said Act with the Registrar), 2 small companies and 1 dormant company as these are excluded from the
ceiling limit of company audits given under section 141(3)(g) of the Companies Act, 2013.
IV. In the given case, out of the 80 private companies RAJUL & Co. is being offered, 65 companies have paid-up
share capital of Rs. 115 crore each. Therefore, RAJUL & Co. can accept the appointment as an auditor for 2 small
companies, 1 dormant company, 15 private companies having paid-up share capital less than Rs. 100 crore
(private company which has not committed a default in filing its financial statements under section 137 of the
said Act or annual return under section 92 of the said Act with the Registrar.”) and 60 private companies having
paid-up share capital of Rs. 115 crore each in addition to above 40 company audits already held.

Section 140- Removal, resignation of auditor and giving of special notice


Removal before expiry of term

140. (1) The auditor appointed under section 139 may be removed from his office before the expiry of his term
only by a special resolution of the company, after obtaining the previous approval of the Central Government in
that behalf in the prescribed manner:

Provided that before taking any action under this sub-section, the auditor concerned shall be given a reasonable
opportunity of being heard.

Removal of the auditor before expiry of his term

7. (1) The application to the Central Government for removal of auditor shall be made in Form ADT-2 and
shall be accompanied with fees as provided for this purpose under the Companies (Registration Offices and
Fees) Rules, 2014.

(2) The application shall be made to the Central Government within thirty days of the resolution passed by
the Board.

(3) The company shall hold the general meeting within sixty days of receipt of approval of the Central
Government for passing the special resolution.

Statement of Reasons
(2) The auditor who has resigned from the company shall file within a period of thirty days from the date of
resignation, a statement in the prescribed form with the company and the Registrar, and in case of companies
referred to in sub-section (5) of section 139, the auditor shall also file such statement with the Comptroller and
Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his
resignation.

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Non compliance with sub-section 2


(3) If the auditor does not comply with the provisions of sub-section (2), he or it shall be liable to a penalty of
fifty thousand rupees or an amount equal to the remuneration of the auditor, whichever is less, and in case of
continuing failure, with further penalty of five hundred rupees for each day after the first during which such
failure continues, subject to a maximum of two lakh rupees.

Special Notice
(4)
i. Special notice shall be required for a resolution at an annual general meeting appointing as auditor a
person other than a retiring auditor, or providing expressly that a retiring auditor shall not be
re-appointed, except where the retiring auditor has completed a consecutive tenure of five years or, as
the case may be, ten years, as provided under sub-section (2) of section 139.
ii. On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring
auditor.
iii. Where notice is given of such a resolution and the retiring auditor makes with respect thereto
representation in writing to the company (not exceeding a reasonable length) and requests its
notification to members of the company, the company shall, unless the representation is received by it
too late for it to do so,—
a. in any notice of the resolution given to members of the company, state the fact of the
representation having been made; and
b. send a copy of the representation to every member of the company to whom notice of the
meeting is sent, whether before or after the receipt of the representation by the company, and if
a copy of the representation is not sent as aforesaid because it was received too late or because
of the company's default, the auditor may (without prejudice to his right to be heard orally)
require that the representation shall be read out at the meeting:

Provided that if a copy of representation is not sent as aforesaid, a copy thereof shall be filed with the Registrar:

Provided further that if the Tribunal is satisfied on an application either of the company or of any other
aggrieved person that the rights conferred by this sub-section are being abused by the auditor, then, the copy of
the representation may not be sent and the representation need not be read out at the meeting.

Power of Tribunal to change the auditors


(5) Without prejudice to any action under the provisions of this Act or any other law for the time being in force,
the Tribunal either suo motu or on an application made to it by the Central Government or by any person
concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a
fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or
officers, it may, by order, direct the company to change its auditors:

Provided that if the application is made by the Central Government and the Tribunal is satisfied that any
change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that
he shall not function as an auditor and the Central Government may appoint another auditor in his place:

Provided further that an auditor, whether individual or firm, against whom final order has been passed by the
Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of
five years from the date of passing of the order and the auditor shall also be liable for action under section 447.

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Explanation I.—It is hereby clarified that in the case of a firm, the liability shall be of the firm and that of every
partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to,
the company or its directors or officers.

Explanation II.—For the purposes of this Chapter the word "auditor" includes a firm of auditors.

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Remuneration of auditors. 142


142. (1)
The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may be
determined therein

Provided that the Board may fix remuneration of the first auditor appointed by it.

142(2)
The remuneration under sub-section (1) shall, in addition to the fee payable to an auditor, include the expenses,
if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but
does not include any remuneration paid to him for any other service rendered by him at the request of the
company.

Auditor to sign audit reports, etc. - 145.


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 auditor's report shall be read before the company in general
meeting and shall be open to inspection by any member of the company.

Auditors to attend a general meeting - 146


All notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of
the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself or

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through his authorised representative, who shall also be qualified to be an auditor, any general meeting and
shall have right to be heard at such meeting on any part of the business which concerns him as the auditor.

Central Government to specify audit of items of cost in respect of certain


companies - Section 148

Cost Records
148. (1) Notwithstanding anything contained in this Chapter,
● the Central Government may, by order,
● in respect of such class of companies
● engaged in the production of such goods or providing such services as may be prescribed,
● direct that
○ particulars relating to the utilisation of
■ material or
■ labour or to
■ other items of cost as may be prescribed
○ shall also be included in the books of account kept by that class of companies:

Provided that the Central Government shall, before issuing such order in respect of any class of companies
regulated under a special Act, consult the regulatory body constituted or established under such special Act.

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Rule 3

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Rule 5

Cost Audit - 148(2) Read with Rule 4


If
● the Central Government is of the opinion,
○ that it is necessary to do so,
○ it may,
○ by order,
● direct that the audit of cost records of class of companies,
○ which are covered under sub-section (1) and
■ which have a net worth of such amount as may be prescribed or
■ a turnover of such amount as may be prescribed,
● shall be conducted in the manner specified in the order.

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Who can be cost auditor


(3) The audit under sub-section (2) shall be conducted by a cost accountant who shall be appointed by the Board
on such remuneration as may be determined by the members in such manner as may be prescribed :[Read Rule
6(1) & (1A), 2 of Cost Records And Audit) Rules 2014.]

Provided that no person appointed under section 139 as an auditor of the company shall be appointed for
conducting the audit of cost records:

Provided further that the auditor conducting the cost audit shall comply with the cost auditing standards.
Explanation.—For the purposes of this sub-section, the expression "cost auditing standards" mean such
standards as are issued by the 5a[Institute of Cost Accountants of India, constituted under the Cost and Works
Accountants Act, 1959 (23 of 1959), with the approval of the Central Government.

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Procedure for appointment and fixation of remuneration of the Cost Auditor - Rule 14 of Companies (Audit
and Auditors) Rules, 2014.

Case I: The Company is required to constitute an audit committee


● The Board shall appoint the cost auditor on the recommendations of the Audit Committee.
● The Audit Committee shall recommend the remuneration of the cost auditor.
● The remuneration of the cost auditor shall be considered and approved by the Board and ratified
subsequently by the members.

Case II: The Company is not required to constitute an audit committee


● The Board shall appoint the cost auditor.
● The remuneration of the cost auditor shall be fixed by the Board and ratified subsequently by the
members.
● Only a cost accountant in practice or a firm of cost accountants in practice can be appointed as a cost
auditor.

(4) An audit conducted under this section shall be in addition to the audit conducted under section 143.

(5) The qualifications, disqualifications, rights, duties and obligations applicable to auditors under this Chapter
shall, so far as may be applicable, apply to a cost auditor appointed under this section and it shall be the duty of
the company to give all assistance and facilities to the cost auditor appointed under this section for auditing the
cost records of the company:

Provided that the report on the audit of cost records shall be submitted by the cost accountant to the Board of
Directors of the company. [Read Rule 6(5) of Cost Records And Audit) Rules 2014.]

(6) A company shall within thirty days from the date of receipt of a copy of the cost audit report prepared in
pursuance of a direction under sub-section (2) furnish the Central Government with such report along with full
information and explanation on every reservation or qualification contained therein. [Read Rule 6(6) of Cost
Records And Audit) Rules 2014.]

(7) If, after considering the cost audit report referred to under this section and the information and explanation
furnished by the company under sub-section (6), the Central Government is of the opinion that any further
information or explanation is necessary, it may call for such further information and explanation and the
company shall furnish the same within such time as may be specified by that Government.

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(8) If any default is made in complying with the provisions of this section,—
a. the company and every officer of the company who is in default shall be punishable in the manner as
provided in sub-section (1) of section 147;
b. the cost auditor of the company who is in default shall be punishable in the manner as provided in
sub-sections (2) to (4) of section 147.

Cost Audit Rule 6 of Companies (Cost Records And Audit) Rules 2014.

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(1) The category of companies specified in rule 3 and the thresholds limits laid down in rule 4, shall within one
hundred and eighty days of the commencement of every financial year, appoint a cost auditor:

Provided that before such appointment is made, the written consent of the cost auditor to such appointment,
and a certificate from him or it, as provided in sub-rule (1A), shall be obtained.

(1A) The cost auditor appointed under sub-rule (1) shall submit a certificate that—

● the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for
appointment under the Act, the Cost and Works Accountants Act, 1959 (23 of 1959) and the rules or
regulations made thereunder;
● the individual or the firm, as the case may be, satisfies the criteria provided in section 141 of the Act, so
far as may be applicable;
● the proposed appointment is within the limits laid down by or under the authority of the Act; and
● the list of proceedings against the cost auditor or audit firm or any partner of the audit firm pending
with respect to professional matters of conduct, as disclosed in the certificate, is true and correct.

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Company Audit

(2) Every company referred to in sub-rule (1) shall inform the cost auditor concerned of his or its appointment as
such and file a notice of such appointment with the Central Government within a period of thirty days of the
Board meeting in which such appointment is made or within a period of one hundred and eighty days of the
commencement of the financial year, whichever is earlier, through electronic mode, in form CRA-2, alongwith
the fee as specified in Companies (Registration Offices and Fees) Rules, 2014.

(3) Every cost auditor appointed as such shall continue in such capacity till the expiry of one hundred and eighty
days from the closure of the financial year or till he submits the cost audit report, for the financial year for
which he has been appointed:

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Company Audit

Provided that the cost auditor appointed under these rules may be removed from his office before the expiry of
his term, through a board resolution after giving a reasonable opportunity of being heard to the Cost Auditor
and recording the reasons for such removal in writing

Provided further that the Form CRA-2 to be filed with the Central Government for intimating appointment of
another cost auditor shall enclose the relevant Board Resolution to the effect:

Provided also that nothing contained in this sub-rule shall prejudice the right of the cost auditor to resign from
such office of the company.

(3A) Any casual vacancy in the office of a cost auditor, whether due to resignation, death or removal, shall be
filled by the Board of Director, within thirty days of occurrence of such vacancy and the company shall inform
the Central Government in Form CRA-2 within thirty days of such appointment of cost auditor.

(3B) The cost statements, including other statements to be annexed to the cost audit report, shall be approved
by the Board of Directors before they are signed on behalf of the Board by any of the director authorised by the
Board, for submission to the cost auditor to report thereon.

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Company Audit

(4) Every cost auditor, who conducts an audit of the cost records of a company, shall submit the cost audit report
along with his or its reservations or qualifications or observations or suggestions, if any, in form CRA-3.

(5) Every cost auditor shall forward his duly signed report to the Board of Directors of the company within a
period of one hundred and eighty days from the closure of the financial year to which the report relates and the
Board of Directors shall consider and examine such report, particularly any reservation or qualification
contained therein.

(6) Every company covered under these rules shall, within a period of thirty days from the date of receipt of a
copy of the cost audit report, furnish the Central Government with such report along with full information and
explanation on every reservation or qualification contained therein, in Form CRA-4 in Extensible Business
Reporting Language format in the manner as specified in the Companies (Filing of Documents and Forms in
Extensible Business Reporting Language) Rules, 2015 along with fees specified in the Companies (Registration
Offices and Fees) Rules, 2014.

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Company Audit

Provided that the Companies which have got extension of time of holding Annual General Meeting under
section 96 (1) of the Companies Act, 2013, may file form CRA-4 within resultant extended period of filing
financial statements under section 137 of the Companies Act, 2013

(7) The provisions of sub-section (12) of section 143 of the Act and the relevant rules made thereunder shall
apply mutatis mutandis to a cost auditor during performance of his functions under section 148 of the Act and
these rules.

Punishment for contravention.


147. (1) If any of the provisions of sections 139 to 146 (both inclusive) is contravened, the company shall be
punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five
lakh rupees and every officer of the company who is in default shall be punishable with fine which shall not be
less than ten thousand rupees but which may extend to one lakh rupees

147 (2) If an auditor of a company contravenes any of the provisions of section, section 144 or section 145, the
auditor shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may
extend to five lakh rupees or four times the remuneration of the auditor, whichever is less

Provided that if an auditor has contravened such provisions knowingly or wilfully with the intention to deceive
the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment for a

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Company Audit

term which may extend to one year and with fine which shall not be less than fifty thousand rupees but which
may extend to twenty-five lakh rupees or eight times the remuneration of the auditor, whichever is less

147 (3) Where an auditor has been convicted under sub-section (2), he shall be liable to—
i. refund the remuneration received by him to the company; and
ii. pay for damages to the company, statutory bodies or authorities or to members or creditors of
the company for loss arising out of incorrect or misleading statements of particulars made in his
audit report.

147 (4) The Central Government shall, by notification, specify any statutory body or authority or an officer for
ensuring prompt payment of damages to the company or the persons under clause (ii) of sub-section (3) and
such body, authority or officer shall after payment of damages to such company or persons file a report with the
Central Government in respect of making such damages in such manner as may be specified in the said
notification.

147 (5) Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or
partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in
relation to or by, the company or its directors or officers, the liability, whether civil or criminal as provided in
this Act or in any other law for the time being in force, for such act shall be of the partner or partners
concerned of the audit firm and of the firm jointly and severally:

Provided that in case of criminal liability of an audit firm, in respect of liability other than fine, the concerned
partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud
shall only be liable.

Salient Features Of Limited Liability Partnerships (LLP) Audit


LLP Annual Accounts and Obligations
● Maintain annual accounts with true and fair view
● File "Statement of Accounts and Solvency" with the Registrar annually
● Books may be maintained on cash basis or accrual basis and according to double entry system of
accounting.
● Books shall be maintained at registered office for such period as may be prescribed.
● The books of account shall contain
○ particulars of all sums of money received and expended by the LLP and the matters in respect of
which the receipt and expenditure takes place;
○ a record of the assets and liabilities of the LLP;
○ statements of cost of goods purchased, inventories, WIP, finished goods and cost of goods sold;
and
○ any other particulars which the partners may decide.
● The books of account which a LLP is required to keep shall be preserved for eight years from the date
on which they are made.

LLP Audit Requirements


● A LLP whose turnover does not exceed, in any financial year,₹ 40 Lacs, or whose contribution does not
exceed₹ 25 Lacs shall not be required to get its accounts audited.
● Voluntary audit allowed for other LLPs if partners decide

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Appointment of Auditor
A person shall not be qualified for appointment as an auditor of a LLP unless he is a Chartered Accountant in
practice.

Auditor of a LLP shall be appointed for each financial year of the LLP for auditing its accounts.

The auditor may be appointed by the designated partners of the LLP –


1. At any time for the first financial year but before the end of first financial year,
2. At least thirty days prior to the end of each financial year (other than the first financial year),
3. To fill the causal vacancy in the office of auditor,
4. To fill the casual vacancy caused by removal of auditor.
5. The partners may appoint the auditors if the designated partners have failed to appoint them.

Advantages of Audit for LLPs


1. Error and fraud detection: Verifies financial statements and uncovers errors or frauds.
2. Dispute resolution: Helps settle disputes among partners regarding accounts.
3. Access to credit: Banks and financial institutions rely on audited accounts for lending money.
4. Improved management: Auditor's periodic visits and suggestions enhance LLP management.
5. Account settlement: Audited accounts facilitate account settlements during admission, death,
retirement, insolvency, or insanity of partners.

Auditor's Duty Regarding Audit of LLP


1. Obtain written instructions: Ensure clarity on the work to be performed.
2. Mention key audit aspects:
a. Evaluate the accuracy and reliability of the firm's records.
b. Assess the availability of all necessary information and explanations.
c. Report any restrictions imposed during the audit.
3. Review the LLP agreement and note provisions:
a. Nature of the business.
b. Capital contributions by partners.
c. Interest on additional capital contributed.
d. Duration of partnership.
e. Allowed partner drawings.
f. Salaries, commissions, etc., payable to partners.
g. Borrowing powers of the LLP.
h. Rights and duties of partners.
i. Settlement methods for accounts during partner admission, retirement, etc.
j. Loans advanced by partners.
k. Profit-sharing ratio.
4. Refer to minute book (if available): Check for resolutions related to accounts.

Filing Annual Return (Form 11)


● Required for every LLP
● Filed with ROC within 60 days of the financial year's end
● Available for public inspection upon payment of prescribed fees

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LLP Statement of Account and Solvency (Form 8)


● Submission required for every LLP
● Filing deadline: within 30 days from the end of 6 months of the financial year

Registrar's Powers
● Obtain necessary information for enforcing provisions of the Act from:
○ Designated partners
○ Partners
○ Employees of the LLP
● Summon designated partners, partners, or employees for information if:
○ Information not furnished
○ Registrar unsatisfied with the information provided

Documents Available for Inspection


● Incorporation document
● Names of partners and any changes made therein
● Statement of Account and Solvency
● Annual Return

Fees
● Inspection fee: Rs. 50
● Certified copy or extract of any document under section 36: Rs. 5 per page

True and Fair Concept in Auditing


● Fundamental auditing concept
● Auditor's opinion on whether the entity's state of affairs and results are accurately and fairly
represented in the accounts
● Verification process includes:
○ Ensuring all assets, liabilities, income, and expenses are stated in accordance with relevant
accounting principles and policies
○ Confirming no material amount, item, or transaction has been omitted

NATIONAL FINANCIAL REPORTING AUTHORITY - SEC. 132


Constitution of NFRA
● Central Government may constitute NFRA for accounting and auditing standards under the Act.

Functions of NFRA
● Recommend accounting and auditing policies and standards to the Central Government.
● Monitor and enforce compliance with accounting and auditing standards.
● Oversee the quality of service for professions ensuring compliance with standards.
● Perform other functions related to the above as prescribed.

Powers of NFRA
1. Power to Investigate Professional or Other Misconduct
● Investigate suo motu or upon reference by the Central Government.

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● Applies to members or firms of chartered accountants registered under the Chartered


Accountants Act, 1949.
● No other institute or body may initiate or continue proceedings if NFRA has initiated an
investigation.
2. Powers of Civil Court
● NFRA has the same powers as a civil court under the Code of Civil Procedure, 1908 for specific
matters.
3. Power to Impose Penalty
● If misconduct is proved, NFRA may impose penalties:
● Individuals: Not less than ₹1 lakh, up to 5 times the fees received.
● Firms: Not less than ₹5 lakh, up to 10 times the fees received.
● NFRA may debar a member or firm from:
● Being appointed as an auditor, internal auditor, or undertaking any audit for a company
or body corporate.
● Performing any valuation under section 247
➢ for a minimum of 6 months,
➢ up to a maximum of 10 years.

NFRA Rules, 2018


Rule 3: Classes of Companies and Bodies Corporate Governed by the Authority
1. The Authority's powers include monitoring and enforcing compliance with accounting standards,
overseeing the quality of service, and investigating auditors for the following classes of companies and
bodies corporate
a. Companies with securities listed on any stock exchange in India or abroad.
b. Unlisted public companies with:
i. Paid-up capital of at least ₹500 crores, or
ii. Annual turnover of at least ₹1,000 crores, or
iii. Outstanding loans, debentures, and deposits of at least ₹500 crores as of 31st March of
the immediately preceding financial year.
c. Insurance companies, banking companies, companies involved in electricity generation or
supply, companies governed by a special Act, or bodies corporate incorporated by an Act.
d. Body corporates, companies, or persons referred to the Authority by the Central Government in
the public interest.
e. Foreign subsidiaries or associate companies of Indian companies or body corporates with
income or net worth exceeding 20% of the consolidated income or consolidated net worth.
2. Every body corporate formed in India and governed by this rule shall inform the Authority in Form NFRA-1
about the appointment of an auditor within 15 days of appointment under section 139(1).
3. A company or a body corporate governed by this rule shall continue to be under the Authority's
jurisdiction for three years after it ceases to be listed, or its paid-up capital, turnover, or aggregate of
loans, debentures, and deposits falls below the specified limits.

Rule 5
Every auditor mentioned in Rule 3 must file a return with the Authority using Form NFRA-2 on or before 30th
November each year.

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Rule 6: Recommending Accounting Standards and Auditing Standards


1. To recommend accounting standards or auditing standards for approval by the Central Government
(C.G.), the NFRA:
a. Shall receive recommendations from the ICAI on proposals for new accounting standards or
auditing standards, or for amendments to existing accounting standards or auditing standards.
b. May seek additional information from the ICAI on the recommendations received under clause
(a), if required.
2. The Authority shall consider the recommendations and additional information in such a manner as it
deems fit before making recommendations to the C.G.

Rule 8: Monitoring and Enforcing Compliance with Auditing Standards


1. Monitoring and enforcing compliance with auditing standards by companies governed under Rule 3:
● Review working papers, audit plans, and other audit documents
● Evaluate the quality control system and its documentation
● Perform necessary testing of audit, supervisory, and quality control procedures
2. Auditor's governance practices and internal processes:
● Require auditors to report on practices and processes promoting audit quality
● Take necessary action based on the report
3. Seeking additional information:
● Request more information or personal presence of the auditor for explanations
4. NFRA officers and experts:
● Utilize officers and experts with relevant industry experience
5. Publication of non-compliance findings:
● Publish findings on NFRA website and other appropriate platforms, unless not in the public
interest
6. Proprietary or confidential information:
● Avoid publishing unless necessary for public interest with recorded reasons
7. Reporting to Central Government:
● Send separate report containing proprietary or confidential information for government's
information
8. Investigation or enforcement action:
● In case of potential violations, decide on further course of action through concerned Division

Rule 9: Overseeing Quality of Service and Suggesting Measures for Improvement


1. Directing auditors for improvement:
● Based on NFRA review, direct auditors to improve audit quality
● Include changes in audit processes, quality control, and audit reports
● Specify a detailed plan with time-limits
2. Auditor's duty to comply:
● Implement required improvements
● Send a report to NFRA explaining compliance with directions
3. Monitoring improvements:
● NFRA to monitor the improvements made by the auditor
● Take appropriate action based on the progress
4. Referring cases to Quality Review Board:
● NFRA may refer cases to Quality Review Board under the Chartered Accountants Act, 1949
● Call for reports or information from the Board as deemed appropriate

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Company Audit

5. Assistance from experts:


● NFRA may seek help from experts for oversight and monitoring activities.

Rule 13: Punishment in Case of Non-Compliance


● Initial penalty: Fine not exceeding ₹75,000 for contravening any provisions of these rules.
● Continuing contravention: Additional fine not exceeding ₹500 for every day after the first day during
which the contravention continues.

Key Aspects discussed in Guidance Note on Internal Financial Control over


Financial Reporting
What is Internal Financial Control (IFC)? (Sec 134)
● As per Section 134 of the Companies Act 2013, the term Internal Financial Controls means the policies
and procedures adopted by the company for ensuring:
○ Orderly and efficient conduct of its business, including adherence to Company's policies,
○ Safeguarding of its assets,
○ Prevention and detection of frauds and errors,
○ Accuracy and completeness of the accounting records, and
○ Timely preparation of reliable financial information.
What is Internal Controls over financial Reporting (ICFR)?
As per Guidance Note issued by ICAI on Guidance Note on Audit of Internal Financial Controls Over
Financial Reporting (September, 2015), “Internal Financial Controls Over Financial Reporting (ICFR) shall
mean:

“A Process designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting
principles”. A Company’s internal financial control over financial reporting includes those policies and
procedures that:
● relates to the maintenance of the records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company;
● provide reasonable assurance that
○ transactions are recorded as necessary to permit preparation of financial statement in
accordance with generally accepted accounting principles, and
○ those receipts and expenditures of the company are being made only in accordance with
authorizations of management and director of the company; and
● provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use
or disposition of the company’s assets that could have a material effects of the financial statements.

Reporting Requirements
Section 134: Directors' Responsibility
● Listed company directors must ensure adequate and effective Internal Financial Controls (IFC)
are in place
Section 134: Board of Directors' Confirmation
● Listed company boards must confirm the adequacy and effectiveness of IFC in relation to
financial statements

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Section 143: Auditor's Report


● The auditor's report should address the adequacy of the IFC system and its operating
effectiveness
Section 177: Audit Committee's Role
● The audit committee may discuss internal control systems with internal and statutory auditors
and management before submitting comments to the board
Schedule IV: Independent Directors' Responsibility
● Independent directors must ensure the integrity of financial information and the robustness of
financial controls and risk management systems
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014
● The director's report should include details on the adequacy of internal financial controls with
reference to financial reporting

Applicability
● Auditors to report on ICFR for both standalone and consolidated financial statements

Effective Date and Period


● Auditors report on ICFR adequacy and effectiveness at the balance sheet date, with testing throughout
the financial year
Extent of Reporting
● Auditor obtains reasonable assurance on ICFR for financial reporting only, not covering future viability
or management efficiency

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Bank Audit

Chapter-6 Audit of Banks - Bank Audit

Special Audit Consideration


Auditor has to consider the following while doing / accepting the audit of banks.
(Special audit consideration in the audit of bank)

1. RISK - the particular nature of risks associated with the transactions undertaken;
2. SCALE - the scale of banking operations and the resultant significant exposures which can arise within
a short period of time.
3. IT DEPENDENCE - the extensive dependence on IT to process transactions
4. STATUTORY and REGULATORY - The effect of the statutory and regulatory requirements
5. NEW PRODUCTS AND SERVICES - 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.

Other Points
● Technology evolution in Net Banking and Mobiles exposes banks to operational and financial risks.
● Auditors must consider these factors when designing audit approaches.
● Branch Auditors and SCAs need in-depth knowledge of products and associated risks.
● Audit plans should address risks leading to material misstatements in financial statements.
● Banks use various applications for transactions, requiring auditors to understand interface controls.

Distinguishing Characteristics of Bank


1. Custody of large volume of monetary items which are prone / vulnerable to misappropriation and
therefore leads to DIM of stringent internal control
2. Large volume and variety of transaction in terms of number and volume - requires robust accounting
and internal control and increase the dependence on IT
3. Geographically dispersed branches and departments
4. Huge off balance sheet items. Commitments without transfer of funds.
5. Nature of Initiation, Processing and recording of transactions.
6. Customers can complete transaction without involvement of bank personnels
7. National and international settlement systems
8. Regulatory requirements.

Legal Framework
● Reserve Bank of India Act, 1934
● Banking Regulation Act, 1949.
● State Bank of India Act, 1955.
● Companies Act, 2013.
● State Bank of India (Subsidiary Banks) Act 1959.
● Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
● Regional Rural Banks Act, 1976.
● Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980.
● Information Technology Act, 2000.
● Prevention of Money Laundering Act, 2002.
● Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

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● Credit Information Companies Regulation Act, 2005.


● Payment and Settlement Systems Act, 2007.
● Co-operative Societies Act, 1912.

Form And Content Of Financial Statements


● Banks need to create a Balance Sheet and Profit and Loss Account based on the Banking Regulation
Act, 1949.
● Banks must follow disclosure rules in Accounting Standards and the Companies Act, 2013.
● RBI has postponed the implementation of Indian Accounting Standards (Ind AS) for scheduled
commercial banks.
● Bank balance sheets include standalone and consolidated statements, with different processes for
various banks.
● Listed public and private banks must adhere to SEBI regulations and LODR.

Appointment of Auditor
Banking Company At the annual general meeting of the shareholders with approval of RBI

Nationalised Bank By the concerned bank acting through its Board of Directors with approval of RBI

SBI Comptroller and Auditor General of India in consultation with the Central
Government.

Subsidiaries of SBI State Bank of India

Regional Rural Banks Concerned bank with the approval of the Central Government.

Content of Appointment Letter Sent By Banks


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.
● 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.

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Conducting an Audit

Initial Consideration

● Acceptance & Continuance


● Assess engagement risk before accepting audit engagement
● Affects planning decisions if accepted
● Declaration of Indebtedness
● Banks obtain written confirmation on auditor's indebtedness status
● Comply with Section 141 of Companies Act 2013
● Internal Assignments in Banks by Statutory Auditors
● Audit firms avoid internal assignments during statutory audit
● Terms of Audit Engagements
● Agree on terms before significant fieldwork
● Document terms to prevent confusion
● Use engagement letter acknowledged by bank
● Communication with Previous Auditor
● Communicate in writing before accepting position
● Planning

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Bank Audit

● Document audit plan with nature, timing, extent, of audit procedures


● Keep plan flexible and updated
● Establish the Engagement Team
● Assign qualified professionals based on bank's size and complexity

Understanding the business operations.


Auditor will obtain understanding of the
● Bank
● IC of Bank
● Bank’s Accounting Process
● Bank’s Risk Management Process

Effective Risk Management Process in banks


An effective risk management process will have the following elements
● Involvement of TCWG
○ Approval of risk management policies should be done by TCWG
○ The policies must be clearly in line with bank’s overall vision, strategies, objectives, area of
expertise, regulatory compliances etc
● Entity's RAP - Identification, measurement and monitoring of risk against pre- approved limits and
benchmarks
● Control Activities
○ A bank must have clear directives and control to manage the risk in an effective and efficient
manner.
○ There must be proper SODs, Approval matrix, Reporting requirements etc.
● Monitoring Activities
○ There must be an independent risk management unit to monitor the performance of the
controls of the bank and the validity of assumptions used while creating strategies etc
● Reliable Information system
○ Financial, Operational and Compliance information is of utmost importance in banks and it
must be available on time and one of the important considerations of such information is
consistency and integrity.

Risk Assessment
Auditor needs to identify and assess the following risk while doing the audit of banks
● Risk of material misstatements at financial statement level
● Risk of Material misstatement at assertion level
● Risk of fraud including the risk of money laundering
● Risk associated with outsourcing of activity

Execution
● Engagement Team Discussions
● Response to the Assessed Risks
● Establish the Overall Audit Strategy
● Audit Planning Memorandum
● Determine Audit Materiality
● Consider Going Concern

Neeraj Arora 6.4


Bank Audit

Reporting
● As discussed in SA 700 series plus other reports required under various laws and regulations for
example long form audit report

Audit Planning Memorandum


Audit Planning Memorandum: The auditor should summarise their 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.

AUDITOR'S REPORT
Matters to be included
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 (The report of auditors of State Bank of India is also to be made to the
Central Government and is almost identical to the auditor’s report in the case of a nationalised bank.)
● 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.

Format of Audit Report


Auditors (central and branch) must ensure compliance with:
● 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
● SA 720: The Auditor's Responsibility Relating to Other Information in Documents Containing Audited
Financial Statements

● Auditor should ensure disclosure of:


■ Number of unaudited branches
■ Quantification of advances, deposits, interest income, and interest expense for unaudited branches in
the audit report

Neeraj Arora 6.5


Bank Audit

● Auditors of banking companies must also cover matters in Section 143 of the Companies Act, 2013
● Reporting requirements of Companies (Auditor's Report) Order, 2020 do not apply to banking companies
as defined in Section 5(c) of the Banking Regulation Act, 1949

Long Form Audit Report


● Statutory audit report supplemented by Long Form Audit Report (LFAR) (statutory audit, LFAR)
● Applies to public sector banks, private sector banks, and foreign banks (including branches) (public
sector, private sector, foreign banks)
● Both statutory branch auditors and statutory central auditors provide LFARs (branch auditors, central
auditors)
● Branch-level LFAR: questionnaire format, covers various matters (questionnaire, various matters, cash,
investments)
● Head office level: LFARs consolidated, submitted to bank management by statutory central auditors
(head office, consolidation, management)
● LFAR presented to Audit Committee of the Board (ACB), includes actions taken or proposed for
rectifying irregularities (ACB, actions, rectification)
● LFAR copy, agenda note, and Board's views submitted to Reserve Bank of India (RBI) within 60 days of
submission (RBI, 60 days, submission)

Other Reporting Requirements (Fraud)


● RBI Circular: Implementation of recommendations on legal aspects of bank frauds (RBI, bank frauds,
recommendations)
● Applicable to all scheduled commercial banks (excluding Regional Rural Banks) (commercial banks,
exclusions)
● Details on liability of accounting and auditing profession, professional conduct, non-disclosure, fraud
reporting (liability, professional conduct, fraud reporting)
● Compliance with provisions of Standards on Auditing (Standards on Auditing, compliance)
● Section 143(12) of Companies Act, 2013: Auditors reporting fraud to Central Government (Companies
Act, fraud reporting, Central Government)
● Auditor's role: evaluate the system as a whole, not each transaction (system evaluation, not individual
transactions)
● Report instances of fraud to RBI and bank's management (RBI, bank management, fraud reporting)

Special Consideration in IT Environment


IT Related information banks should share with auditors:
● Overall IT policy, structure, and environment
● Data processing and interface under various systems
● Data integrity and security
● Business Continuity and disaster control plans
● Accounting manual, critical accounting entries, and IT system involvement
● Controls over key aspects and e-banking products
● MIS reports and periodicity
● Exception reports and generation process
● Disclosure-related information in financial statements and IT system involvement

Neeraj Arora 6.6


Bank Audit

Key security control aspects for auditors: (DREAMC)


● DATA - Ensure authorized, accurate, and complete data for processing
● RESTART - Check system restarts after interruptions without distortion
● AMENDMENTS - Prevent unauthorized program amendments
● ACCESS CONTROLS - Verify access controls match staff responsibilities
● SOD and Monitor - Ensure segregation of duties and monitor user activities
● CHANGES - Authenticate changes in parameters or user levels
● MANUAL CHARGES - Verify proper accounting and authorization for manual charges
● EXCEPTION REPORTS - Check daily authorization and verification of exceptional transaction reports
● ACCOUNT MASTER and BALANCE - Ensure account master and balance protection from
unauthorized alterations
● GENERAL LEDGER - Confirm general ledger balance tallies with subsidiary book balance

Internal Audit and Inspection:


● Central audit and inspection department headed by Chief Audit Executive
● Responsible for Risk-Based Internal Audit (RBIA) per RBI framework
● Identifies branches for revenue audit, appoints concurrent auditors, and reviews their work
● Ensures smooth, effective, and efficient audit function.

Risk-based Internal Audit:


● Conducted based on risk assessment of business and control risks of branches.
● Risk assessment process includes:
● Identifying inherent business risks in branch activities
● Assessing effectiveness of control systems for monitoring risks
● Assessing levels and directions of various risk areas and overall business risk
● Creating a risk matrix considering factors like branch risk

Internal Control Evaluation in Selected Areas

General
● Job rotation of officers must be done on a regular and adhoc basis without any prior notice.

Neeraj Arora 6.7


Bank Audit

● The work carried out by one person should be checked by another automatically as a part of routine.
(Internal Check)
● 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.
● Insurance policies must be taken by the bank against loss and employees’ infidelity.
● The financial powers of officers of different grades should be clearly defined.
● There should be a surprise inspection of head office and branches at periodic intervals by the internal
audit department.
● The irregularities pointed out in the inspection reports should be promptly rectified.

Clearings:
● Cheque Truncation System (CTS) by RBI
● Electronic image of cheque transmitted with relevant information
● Reduces cost and time for cheque collection
● Auditor's responsibilities:
● Verify compliance with RBI guidelines for cheques above Rs. 5 lakh on a test check basis
● Ensure customer is called or emailed for inward clearings
● Check if staff verifies drawer's signature on cheques
● Avoid liability for the paying bank
● Ensure unpaid cheques in outward clearing are handled properly
● Sent to customers' recorded addresses or customers informed to collect from the bank
branch

Credit Card Operations


● Application - There should be effective screening of applications with reasonably good credit
assessments.
● Storage and Issue - There should be strict control over storage and issue of cards.
● Check on Unutilised Limit - 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
● Reporting by merchants - There should be a system of prompt reporting by the merchants of all
settlements accepted by them through credit cards.
● Payment to merchants - Reimbursement to merchants should be made only after verification of the
validity of the merchant's acceptance of cards.
● STATEMENTS - There should be a system to ensure that statements are sent regularly and promptly to
the customer.
● PAYMENTS - There should be a system to monitor and follow-up customers’ payments.
● Review - Credit card account holders accounts should be reviewed and limits must be revised based on
it.

Loans and Advances


● Creditworthiness and Sanctions - The bank should make advances only after satisfying itself as to the
creditworthiness of the borrowers and after obtaining sanction from the proper authorities of the bank.
● Documentation - All the necessary documents (e.g., agreements, demand promissory notes, letters of
hypothecation, etc.) should be executed by the parties before advances are made.
● Security margin - Sufficient margin should be kept to compensate for the decline in the value of the
security.

Neeraj Arora 6.8


Bank Audit

● Security custody - Should be kept in joint custody of at least 2 officers.


● Security registration - If security is to be registered then it should be registered in name of the bank
● The operation in each advance account must be reviewed at least one every year.
● All irregular accounts should be brought to the attention of the management regularly.

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 officer other than those handling the cash.
● Actual cash in hand should agree with the balance shown by the Day Book every day.
● 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.
● High value cash receipts and payments should be verified by a higher officer/ branch manager.
● Where the teller system is prevalent, over and above other things
○ A limit should be placed on the powers of tellers to make payment.
○ There should be frequent rotation of tellers.

Bills for Collection


● DOCUMENTS
○ All the documents accompanying the bills should be received and 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.
● CREDIT - 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.
● AVOID Duplicate Entries of Same Bill - 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 Purchased
● DOCUMENT OF TITLE - At the time of purchase of the bills, an officer should verify that all the
documents of title are properly assigned to the bank.
● SUFFICIENT MARGIN - Sufficient margin should be kept while purchasing or discounting a bill to
cover any decline in the value of the security etc.
● UNABLE TO COLLECT - 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.
● IRREGULAR - All irregular outstanding accounts should be reported to the Head Office.
● DISCOUNT Received Apportioned - 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.

Telegraphic Transfers and Demand Drafts


● SIGNATURE - The signatures on a demand draft should be checked by an officer with the Signature
Book.
● CONFIRMATION - All the T.Ts and D.Ds. sold/ issued by a branch should be immediately confirmed by
an advice to the paying branch.

Neeraj Arora 6.9


Bank Audit

● NO CONFIRMATION - If the paying branch does not receive proper confirmation of any T.T or 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 Accounts


● The accounts should be adjusted only on the basis of advices (and not 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.

Compliance with CRR and SLR requirements


Cash Reserve Ratio
Definition - 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

The amount specified as the CRR is held in cash and cash equivalents, is stored in bank vaults or parked with
the Reserve Bank of India. The aim here is to ensure that banks do not run out of cash to meet the payment
demands of their depositors. CRR is a crucial monetary policy tool and is used for controlling money supply in
an economy.

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.

Statutory Liquidity Ratio (SLR) Requirements

● Apart from Cash Reserve Ratio (CRR), banks have to maintain a stipulated proportion of their net
demand and time liabilities in the form of liquid assets like cash, gold and unencumbered securities.
● The SLR is fixed by the RBI and is a form of control over the credit growth in India.
● The 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 report of the statutory auditors in relation to compliance with SLR requirements should cover two
aspects:
○ Correctness of the compilation of DTL (Demand and Time Liabilities) position; and
○ Maintenance of liquid assets as prescribed u/s 24 of Banking Regulation Act

Audit Approach
● Obtain an understanding of the relevant circulars/ instructions of the RBI, particularly regarding
composition of items of DTL.
● The statutory central auditor should request the branch auditors to verify the correctness of the trial
balances relevant to calculation of DTL
● 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.

Neeraj Arora 6.10


Bank Audit

● Examine whether the consolidations prepared by the bank include the relevant information in respect
of all the branches.
● Examine whether interest accrued but not accounted for in books is included in the computation of
DTL.
● 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.

Verification of Assets
Cash, Bank Balances, and Money at Call and Short Notice:
● Disclosure requirements in the balance sheet as per Banking Regulation Act, 1949
● Audit approach focused on existence and completeness
Audit procedures:
1. Cash:
● Physically verify cash, including foreign currency, ATM cash, and cash deposit machines
● Agree with cash register/CBS balance
2. Balance with Reserve Bank of India:
● Verify ledger balances with bank confirmation certificates and reconciliation statements
● Review reconciliation statements, focusing on unresponded cash transactions, revenue items
requiring adjustments/write-offs, and unresponded credit/debit entries for over 15 days
3. Balance with Other Banks (Other than Reserve Bank of India):
● Review reconciliation statements and verify no debit for charges or credit for interest is
outstanding
● Ensure all items have been taken to revenue for the year
● Verify no outstanding cheques in clearing
● Examine outstation cheques and bills sent for collection
● Examine large transactions for potential window-dressing
● Verify balances with banks outside India and convert to Indian currency at prevailing exchange
rates
4. Money at Call and Short Notice:
● Examine authorization system for lending money at call or short notice
● Verify compliance with head office or controlling office guidelines
● Verify call loans with borrowers' certificates and call loan receipts
● Ensure aggregate balances match general ledger control accounts
● Examine subsequent repayments from borrowing banks
● Verify interest accrual and accounting on year-end outstanding call/short notice money balances

Verification of Investments.
Do you remember what we read in assertions? Specifically assertion of an account balance.
We need to check
● Existence
● Rights / Obligation
● Completeness
● Valuation

Over and above the basic assertion we also need to check the investments are in compliance with the law and
regulations. This even becomes more important in case of banks.

Neeraj Arora 6.11


Bank Audit

The most important regulation w.r.t investments of banks is the RBI regulations.

Audit procedures to be followed for audit of investments


● Evaluation of Internal control and review of investment policy
● Separation of Investment Functions
● Examination of Reconciliation
● Examination of Documents
● Physical Verification
● Examination of Valuation
● Dealings in Securities on Behalf of Others
● Special-purpose Certificates Relating to Investments
● Examination of classification and shifting

Evaluation of ● Examine whether investment policy of the bank is in compliance with


Internal control and RBI’s guidelines and other statutory guidelines in all material aspects.
review of investment ● Broad investment objectives should be clearly mentioned for all the
policy investments.

Separation of ● Check the segregation of duties within the bank staff in terms of
Investment executing trades, settlement and monitoring of such trades, and
Functions accounting of the same (generally termed as front office, middle office and
back office functions’ segregation).

Examination of ● Reconcile the investment account with the details available.


Reconciliation

Examination of ● Relevant documents related to ownership, restriction on right of


Documents ownership / disposal, acquisition or disposal must be inspected.

Physical ● Physical certificates / scrips must be verified on the balance sheet date.
Verification ● Confirmations must be taken from the counterparty bank in case of BRs.
Verify Investments with Public Debt Office of RBI, Custodians, and Depository:
● Obtain statement of holdings as on the balance sheet date
● Send independent balance confirmation requests in accordance with
SA-505
● If confirmations not received, consider alternative audit procedures:
● Request bank personnel to download investment statement from
E-Kuber (RBI's CBS platform) for government securities in the
auditor's presence
● Evaluate the reliability and accuracy of the downloaded statement

Examination of ● Examine whether the method of accounting followed by the bank in


Valuation respect of investments, including their year-end valuation, is appropriate.
● Examine compliance by the bank with the guidelines of the RBI relating
to valuation of investments.
● Verify whether adequate disclosure of any change in method of valuation
of investment is made.

Neeraj Arora 6.12


Bank Audit

Dealings in ● Check whether prior approvals have been obtained for the same.
Securities on Behalf ● Check the treatment of the income on such investments.
of Others

Special Purpose ● Certificate on reconciliation of securities by the bank (both on its own
Certificate relating investment account as well as PMS Banks' account).
to investments

Examination of ● Examine whether the investments are properly classified as


classification and ○ Held till maturity - For long term
shifting of ○ Available for sale - Others
investments from ○ Held for trading - To be sold in 90 Days
one category to ● Also check whether shifting from one category to another is as per the
another category appropriate regulations and all required approvals have been taken for the
same.

Verification of Advances.
The auditor is primarily concerned with obtaining evidence about the following while carrying out audit of
advances
● Balance sheet amounts outstanding on reporting date (balance sheet, outstanding, reporting date)
● Advances represent bank dues (advances, bank dues)
● Loan documents support bank dues (loan documents, bank dues)
● No unrecorded advances exist (unrecorded advances, nonexistent)
● Valuation of advances appropriate, recoverability recognized (valuation, advances, recoverability)
● Compliance with accounting policies, statutory and regulatory requirements (accounting policies,
compliance, regulatory requirements)
● Provisions per RBI norms, accounting standards, and accepted practices (provisions, RBI norms,
accounting standards)

Evaluation of Internal controls over advances


● Examine loan documentation;
● Examine the validity of the recorded amounts;
● Examine the existence, enforceability and valuation of the security;
● Ensure compliance with the terms of sanction and end use of funds.
● Ensure compliance with Loan Policy of Bank as well as RBI norms including appropriate classification
and provisioning
● Review the operation of the accounts;

Substantive Procedures
● Check whether the amounts included in the balance sheet for advances accounts are outstanding as on
the date of the balance sheet.
● Check that advances represent the amount due to the bank.
● Verify that amounts due to the bank are appropriately supported by Loan documents and other
documents as applicable to the nature of advances.
● Ensure there are no unrecorded advances.
● Check that the stated basis of valuation of advances is appropriate and properly applied, and that the
recoverability of advances is recognised in their valuation.

Neeraj Arora 6.13


Bank Audit

● Verify that the advances are disclosed, classified and described in accordance with recognised
accounting policies and practices and relevant statutory and regulatory requirements.
● Check that appropriate provisions towards advances have been made as per the RBI norms, Accounting
Standards and generally accepted accounting practices.
● Examine all large advances while other advances may be examined on a sample basis
● Verify completeness and accuracy of interest being charged.

Recoverability of Advances
● Review periodic statements submitted by the borrowers indicating the extent of compliance with terms
and conditions.
● Review the latest financial statements of borrowers.
● Review reports on inspection of security.
● Review Auditors’ reports in the case of borrowers enjoying aggregate credit limits of Rupees 10 lakh
or above for working capital from the banking system.

Verification of asset classification, income recognition and Provision for Non-performing assets:
Asset classification and provisioning are crucial in auditing advances, ensuring compliance with prudential
norms and accurate income recognition (asset classification, provisioning, prudential norms).
Audit Approach:
● Familiarize with RBI's latest Master Circular and subsequent circulars (RBI Master Circular, latest
updates)
● Consider RBI's norms as minimum provisioning requirements, make higher provisions when necessary
(minimum requirements, higher provisions)
● Section 15 of Banking Regulation Act, 1949 demands adequate provision for bad debts before dividends
(Banking Regulation Act, bad debts, dividends)
● Verification of prudential norms is the responsibility of both statutory branch auditor and statutory
central auditor (verification, statutory auditors, prudential norms)

Classification and Provision


● Check the bank's system for ongoing identification and classification of advances through CBS
(ongoing identification, CBS)
● Evaluate the appropriateness of the branch's classification, especially for advances with recovery threats
(appropriate classification, recovery threats)
● Ensure correct segregation of secured and unsecured portions and accurate calculation of provisions
(segregation, secured/unsecured, provisions)
● Review and compare NPA dates in loan accounts with previous year, ascertain reasons for changes (NPA
dates, comparison, reasons for change)

Accounts regularised near balance sheet date.


● As per the Reserve Bank guidelines, if an account has been regularised before the balance sheet date by
payment of overdue amount through genuine sources, the account need not be treated as NPA.
● Where the account indicates inherent weakness based on the data available, the account should be
deemed as a NPA.
● 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.

Neeraj Arora 6.14


Bank Audit

Drawing Power Calculation


● Ensure that the drawing power is calculated as per the Credit Policy of the Bank formulated by the
Board of Directors of the respective bank and agreed upon by the concerned statutory auditors.
● Special consideration should be given to proper reporting of sundry creditors for the purposes of
calculating drawing power.
● The stock audit 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.
● The drawing power needs to be calculated carefully in case of working capital advances to companies
engaged in construction business.

Accounts with temporary deficiencies


● Avoid classifying advance accounts as NPA due to temporary deficiencies (NPA, temporary deficiencies)
● Confirm stock statements used for determining drawing power are within 3 months (drawing power,
stock statements, 3 months)
● Check outstanding balances using older stock statements are marked as irregular (outstanding balances,
older stock statements, irregular)
Limits not reviewed
● Accounts with unreviewed regular/ad hoc limits after 180 days considered as NPA (unreviewed limits,
180 days, NPA)
● Ensure ad hoc/short reviews aren't repetitive (ad hoc reviews, repetitive basis)
● Consider account classification based on other parameters and functioning (account classification,
other parameters, functioning)

Asset Classification - Borrower Wise, Not Facility Wise:


Asset classification should be borrower wise, not facility wise (borrower wise, asset classification)
All facilities granted by a bank to a borrower considered as NPA, not just irregular facilities (NPA, all facilities)

Government Guaranteed Advances


● If government guaranteed advance becomes NPA, then for the purpose of income recognition, interest
on such advance should not be taken to income unless interest is realized.
● However, for the 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.

CA Final RTP November 2019 , MTP April 2018 , May 2013 (Old)- (www.icai.org)

In the course of audit of True Princi Bank as at 31st March, 2019, you observed that 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

Answer

Neeraj Arora 6.15


Bank Audit

Government Guaranteed Advance:


➔ If a government guaranteed advance becomes NPA, then for the purpose of income recognition, interest on such
advance should not be taken to income unless interest is realized. However, for the 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 revoked 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 purposes. But this exemption is not available in
respect of income recognition norms. Hence the income to the extent not recovered should be reversed.

➔ The situation would be different if the advance is guaranteed by the 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.

Agricultural Advances
Agricultural advances are classified as NPA if interest and/or Instalment of principal is overdue for (a) two crop
seasons, in case loans granted for Short Duration crops, (b) one crop season, in case loans granted for Long
Duration crops (i.e. more than 1 year).
Long duration crops mean the crops with crop season longer than one year. Short Duration Crops means the
crops, other than long duration crops.
● Ensure that NPA norms have been applied in accordance with the crop season determined by the State
Level Bankers’ Committee in each State.
● Also ensure that these norms are made applicable to all direct agricultural advances.
● 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.

Restructuring:
● Lender grants concessions to borrower in financial difficulty (lender, borrower, financial difficulty)
● Modifications can include altered terms, repayment period, interest rates, or additional credit
(modifications, altered terms)
● RBI issued revised guidelines for restructured accounts (RBI, revised guidelines)
● Restructuring allowed for standard, substandard, or doubtful accounts (account categories,
restructuring)
● No retrospective restructuring allowed (no retrospective restructuring)
● Auditors assess provisions for accounts pending restructuring (auditors, provisions, pending
restructuring)
● Restructured accounts downgraded from standard to substandard, NPAs remain in the same category
(downgraded accounts, NPAs)

Upgradation of Account:
● Examine all accounts upgraded from NPA to standard category (examine, upgraded accounts)
● Ensure compliance with RBI guidelines (RBI guidelines, compliance)
● Be cautious of incorrect upgradations due to partial recoveries (partial recoveries, incorrect
upgradation)
● Consider overdue portion not completely wiped out (overdue portion, not wiped out)
● Account for recoveries made after cut-off date (recoveries, cut-off date)

Neeraj Arora 6.16


Bank Audit

Provisioning Towards Standard Assets:


● Check latest RBI Circulars (RBI Circulars, latest)
● Provisions required at variable rates for different sectors (variable rates, sectors)
● Made in accordance with RBI norms (RBI norms, prudence)
● Check provisions in detail with statement of advances (provisions, statement of advances)
● Bifurcate standard advances under relevant categories (bifurcation, relevant categories)
● Verify and certify at branch level (certify, branch level)
● Adhere to RBI-defined item specifications (RBI definitions, adherence)

Sale/Purchase of NPAs:
● Examine the policy laid down by the Board of Directors (policy, Board of Directors)
● Ensure NPAs sold remained NPA for at least 2 years (2 years, NPA)
● Verify assets sold/purchased "without recourse" (without recourse, credit risk)
● Ensure no legal, operational, or other risks assumed after sale (no risks, after sale)
● Confirm NPA sold on cash basis only (cash basis, upfront payment)
● Check bank hasn't purchased originally sold NPA (not repurchased, original NPA)

Sale of NPA:
● Ensure NPA removed from seller's books (removed, seller's books)
● Confirm shortfall debited to P&L if sold below NBV (shortfall, P&L)
● Verify excess provision not reversed, but utilized for other NPAs (excess provision, utilized)
Purchase of NPA:
● Check appropriate provisioning for purchased NPA (provisioning, classification status)
● Verify recovery adjusted against acquisition cost (recovery, acquisition cost)
● Ensure 100% risk weight assigned for capital adequacy (100% risk weight, capital adequacy)

FIXED ASSETS
● Required classification by the Banking Regulation Act, 1949 (Banking Regulation Act, classification)
● Two categories: Premises and Other Fixed Assets (Premises, Other Fixed Assets)
● Premises: wholly/partly owned, for business or employee residential use (owned, business, residential)
● Other Fixed Assets: furniture, fixtures, motor vehicles, computers, office equipment, etc. (furniture,
vehicles, computers)
● Show leased assets and intangible assets separately (leased assets, intangible assets)
● Comply with Accounting Standards requirements (Accounting Standards, compliance)\
● Section 9 of the Banking Regulation Act, 1949 prohibits banks from holding immovable property for
more than 7 years, except for their own use. (immovable property, Banking Regulation Act)
● Fixed assets in banks are generally purchased by head office/regional offices. Statutory branch auditor
needs to plan accordingly. (fixed assets, purchase, branch auditor)
● Maintenance of fixed asset records is often centralized at head office level. Some banks use fixed asset
management software. (record keeping, fixed asset management software)
● In auditing fixed assets, auditors focus on obtaining evidence of ownership, existence, and valuation.
(audit procedures, ownership, existence, valuation)

Internal Controls
● Control over expenditures on fixed assets (expenditure control)
● Accountability and utilization controls

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Bank Audit

● Information controls for reliable fixed assets information


● Location of fixed assets accounts maintenance (branch or central)
● Location of documents evidencing ownership of fixed assets
● Communication of branch-level fixed assets transactions to head office

Premises
● Verify opening balance with fixed assets schedule/ledger/register
● Verify acquisition of new premises with authorization, payment record, title deeds, etc.
● Verify self-constructed fixed assets with authorization and related documents
● Reconcile balances as per fixed assets register with those as per ledger/statements
● Capitalization and amortization of lease premium for leasehold premises
● Amortization of improvements over useful life for leasehold premises
● Obtain written representation if title deeds are held at a different location
● Separate heading for premises under construction and advances/payments to contractors
● Examine appropriateness of revaluation basis and treatment of resultant surplus/deficit
● Check for impairment following relevant Accounting Standard
● No inclusion of immovable properties other than those required for own use of bank (obtain written
representation)

Other Fixed Assets


● Other fixed assets should be verified similarly to premises.
● Verify movements and controls over movable fixed assets, including physical verification, discrepancies,
and adequate provision for damaged assets.
● Transfer of fixed assets should include the transfer of accumulated depreciation.
● Verify compliance with RBI guidelines and AS 26 for intangible assets.
● Fixed assets should be properly classified and grouped together.
● Head office auditor should ensure consolidated schedule matches with transfers in/out and check
depreciation amounts with emphasis on computer hardware/software.

Sale of Fixed Assets


● Verify copy of sale deed and receipt of sale value
● Ensure profit/loss on sale of assets has been properly accounted for

Leased Assets
● Verify accounting and provisioning norms followed by banks in leasing activity based on RBI circulars
and guidelines
● Consider requirements of AS 19, "Leases," in regards to leased assets.

Impairment of Assets
● Verify whether the guidelines given by RBI’s circular on compliance with Accounting Standards,and the
requirements of AS 28 have been followed.

OTHER ASSETS
Inter-Office Adjustments
● Verify if Inter-branch accounts are reconciled at central level
● Report on the status of inter-branch accounts at year-end
● Indicate dates up to which accounts have been reconciled

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Bank Audit

● Report number and amount of outstanding entries separately for debit and credit entries
● Ensure that any discrepancies in inter-branch accounts have been properly dealt with in the books
● Obtain information from branch audit reports

Interest Accrued
● Verify interest accrued on the entire loans and advances portfolio, including overdue bills
purchased/discounted.
● Ensure only interest that can be realised in the ordinary course of business is shown, based on AS 9
principle.
● No significant uncertainty should exist about the collectability of the interest revenue.

Tax Paid in Advance/Tax Deducted at Source


● Ensure collection of certificates for tax deducted at source (TDS) by the branch and submission of the
original copy to Head Office along with transfer of TDS amount on periodic basis.
● Check TDS certificates/credits in form 26AS and the justification of the claim towards them in Income
Tax returns filed.
● Check availability of all TDS certificates/credits in form 26AS and justification of the claim towards
them at Head Office level.

Stationery and Stamps


● Exceptional stationery items only (bulk security paper) (exceptional, stationery)
● Valued at cost (valued, cost)
● Normal stationery charged to P&L account (normal, P&L account)
● May not appear at branch level (branch level, head office)
● Evaluate internal controls (existence, effectiveness, continuity)
● Comment on controls in LFAR (branch auditor, LFAR)
● Physical verification of stationery and stamps (year-end, security items)
● Inquire into shortages (shortage, potential loss)
● Examine cost charging to P&L account (properly charged, accounting policy)

Non-Banking Assets Acquired in Satisfaction of Claims


● Heading for immovable properties/tangible assets (acquired, satisfaction of debts)
● Intention of disposal (intention, disposal)
● Verify assets with documentary evidence (terms of settlement, court order)
● Verify legal ownership (ownership, legal)
● Examine recording if disputes arise (dispute, recording)
● Provision for liability or disclosure (AS 29, contingent liability)
● Compliance with Section 9 of Banking Regulation Act (holding period, compliance)
● Record assets at lower of net book value or net realizable value (acquisition, lower value)

OTHERS
● Residual heading (others, residual)
● Items not covered under other subheads (not covered, subheads)
Examples:
● Unreceived claims (claims, unreceived)
● Technical reasons (technical, particulars)
● Government business receivables (government, receivables)

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Bank Audit

● Prepaid expenses (prepaid, expenses)


● Accrued non-interest income (accrued, non-interest)

Non-Interest Bearing Staff Advances:


● Examine documentation and policy (relevant, documentation)
● Check security, enforceability, valuation (availability, security)
● Relate to employees (employees, financial statements)
Loans and Advances to Officials and Relatives:
● Verify sanctioning authority (next higher, recipient)
● Report loans to the Board (senior officers, Board)
Security Deposits:
● Examine deposits with authorities (telephone, electricity)
● Check documents, terms, receipts (relevant, terms)
● Deposit not due yet (due, recoverability)
● Consider provision for doubtful recovery (provision, doubtful)
Suspense Account:
● Obtain details of old outstanding entries (management, outstanding)
● Examine provisions and write-offs (necessary, provision)
Prepaid Expenses:
● Examine allocation basis (allocation, reasonable)
● Verify discounting and rediscounting charges (allocation, accounting policy)
Miscellaneous Debit Balances on Government Account:
● Review ageing statements (ageing, statements)
● Examine recoverability (old, outstanding)
● Check reimbursement claims (reimbursement, terms)
● Net balances at Head Office level (net, age-wise analysis)
● Provide for unconfirmed or unjustified balances (provision, accounts)
● Verify reasons for major variance (variance, previous year)

Verification Of Capital & Liabilities


Capital
Audit Approach and Procedures
● Verify opening balance with previous year's audited balance sheet (opening balance, audited)
● Examine relevant documents for capital increase (increase, documents)

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.

BASEL III framework


● Basel III Accord Aims:
○ Improve banking sector's ability to absorb shocks
○ Improve risk management and governance practices
○ Strengthen banks' transparency and disclosure standards

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Bank Audit

Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For
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.

Stress Testing
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.

Capital Adequacy Ratio


Capital Adequacy Ratio (CAR) or Capital-to-risk weighted assets ratio (CRAR) is calculated as follows

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.

Reserves and Surplus:


Disclosure in balance sheet:
● Statutory Reserves
● Capital Reserves
● Share Premium
● Revenue and Other Reserves (including Investment Fluctuation Reserve)
● Balance in Profit and Loss Account.

Audit Approach and Procedures:


● Verify opening balances with previous year's audited balance sheet
● Verify additions/deductions with reference to board resolution
● Examine compliance with legal requirements (statutory reserves, share premium)
● Check exemption documents for transfer requirements, if applicable
● Ensure appropriations conform to legal requirements
● Verify compliance with foreign laws for overseas branches

Deposits
Deposits Audit Approach:
● Deposits are a crucial source of funds for banks
● Aim for reasonable assurance that all known liabilities are recorded and stated accurately
Consider the following areas when auditing Deposits:
● Current Accounts & Savings Accounts (CASA)
● Term Deposits
● Deposits Designated in Foreign Currencies

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Bank Audit

Types of deposits:
● Demand deposits (Current and Savings accounts)
● Term deposits (Fixed Deposits, Recurring Deposits)
Foreign currency deposits:
● Foreign Currency Non-Resident Deposits (FCNR)
● Non-Resident (External) Rupee Account Scheme (NRE)
● Non-Resident Ordinary Rupee Account Scheme (NRO)
Deposits are relevant to auditors at both branch and central/head office levels

Verification of various type of deposits


● Current and Saving Accounts
● Verify sample accounts for KYC norms (KYC, sample accounts)
● Ensure appropriate account types (saving accounts, business transactions)
● Verify balances and interest calculations (balances, interest)
● Examine balance confirmations (balance confirmations, consistency)
● Include debit balances in advances (debit balances, advances)
● Verify inoperative accounts (inoperative accounts, fraud risks)
● Term Deposits
● Check deposit receipts and registers (deposit receipts, registers)
● Verify interest rates for bulk deposits (bulk deposits, interest rates)
● Check foreclosure penalties (term deposit closure, penalties)
● Verify recurring deposit accounts (recurring deposits, sample basis)
● Confirm interest rates on term deposits (term deposits, interest rates)
● Deposits in Foreign Currencies
● Verify FCNR accounts (FCNR accounts, RBI directions)
● Check permissible transactions (FCNR accounts, transactions)
● Examine currency conversion (FCNR accounts, conversion)
● Verify interest payment basis (interest, 360 days)
● Others
● Examine NRE and NRO accounts (NRE, NRO, RBI guidelines)
● Check repatriability (NRE, NRO, repatriability)
● General
● Verify deposit inflation prevention (deposits, inflation)
● Consider qualification for window-dressing (window-dressing, qualification)
● Examine interest accruals (interest, accruals)
● Ensure KYC and Anti-Money Laundering frameworks (KYC, Anti-Money Laundering)

BORROWINGS
● Borrowings classification
● Borrowings in India
● Borrowing from Reserve Bank of India, Other Banks, Other Institutions & Agencies
● Borrowings outside India
● Note secured borrowings (secured borrowings, refinance)
● Exclude inter-office transactions (inter-office, not borrowings)
● Audit Procedures for Borrowings:
● Obtain and verify confirmation certificates (confirmation certificates, supporting documents)
● Comply with SA 505 "External Confirmations" (external confirmations, reliable audit evidence)

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Bank Audit

● Examine distinction between 'rediscount' and 'refinance' (rediscount, refinance)


● Examine authorization for borrowings at call and short notice (authorization, interest rate,
duration)
● Ensure branch authorization for borrowings (branch authorization, borrowing terms)
● Examine proper classification based on security (classification, security)

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
● Bills Payable
● Inter-office adjustments
● Interest Accrued
● Others (Including provisions)

Other Liabilities Audit Procedures:


● Bills Payable
● Evaluate internal controls (existence, effectiveness, continuity)
● Examine sample of outstanding items (bills payable accounts, registers)
● Ascertain reasons for old outstanding debits (drafts, instruments)
● Examine post-year-end correspondence (large value items, balance sheet)
● Inter-office Adjustments:
● Credit balance shown under this head (inter-office adjustments)
● Interest Accrued:
● Examine interest with reference to deposit and borrowing terms (interest accrued,
deposits, borrowings)
● Ensure interest not clubbed with deposit and borrowing figures (interest accrued)
● Others (Including Provisions):
● Examine other provisions and liabilities (advances, investments, balance sheet)
● Assess provisions made to auditor's satisfaction (provisions, liabilities)

CONTINGENT LIABILITIES
1. Claims against the banks not acknowledged as debt.
2. Guarantees Given on Behalf of Constituents.
3. Acceptances, Endorsements and Other Obligations and other Items for which the Bank is Contingently
Liable.
4. Liability on Account of Outstanding Forward Exchange Contracts.
5. Bills for collection.

Contingent Liabilities Audit Approach:


● Ensure management representation for:
● Proper accounting of off-balance sheet transactions
● Compliance with procedures for off-balance sheet transactions
● Adequate documentation for transactions
● Disclosure of all year-end contingent liabilities
● Exclusion of crystallized liabilities from contingent liabilities
● Use of best estimates for financial effect of contingent liabilities (AS 29)
● Adherence to regulations for guarantees issued on behalf of directors

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Bank Audit

● Justification for non-disclosure of remote contingent liabilities

Audit Procedures
Contingent Liabilities
● Verify the existence of a system for extending non-fund based facilities.
● Ensure transactions leading to contingent liabilities are executed by authorized personnel.
● Verify payments to overseas suppliers based on shipping documents.
● Test the completeness of recorded obligations.
● Review the year-end amount of contingent liabilities.
● Review whether comfort letters have been considered for disclosure of contingent liabilities.
● Verify guarantees given on behalf of constituents.
Claims Against the Bank Not Acknowledged as Debts:
● Review relevant evidence and correspondence to identify claims.
● Ascertain the status of outstanding claims with management.
● Review subsequent events to provide evidence about completeness and valuation of claims.
Liability on Account of Outstanding Forward Exchange Contracts & Derivative Contracts:
● Verify outstanding forward exchange and derivative contracts.
● Physically verify underlying documents including confirmations.
● Verify options, interest rate swaps, etc.
Guarantees Given on Behalf of Constituents:
● Ascertain adequate internal controls over issuance of guarantees.
● Verify guarantees register and seek evidence.
● Verify guarantees with copies of letters and counter-guarantees.
● Verify securities held as margin.
● Consider provision if a claim has arisen.
Acceptances, Endorsements and Other Obligations:
● Evaluate adequacy of internal controls over issuance of letters of credit.
● Verify balance of letters of credit from the register.
● Examine potential financial obligations in respect of letters of comfort.
● Verify security obtained for issuing letters of credit.
Bills for Collection:
● Ensure bills drawn on other branches are not included.
● Verify outward bills for collection with corresponding register.
● Examine collections made after the balance sheet date.
● Examine the procedure for crediting parties and debiting customer accounts.
● Verify that no income has accrued in the accounts in respect of bills outstanding.

Concurrent Audit
Meaning
● Audit or verification of transactions or activities of an organisation concurrently as the
transaction/activity takes place.
● The primary objective of concurrent audit is to ensure the accuracy, authenticity, and compliance of
transactions or activities with established procedures, guidelines, and regulations.
Scope
● Detailed scope of concurrent audit determined by Bank's Central Inspection and Audit Department and
ACB - Audit committee of board of directors - (Detailed scope, Central Inspection and Audit
Department, ACB)

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Bank Audit

● Focus on high-risk transactions with large financial implications (high-risk transactions, large financial
implications)
● RBI guidelines cover key areas of branch activities under concurrent audit (RBI guidelines, key areas,
branch activities)
● Most banks have prepared an Audit Manual (Audit Manual, banks)

Areas covered by RBI Guidelines


- Cash
- Deposits
- Foreign Exchange
- Investments
- Advances
- Housekeeping
- Other items

Concurrent Audit System in Commercial Banks


● Part of bank's early-warning system (early-warning system, timely detection, irregularities)
● Requires serious attention from bank management (bank management, implementation, various
aspects)
● Annual review of effectiveness and taking corrective measures (annual review, effectiveness, corrective
measures)

Coverage of Business/Branches
● Scope and coverage determined by head of internal audit with ACB approval (scope, coverage, head of
internal audit, ACB approval)
● Ensure risk-sensitive areas are covered (risk-sensitive areas, as per specific business models, coverage)
● Broad areas of coverage based on identified risk (identified risk, coverage, random transaction testing)

Appointment of Concurrent Auditors and Accountability


● Option for bank's staff or external auditors (bank's staff, external auditors, individual banks' discretion)
● Bank's officials should be experienced, well-trained, senior, and independent (experienced, well-trained,
senior, independent)
● ACB decides maximum tenure.
○ 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.

Remuneration of Concurrent Auditor


● Terms and remuneration fixed by ACB (terms, remuneration, ACB decision)
● Consideration of factors: coverage, skill sets, staff, and time (coverage, skill sets, staff, time)

Reporting Systems
● Proper reporting of concurrent audit findings (reporting, findings)
○ Preparation of structured format for each bank (structured format, bank)

Neeraj Arora 6.25


Bank Audit

○ Highlight major deficiencies/aberrations in special note (deficiencies, special note)


○ Immediate reporting to branch/controlling offices (immediate, reporting)
○ Quarterly review of key features to ACB (quarterly review, ACB)
● Zone-wise reporting to ACB, annual appraisal of audit system (zone-wise, annual appraisal)
● Auditor discussion with branch manager/officers before report submission (discussion, submission)
○ Consideration of opposite viewpoints, clarification of doubts (opposite viewpoints, clarification)
● Timely rectification of minor irregularities (timely, minor irregularities)
○ Reporting serious irregularities to controlling/head offices (serious irregularities, reporting)
● Immediate reporting of fraudulent transactions (fraudulent transactions, immediate)
● Notify Inspection & Audit Department, Chief Vigilance Officer, Branch Managers (Inspection & Audit,
Chief Vigilance Officer)
● High priority follow-up on concurrent audit reports (high priority, follow-up)
○ Timely rectification of reported features (rectification, timely)

Activities Covered
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 a sizable 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 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.

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Bank Audit

● 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 are 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 Exchange ● Foreign Bills - Check foreign bills negotiated under letters of credit.
● FCNR - Check FCNR (Foreign Currency non-resident)and other non-resident
accounts whether the debits and credits are permissible under rules.
● Remittance - Check whether inward/outward remittance have been properly
accounted for.
● Forward Contract - 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 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 accounts
transactions.

House-Keeping ● Ensure that the maintenance and balancing of accounts, ledgers and
registers including clean cash is proper.
● Reconciliation of Inter Branch and Inter bank transactions.
● Ensure timely adjustment of large value entries.
● Carry out a percentage check of calculations of interest, discount,
commission and exchange.
● Check the transactions of staff accounts.
● Detection & prevention of revenue leakages through close examination of
income and expenditure transactions
● Verify cheques returned/bills returned register and look into reasons for
return of those instruments.

AUDIT COMMITTEE
● Audit Committee constituted per RBI guidelines (Audit Committee, RBI guidelines)
● Provides direction, oversees total audit function (direction, oversight)
● Reviews internal inspection/audit function (reviews, internal audit)
● Emphasises system quality, effectiveness, follow-up (quality, effectiveness, follow-up)

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Bank Audit

● Audit
○ Reviews concurrent auditors' appointment and remuneration (appointment, remuneration)
○ Connected to concurrent audit system (connected, concurrent audit)
○ Reviews auditors' work quality (work quality, review)
○ Periodical meetings with concurrent and statutory auditors (periodical meetings, auditors)
○ Helps oversee total audit function in bank (oversight, total audit function)

Neeraj Arora 6.28


Peer Review

Chapter-7 Peer Review & Quality Review


Introduction
● Peer - The term ‘peer’ means a person of similar standing.
● Review - The term ‘review’ means conduct of reexamination or retrospective evaluation of the subject
matter.
● In general, for a professional, the term "peer review" would mean review of work done by a professional,
by another professional of similar standing.

Peer Review - Meaning


Peer Review - means an examination and review of (KYA)
● the systems and procedures (KISKA)
● (KYUN) to determine whether the same have been put in place by the Practice Unit
○ for ensuring the quality of assurance services as mentioned
■ by the Technical, Professional and Ethical Standards as applicable including Audit
Quality Maturity Model wherever applicable or any other regulatory requirements as
may be prescribed by the Council or any Committee and (TPE, AQMM, ORR)
■ whether the same were consistently applied during the period under review;
Reviewer
“Reviewer” - means a member duly approved and empanelled by the Board on fulfilling the qualifications
prescribed for a Reviewer as per Guideline 26 of these Guidelines

Practice Unit
Means a firm of Chartered Accountants or a member in Practice, practicing whether in an individual name or
a trade name or such other entity as recognized by the Institute of Chartered Accountants of India from time to
time.

Peer Review Board


Means the Board constituted by the Council in terms of this Guideline from time to time.
The expression “Peer Review Board'' is hereinafter referred to as “Board”.

Peer Review period


Means three financial years preceding the year in which the Practice Unit is selected or such other period or
any period as may be prescribed by the Peer Review Board for conducting a Peer Review in a specific case;

The Peer Review process shall apply to all the assurance engagements signed by a Practice Unit during the
period under review.

Peer Review Guidlines


The Peer Review Guidelines, 2022 issued by Council are covered under clause (1) of Part II of Second Schedule
to the Act and it is obligatory for the Practice Unit to comply with the provisions contained in this Guidelines.

SCOPE OF PEER REVIEW


The Peer Review shall cover
● The Review shall cover:

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Peer Review

○ Compliance with Technical, Professional and Ethical Standards.


○ Quality of reporting.
○ Systems and procedures for carrying out assurance services.
○ Self-evaluation under Audit Quality Maturity Model or any other guideline issued by the Centre for
Audit Quality”
○ Training programmes for staff (including articled and audit assistants) concerned with
assurance functions, including availability of appropriate infrastructure.
○ Compliance with directions and / or guidelines issued by the Council to the Members,
including
■ Fees to be charged,
■ Number of audits undertaken,
■ register for Assurance Engagements conducted during the year and
■ such other related records.
○ Compliance with directions and / or guidelines issued by the Council in
■ relating to article assistants and / or audit assistants, including
● attendance register,
● work diaries,
● stipend payments, and
● such other related records.

Meaning of Technical, Professional and Ethical Standards


As per the guideline, Technical, Professional and Ethical Standards – means
● Accounting Standards issued by ICAI that are applicable for entities other than companies under the
Companies Act, 2013;
● Accounting Standards prescribed under section 133 of the Companies Act; 2013 by he Central
Government based on the recommendation of ICAl and in consultation with and after examination of
the recommendations made by the National Financial Reporting Authority (NFRA);
● Indian Accounting Standards prescribed under section 133 of the Companies Act 2013 by the Central
Government based on the recommendation of ICAI and in consultation with NFRA and notified as
Companies (Indian Accounting Standards) Rules, 2015, as amended from time to time;
● Standards
○ Engagement and Quality Control Standards
○ Statements
○ Guidance notes
○ Standards on Internal Audit.
○ Directions /Announcements / Pronouncements / Professional Standards issued from time to
time by the Council or any of its Committees.
● Framework for the preparation and presentation of financial statements , Preface to the Standards on
Quality Control, Auditing, Review, Other Assurance and Related Services and Framework for Assurance
engagements;
● Provisions of the relevant statutes and / or rules or regulations which are applicable in the context of the
specific engagements being reviewed including instructions, guidelines, notifications, directions issued
by regulatory bodies as covered in the scope of assurance engagements.
● Any other Technical, Professional, Ethical Standards and other Standards issued by any authority
governing the profession of Chartered Accountancy.

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Peer Review

Meaning of Assurance Engagements


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 but does not
include
❖ Management Consultancy Engagements;
❖ Representation before various Authorities;
❖ Engagements to prepare tax returns or advising clients in taxation matters;
❖ Engagements for the compilation of financial statements.
❖ Engagements solely to assist the client in preparing, compiling or collating information other
than financial statements;
❖ Testifying as an expert witness;
❖ Providing expert opinion on points of principle, such as Accounting Standards or the
applicability of certain laws, on the basis of facts provided by the client; and
❖ Engagement for Due diligence.
❖ Any other service rendered or function performed by practitioner not prescribed by the Council
to be ‘Assurance Engagement’.
The phrase 'Assurance Services' is used in the Guidelines interchangeably with Audit Services, Attestation
Functions and Audit Functions.

APPLICABILITY
The Criteria of Peer Review are as follows:
1. Mandatory: Peer Review can be mandated for such Practice Units as may be decided by the Council.
2. Voluntary : Any Practice Unit may, suo motu, apply to the Board for the conduct of its Peer Review.
3. Special case - The Board, based on specific information received from Secretary, ICAI or Disciplinary
directorate or any other Regulator, which in the opinion of the Board requires a special Peer Review of
the Practice Unit, may conduct a special Peer Review of the Practice Unit for such a period determined
by the Board.
4. Prescribed criteria - The Board may prescribe any other criteria of selection of Practice Unit for Peer
Review as it may deem fit.

Accordingly, the Peer Review Mandate (Revised), operative from April 1, 2022, has been made in following four
stages:

Phase Category of firms covered for Mandatory Peer Review Date from Peer
Review which is
Mandatory

1. Practice Units which propose to undertake Statutory Audit of 1st April 2022
enterprises whose equity or debt securities are listed in India or
abroad as defined under SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015: For these Practice
Units, there is a pre-requisite of having Peer Review
Certificate.

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For auditors from this category, Peer Review is already


mandatory by SEBI; this mandate is a further requirement
stipulated by the ICAI.

2. Practice Units which propose to undertake Statutory Audit of 1st April 2023
unlisted public companies having
● paid-up capital of not less than rupees five hundred
crores or
● having annual turnover of not less than rupees one
thousand crores or
● having, in aggregate, outstanding loans, debentures and
deposits of not less than rupees five hundred crores as
on the 31st March of immediately preceding financial
year:
OR
Practice Units rendering attestation services and having 5 or
more partners:

3. Practice Units which propose to undertake the Statutory Audit 1st April 2024
of entities which have raised funds from public or banks or
financial institutions of over Fifty Crores rupees during the
period under review or of anybody corporate including trusts
which are covered under public interest entities - For these
Practice Units, there is a pre-requisite of having Peer Review
Certificate.
OR
Practice Units rendering attestation services and having 4 or
more partners: For these Practice Units, there is a pre-requisite
of having Peer Review Certificate before accepting any
Statutory audit.

4. Practice Units which propose to undertake audits of branches 1st April 2025
of Public Sector banks : For these Practice Units, there is a
pre-requisite of having Peer Review Certificate.
OR
Practice Units rendering attestation services and having 3 or
more partners: For these Practice Units, there is a pre-requisite
of having Peer Review Certificate before accepting any
Statutory audit

PEER REVIEW BOARD


Establishment and Constitution
1. The Board shall be constituted by the Council.
2. The Board shall consist of a minimum of six and a maximum of twelve members to be appointed by the
Council, of whom not less than fifty per cent shall be from amongst the members of the Council.

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3. The Council may nominate members to the Board from outside bodies and from amongst prominent
individuals of high integrity and reputation, including but not limited to, regulatory authorities,
bankers, academicians, economists, legal professionals and business executives.
4. The Council shall appoint the Chairman and the Vice-Chairman to the Board from amongst its elected
members of the Council.
5. The term of two thirds members shall be for three years or end of the term of the member in the
Council whichever is earlier, or such other period as may be prescribed by the Council from time to
time. The Chairman and the Vice-Chairman of the Board, as far as possible, may be rotated every year
by the Council of the Institute.
6. Casual vacancies on the Board shall be filled by the Council.
7. A Member of the Disciplinary Committee or the Board of Discipline shall not be eligible for
appointment as a member of the Board.

Meetings of Peer Review Board


Provisions related to the time, place and quorum of Meetings of the Peer Review Board as well as procedure for
transaction of business shall be governed by the Chartered Accountants Regulation, 1988.

Reporting
The Board shall submit a report to the Council prior to the date of every meeting of the Council.

ELIGIBILITY TO BE A REVIEWER
A member in practice shall be eligible to be enrolled as a Peer Reviewer if:
a. He is a member in practice having at least seven years of assurance practice experience or
b. A member in employment who has subsequently obtained a Certificate of Practice,
➢ having at least ten years of experience in employment and
➢ at least three years audit experience in practice and
➢ is in whole time practice at the time of enrolment and appointment as Peer Reviewer.

A member shall not be eligible for being appointed as a Reviewer of a Practice Unit, if -
a. any disciplinary action / proceeding is pending against him
b. he has been found guilty of professional or other misconduct by the Council or the Board of Discipline
or the Disciplinary Committee at any time
c. he has been convicted by a competent court whether within or outside India, of an offence involving
moral turpitude and punishable with imprisonment,

A Peer Reviewer shall not accept any professional assignment from the Practice Unit for a period of two years
from the date of appointment.

Further, he should not have accepted any professional assignment from the Practice Unit for a period of two
years prior to the date of appointment as a Peer reviewer of that Practice Unit or its partners in case of a firm.

A Reviewer shall be de-empanelled by the Board if his name is removed from the register of members or if he
surrenders his Certificate of Practice at any time after he is empanelled with the Board.

A member on being appointed as a Reviewer shall be required to furnish a Declaration of Confidentiality to


the Practice Unit as per Form 2 of these Guidelines while giving consent for appointment as a Peer Reviewer.

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Qualified Assistant
● Means a member who is an associate of the Reviewer either as his partner or as a paid assistant as per the
records of the Institute of Chartered Accountants of India.
● The reviewer may take the help of a qualified assistant while carrying out peer review.
● Only one assistant who shall be a chartered accountant and a person who does not attract any of the
dis-qualifications prescribed under Section 8 (Disabilities.) of the Chartered Accountants Act, 1949.
● The name of the qualified assistant which the reviewer would like to assist him shall be identified and
intimated to the Board as well as the practice unit before the commencement of the peer review.
● Such a qualified assistant shall also have to sign the declaration of confidentiality.
● He shall have no direct interface either with the practice unit or the Board.

CONFIDENTIALITY
1. Importance of Confidentiality
● Maintained by all involved in Peer Review process
● Reviewers, members of the Board, Peer Review Secretariat, qualified assistants, and Practice
Unit
2. Preservation of Secrecy
● Preserve secrecy in performing functions related to Peer Reviews
● Applies to both direct and indirect involvement
3. Reviewer's Responsibility
● Not to disclose contents of Review report or confidential information
● Except when required by the Board or the Council
4. Non-compliance Consequences
● Professional misconduct under Section 22 of the Chartered Accountants Act, 1949
5. Declaration of Confidentiality
● Form 4 to be signed by all members of the Board and the Board’s Secretariat

Summary
Confidentiality is a crucial aspect of the Peer Review process, and all individuals involved must preserve
secrecy. The Reviewer should not disclose any confidential information except when required by the Board or
the Council. Non-compliance with the secrecy provisions amounts to professional misconduct. A Declaration
of Confidentiality (Form 4) must be signed by all members of the Board and the Board's Secretariat.

Section 22 essentially defines professional misconduct by referring to the acts or omissions listed in the First and Second
Schedules of the Chartered Accountants Act. It clarifies that professional misconduct includes those specific acts, but
the Council still has the authority and responsibility to investigate a member's conduct in other circumstances as well.
The First and Second Schedules contain various clauses detailing the specific instances of professional misconduct that
may warrant disciplinary action against a member of the Institute of Chartered Accountants of India (ICAI).

Obligations of the Practice Unit


All Practice Units shall comply with the provisions of these Guidelines. Any non-compliance by a Practice Unit
shall attract disciplinary action under clause (2) of Part III of the First Schedule and/or under clause (1) of Part
II of the Second Schedule of the Chartered Accountants Act, 1949.

The Board is empowered to forward the name/s of a Practice Unit or Practice Units to the Council for initiating
Disciplinary action.

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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 (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.

Second Schedule - 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.

Any Practice Unit, in addition to the


● prescribed information to be furnished
○ including the
■ questionnaire,
■ statements and
■ such other particulars as the Board may
deem fit,
● shall comply with the following.

1. Produce to the Reviewer or allow access to,

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● any record, document or prescribed register maintained by the Practice Unit and which is in
the possession or under the control of the Practice Unit.

2. Provide to the Reviewer


● such explanation or further particulars/ information in respect of anything produced in
compliance with a requirement under sub clause (1) above, as the Reviewer shall specify.

3. Provide to the Reviewer


● all assistance in connection with Peer Review;

4. Where any information or matter relevant to a Practice Unit is recorded otherwise than in a legible
form, the Practice Unit shall provide and present to the Reviewer
● a reproduction of any such information or matter, or of the relevant part of it in a legible form,
with a translation in English or Hindi, if the matter is in any other language, and if such
translation is requested for by the Reviewer.
● The Practice Unit shall be responsible and accountable for the accuracy and truthfulness of the
translation so provided.

Obligations of the Peer Reviewer


1. The Reviewer shall not take any extracts of the Practice Units clients' file or records examined by him
while conducting Peer Review, as a part of his working papers.
2. The Reviewer shall complete the Review within the prescribed time frame and submit the report to the
Board.
3. The Reviewer shall document all his working papers and submit a copy of his working papers to the
Board, if called for by the Board within 18 months of submission of Review Report.

THE PEER REVIEW PROCESS


“Procedure for initiating Peer Review:
1. Application Submission
● Practice Units voluntarily seeking Peer Review submit Form 1 (Application cum Questionnaire)
● If initiated by the Board, Practice Unit submits Form 1 upon request from the Peer Review
Board Secretary
● Applications received by the Board are duly numbered
2. Reviewer Selection
● Board recommends three Reviewer names within three working days of receiving the
application
● Practice Unit selects one Reviewer from the list and informs the Board within one working day
of receipt of the names.
● Board appoints the selected Reviewer in accordance with the Guidelines
3. Declaration of Confidentiality
● Appointed Reviewer submits Form 2 (Declaration of Confidentiality) to the Practice Unit within
two working days of receiving the Reviewer's name from the Practice Unit
4. Sharing Application cum Questionnaire
● Practice Unit provides a copy of Form 1 (Application cum Questionnaire) submitted to the
Board as per Clause 6(1) or 6(2) to the Reviewer within two working days of Reviewer's
appointment.

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Summary
The procedure for initiating Peer Review involves submitting Form 1 (Application cum Questionnaire),
selecting a Reviewer, obtaining a Declaration of Confidentiality from the Reviewer, and sharing the Application
cum Questionnaire with the Reviewer.

Peer Review Procedure to be followed by the Peer Reviewer:


1. Declaration of Confidentiality
● Ensure Declaration of Confidentiality (Form 2) is furnished to the Practice Unit and an
acknowledgment is obtained
2. Initiation of Peer Review
● Reviewer receives Form 1 (Application cum Questionnaire) from the Practice Unit

3. Request for Additional Information
● If needed, Reviewer may seek further/additional clarification using Form 6
● Practice Unit provides additional information within one working day
4. Selection of Assurance Service Engagements
● Reviewer selects engagements for review within two working days of receiving information from
Practice Unit and informs both Practice Unit and Peer Review Board using Form 5
● Plan "on-site review" visit and initial meeting in consultation with the Practice Unit
● Reviewer gives Practice Unit at least two working days to prepare necessary records.
5. Completion of Review Process
● Reviewer and Practice Unit cooperate to complete the review process within 20 working days
from the date of receipt of the application or notification of selection for Review
● For new units, the review process is completed within seven working days from the receipt of
the application cum questionnaire
Summary
The Peer Review Procedure for Reviewers includes obtaining the Declaration of Confidentiality, initiating the
review, requesting additional information if necessary, selecting assurance service engagements for review, and
completing the review process within the specified time frames.

Form Summaries Till Now.


In the Peer Review process, various forms are used to streamline the procedure and ensure effective
communication between the Practice Unit, Peer Reviewer, and Peer Review Board. Here is a list of the forms
and their usage:
1. Form 1 - Application cum Questionnaire: This form is used by the Practice Unit to apply for Peer
Review and provide necessary information about the Practice Unit to the Board.
2. Form 2 - Declaration of Confidentiality: The Peer Reviewer submits this form to the Practice Unit,
declaring that they will maintain strict confidentiality throughout the Peer Review process.
3. Form 4 - Declaration of Confidentiality: This form is signed by all members of the Peer Review Board
and the Board's Secretariat, confirming their commitment to maintaining confidentiality during the
Peer Review process.
4. Form 5 - Selection of Assurance Service Engagements: The Peer Reviewer uses this form to inform the
Practice Unit and Peer Review Board of the assurance service engagements they have selected for
review.
5. Form 6 - Request for Additional Information: The Peer Reviewer uses this form to seek further or
additional clarification from the Practice Unit regarding the information provided in the Application
cum Questionnaire (Form 1).

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These forms play a crucial role in the Peer Review process, ensuring clear communication and adherence to the
guidelines established by the Peer Review Board.

Execution
Peer Review Visits
Peer Review visits will be conducted at the Practice Unit's head office or /and branch(es) or any other locations.
This on-site Review should not extend beyond SIX working days based on the size of the Practice Unit.

Compliance Review-General Controls


The Reviewer is required to carry out a compliance Review of the following General Controls for evaluating the
degree of reliance to be placed upon them for effective Review
● Independence
● Maintenance of Professional skills and standards
● Outside Consultation
● Staff recruitment, Supervision and Development
● Office Administration

Selection of Assurance Service Engagements for Review


a. The number of assurance service engagements to be reviewed shall depend upon:
i. The Standard of quality controls generally prevailing;
ii. The size and nature of assurance service engagements undertaken by the Practice Unit.
iii. The methodology generally adopted by the Practice Unit in providing assurance services.
iv. The number of partners / members engagements in the Practice Unit; involved in assurance
service
v. The number of locations / branch offices of the practice Unit; The Fees charged / received / GST
paid by the Practice unit.
b. From the initial sample selected at the planning stage, the Reviewer, may enlarge the initial sample size
of assurance service engagements for Review.

Review of Records
The Reviewer is required to adopt a combination of compliance approach and substantive approach in the
Review process.
a. Compliance Approach - The compliance approach is to assess whether proper control procedures have
been established / followed by the Practice Unit to ensure that assurance services are being performed
in accordance with Technical, Professional and Ethical Standards.
b. Substantive Approach - This approach requires a Review of the assurance working papers to check,
whether the assurance work has been carried out as per the Technical, Professional, and Ethical
Standards.

Procedure for Peer Review of a New Unit


New Unit.
Means a firm
● whose date of establishment is less than 12 months
○ immediately preceding the date of receipt of application of Peer Review and
○ which may or may not have rendered any assurance service during the said period or
● a Practice Unit in existence for a period exceeding 12 months but not rendering any assurance services.

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Peer Review of a New Unit:


1. The Peer Review of a New Unit is conducted based on:
a. Antecedents of the partners, and
b. Policy parameters announced by the Practice Unit for the conduct of attest functions.
2. The Reviewer's verification process:
a. Examine the Application cum Questionnaire (Form 1) submitted by the Practice Unit.
b. Conduct an onsite visit to the Practice Unit, which should be limited to one day.
3. After completing the verification process, the Reviewer will:
a. Submit a report to the Peer Review Board in the prescribed formats.

Reporting by the Peer Reviewer


1. After the on-site review, the Reviewer submits the Peer Review Report and Form 9 to the Board if the
Practice Unit is in compliance with Technical, Professional, and Ethical Standards. A copy is also sent
to the Practice Unit.
2. If deficiencies or non-compliance are found, the Reviewer sends a Preliminary Report to the Practice
Unit, which then has two working days to respond in writing.
3. If the Reviewer is satisfied with the response, they submit an unqualified Peer Review Report and Form
9 to the Board, forwarding a copy to the Practice Unit.
4. If the response is unsatisfactory, the Reviewer submits a Qualified Report and Form 9 to the Board,
explaining the reasons, and sends a copy to the Practice Unit.
5. The Peer Review Report should confirm that the Practice Unit's quality control system for assurance
services complies with Technical, Professional, and Ethical Standards.
6. The Reviewer must submit the following documents along with the Peer Review Report:
● Prescribed Annexures to the Report
● Copy of Questionnaire received from the Practice Unit
● List of samples selected by him in accordance with the criteria prescribed by the Board
● Preliminary Report and the Practice Unit's submissions, if applicable
7. The Practice Unit and Reviewer must ensure that all submitted documents are dated, signed, and
complete.
8. The entire review process should be completed within:
● Twenty working days for a regular Practice Unit
➢ from the date of receipt of application from the Practice Unit for being Peer Reviewed
or
➢ from the date of notifying the Practice Unit about its selection for Review as the case
may be.
● Seven working days for a New Unit
➢ from the date of receipt of application cum questionnaire from the Practice Unit for
being Peer Reviewe

Review of Report by Peer Review Secretariat under Supervision of Peer Review


Board Secretary
1. The Peer Review Board Secretary ensures that the Peer Review Report is accompanied by all required
documents as mentioned in the Guidelines and that they are complete.
2. All reports are placed before the Board or its Sub-Committee for consideration and issuance of the Peer
Review Certificate.

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3. In the case of a qualified report, the Peer Review Board Secretary places the report before the Board for
consideration.
4. The Board may decide on a "Follow On" Review after a period of one year from the date of the report
issued by the Peer Reviewer. If the Board decides, this one-year period may be reduced, but not less than
six months from the date of the report.

Issuance of Peer Review Certificate


1. If the Peer Reviewer issues an unqualified report,
● the Peer Review Board Secretary places the report before the Board or its Sub-Committee for
consideration and issuance of a Peer Review Certificate to the Practice Unit.
● This is done only after the Peer Reviewer confirms receipt of the fee from the Practice Unit.
2. A Peer Review Certificate is issued to New Units, subject to the procedures followed by the reviewer as
prescribed under relevant clauses of these Guidelines.
3. The certificates issued by the Board or the Sub-Committee are noted during the Board's meeting.
4. The certificate is signed by the Chairman, Vice Chairman, and Secretary of the Board, mentioning the
validity period.
5. The Peer Review Board Secretary serves the Peer Review Certificate to the Practice Unit.
6. The Peer Review Board Secretary updates the List of Practice Units with valid Peer Review certificates
on the ICAI website, including the names of the Practice Units to whom certificates have been issued.
7. In cases where a Qualified Report is issued by the Reviewer and considered by the Board, the Peer
Review Board Secretary informs the Practice Unit that a Peer Review certificate cannot be issued, along
with the reasons, and informs them about the due date for conducting a follow-on review as decided by
the Board.

Validity of Peer Review Certificate


1. Validity Period:
● The Peer Review Certificate is valid for three years or as decided by the Board.
● Commences from the date the Board receives the Peer Review report.
● Provided that if the Peer Review Report has been received before the expiry of the earlier Peer
Review Certificate, the date of commencement of the Certificate shall be the date following the
date of expiry of the earlier Peer Review Certificate
2. Validity for New Units:
● The validity period is determined by the Board.
3. Practice Unit's Responsibility:
● Complete Peer Review and submit necessary documents before the expiry of the previous
certificate.
● Documents signed by the Practice Unit during the intervening period (The period in which
there was no valid Peer review certificate) are invalid.
4. Extension of Validity:
● The Council may extend the validity for prescribed reasons.
● The Practice Unit must submit an application in Form 8.
5. Revocation and Expiration:
● The certificate ceases to be valid if revoked or expired.

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“Branch Peer Reviewer”


Means a Reviewer appointed to conduct the Peer Review of the Branch of a Practice Unit. The qualifications
and other obligations and duties of the Branch Peer Reviewer shall be the same as that of the Reviewer.

Quality Review

Difference Between Peer Review and Quality Review


Peer Review
● It is done for the purpose of testing the effectiveness of the systems and procedures.
● The intention is to not to find faults but to help the firm develop effective systems.
● It is a kind of mentoring process.
● Peer review is a part of the activities of ICAI aimed at improving the quality of service.

Quality Review
● A quality review is supposed to act as a deterrent.
● Quality Review Board (QRB) is constituted by the Central Government and is independent of ICAI.
● As per Section 28A of the Chartered Accountant’s Act, the Central Government has the authority to
constitute a Quality Review Board.
● QRB carries out supervisory and disciplinary functions.
● A quality review normally pertains to one particular audit conducted by an audit firm.
● The main objective quality review is to find errors or inadequacies, if any, committed by the auditor
while conducting the audit.
● Serious errors detected in quality review lead to disciplinary action against the member.

BASICS
A Process For Evaluation of audit quality and adherence to various statutory and other regulatory
requirements.
This Procedure would not extend to:
● Review of internal audit, tax audit, GST audit and other such special purpose audits conducted by the
members of the Institute which may be covered by the Board at a later stage or unless otherwise
specified; and
● Review of services provided by the members of the institute in employment.

THE SCOPE & OBJECTIVE OF THE QUALITY REVIEW INCLUDES


a. Examining whether the Statutory Auditor has ensured compliance with the applicable technical
standards in India and other applicable professional and ethical standards and other relevant guidance.
(TSOAPES)
b. Examining whether the Statutory Auditor has ensured compliance with the relevant laws and
regulations as required under applicable auditing standard. (L&R)
c. Examining whether the Audit firm under review (AFUR) has implemented a system of quality control
with reference to the applicable quality control standards. (System of QC)
d. Examining whether there is no material misstatement of assets and liabilities as at the reporting date in
respect to the selected entity. (No MMS)
The review would encompass
● AFUR’s working papers of selected audit file/s

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● internal quality controls placed within AFUR,


● AFUR’s independence;
● compliance with technical standards, other relevant guidance and relevant laws and regulations;
● on-site-inspections; and
● discussion of findings with senior management of AFUR.

THE QUALITY REVIEW BOARD (QRB)


Constitution And Composition Of Quality Review Board
The Quality Review Board (hereinafter “QRB”/ “the Board”) has been set up by the Central Government under
section 28A of the Chartered Accountants Act, 1949 (hereinafter “the Act”).
In terms of section 28A of the Chartered Accountants Act, 1949, the Board comprises a Chairperson and ten
other members.
The Central Government nominates the Chairperson and 5 members.
Remaining 5 members are nominated by the Council of the ICAI.
Members are nominated from amongst the persons of eminence having experience in the field of law,
economics, business, finance or accountancy.

FUNCTIONS OF QUALITY REVIEW BOARD


A quality review carried by the QRB is directed towards inspection/evaluation of audit quality and adherence to
various statutory and other regulatory requirements.
Section 28B of the Chartered Accountants Act, 1949 provides that: “The Board shall perform the following
functions, namely:-
a. to make recommendations to the Council with regard to the quality of services provided by the
members of Institute;
b. to review the quality of services provided by the members of the Institute including audit services; and
c. to guide the members of the Institute to improve the quality of services and adherence to the various
statutory and other regulatory requirements.

SELECTION OF AUDIT FIRMS


Selection of audit firms for review may be made on the basis of one or more of the following criteria:-
Criteria based on Entities Audited
i. The entities other than those specified under Rule 3(1) of NFRA Rules, 2018 may be selected on
the basis of one or more of the following:-
1. Risk based selection including regulatory concerns pointing towards stakeholders
risks.
2. On account of being part of a sector otherwise identified as being susceptible to risk on
the basis of market intelligence reports.
3. Reported fraud or likelihood of fraud.
4. Serious accounting irregularities in the financial statements highlighted by the
media and other reports.
5. Major non-compliances under relevant statutes highlighted in past reviews.
ii. In case of joint audits, if required, all joint auditors may be reviewed, as may be decided by the
Board on case to case basis.

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Criteria based on Audit Firms


Selection of audit firms should also be made for quality review of their statutory audit work on a random basis,
the volume of work handled by them represented by the number and nature of clients.

Reference made by Regulatory Bodies


The Board
● may also review the quality of the statutory audit services of AFUR
● with a view to assessing the quality of statutory audit and reporting by the statutory auditors and their
quality control framework

● on a reference made to it by any regulatory body like Reserve Bank of India, Securities and Exchange
Board of India, Insurance Regulatory and Development Authority, Ministry of Corporate Affairs,
National Financial Reporting Authority (NFRA) under Rule 9(4) of NFRA Rules, 2018 etc.

The Board shall not consider cases of complaints received from individuals, firms, companies, other entities
and their partners, directors and other officers etc. which shall be continued to be dealt with in accordance with
the mechanism available under the Chartered Accountants Act, 1949.

THE QUALITY REVIEW PROCESS

VARIOUS STAGES INVOLVED IN THE CONDUCT OF THE QUALITY REVIEW


ASSIGNMENTS

1. QRB selects Audit Firm and the audit file for review and identifies TR to conduct Quality Review.
2. QRB sends an Offer Letter of Engagement to TR.
3. TR conveys his acceptance of Letter of Engagement to QRB by sending necessary declarations for meeting
eligibility conditions and furnishing a statement of confidentiality by himself and his assistant/s, if any.
4. QRB intimates AFUR about the proposed Quality Review. QRB also sends a copy of this intimation letter to
TR and provides them contact details of each other for further communication.
5. TR sends the specified Quality Review Questionnaire to the AFUR for filling-up. He also calls for additional
information from the AFUR, if required.
6. TR & his team carry out the Quality Review by starting their off-site review by making proper planning for
the review and then on-site visiting the office of the AFUR by fixing the date as per mutual consent
ensuring that review exercise gets completed within specified time frame.
7. On completion of on-site review, TR to send the preliminary report to AFUR. TR shall send a copy of the
preliminary report to QRB as well.
8. AFUR to submit representation on the preliminary report to the TR and TR to immediately send the reply
of the AFUR to QRB.

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9. TR to submit a final report along with a copy of the Annual report of the entity for the year under review, to
the QRB in the specified format, on his (individual) letterhead, duly signed and dated within specified time
frame or as extended by the QRB.
● In addition, he shall also send a copy of the final report to the AFUR, requesting them to send
their final reply thereon to the QRB within 7 days of receipt of the final report.
● AFUR shall also send a copy of their final reply to TR.
10. AFUR to submit to QRB their reply on the final report and feedback, in prescribed format, regarding their
experience of the quality review.
11. Upon receipt of the final reply from the AFUR, TR shall submit to QRB within next 7 days a summary of his
findings, in the specified format, containing his findings, technical requirements, final reply of the AFUR
and his final comments thereon.
12. QRG to consider the report of the TR and responses of AFUR and make recommendations to QRB. QRG
may also call for additional details/information/explanations, if required, from TR/AFUR or issue such
directions to TR, as it may deem appropriate, enabling it to assess the quality of audit and reporting by the
AFUR.
13. QRB to consider reports and recommendations of QRG and decide further course of action.

EMPANELMENT OF TECHNICAL REVIEWERS


The Board has specified the following basic minimum criteria for empanelment of Technical Reviewers with
the Board, applications in respect whereof are invited through an on-line empanelment process at the website
of QRB :

● The Reviewer should have minimum fifteen years of post qualification experience as a chartered
accountant and be currently active in the practice of accounting and auditing.
● Reviewer should have handled as a signing partner/proprietor at least three statutory audit assignments
as
○ a Central Statutory Auditor of Banks
○ Public Limited Companies
○ Government Companies
○ Private Limited Companies
■ having annual turnover of rupees fifty crores and above during the last ten financial
years;
○ Provided that out of the aforesaid three statutory audit assignments, at least one must be in
respect of entities other than Private Limited Companies.
● Reviewer should not have any disciplinary proceeding under the Chartered Accountants Act, 1949
pending against him or any disciplinary action under the Chartered Accountants Act, 1949 / penal
action under any other law taken/pending against you during the last three financial years and/or
thereafter.
● Reviewer should not currently be a Member of the QRB or ICAI’s Central Council/Regional
Council/Branch level Management Committee.

The Board may specify any other criteria, from time to time, apart from the aforesaid basic minimum criteria
for empanelment of TRs with the Board. The Board reserves the right to reject any application for
empanelment as TR without assigning any reason whatsoever.

Empanelment as a TR with the Quality Review Board does not, in any way, guarantee allotment of quality
review work to TR which shall be at the sole discretion of the Quality Review Board.

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TRs shall be required to undergo training on emerging areas such as Ind-AS, Amendments in Companies Act,
other technical standards, Valuation Standards, other relevant laws and regulations etc.

Further, they shall submit annual declarations along with relevant evidence, to the QRB regarding their
participation in such training workshops/programmes.

After completion of the initial block period of empanelment, the Board may decide to offer renewal of
empanelment to TR, subject to his consent, for another block period and so on based upon assessment of the
quality of review work performed by the TR during the period, if any, his meeting the basic minimum criteria
for empanelment, participation in training workshops and other such factors as may be considered appropriate
by the Board.

COMPOSITION OF THE REVIEW TEAM


The composition of the review team would depend on the size of the AFUR/entity/(ies) under review. The
composition of the team, mandatorily headed by a TR empaneled with the Quality Review Board, may also
include up to 5 Assistants engaged by the TR, as may be fixed by the Board in each case on need basis.

However, no firm of Chartered Accountants may be included as a member of the review team.

INDEPENDENCE OF TECHNICAL REVIEWERS


While assigning the quality review work to the respective Technical Reviewers, in order to ensure independence
and avoid conflict of interest, the following eligibility conditions were specified for carrying out the specified
quality review assignment to the Technical Reviewers who were required to submit a declaration of eligibility
before starting the assignment.

Not a Statutory No association 141(3) City / Region


Auditor He or his/her firm or any He should comply with He does not belong to
He or his/her firm or any of the network firms or all the eligibility the city/region of head
of the network firms or any of the partners of the conditions laid down for office of the AFUR.
any of the partners of the firm or that of the appointment as an
firm or that of the network firms should not auditor of a company u/s
network firms should not have had any association 141(3) of the Companies
have been the statutory with the specified AFUR, Act, 2013 which apply
auditor of the company, during the last three mutatis mutandis in
as specified, or have financial years and /or respect of the review of
rendered any other thereafter. the quality of statutory
services to the said entity audit of the entity, as
during the last three specified, so far as
financial years and /or applicable.
thereafter.

INDEPENDENCE OF ASSISTANTS
The QRB, from time to time, shall specify the requirements for engaging Assistants by the TR for
ensuring their independence and avoiding conflict of interest including
a. He shall be chartered accountant;

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b. He does not attract any of the disqualifications prescribed under the Chartered Accountants Act,
1949;
c. He shall also have to sign the statement of confidentiality in a prescribed format;
d. He shall have no direct interface either with the audit firm under review (AFUR) or the Board;
e. He should have been working with them for at least one year as a member/a partner in the CA
firm with them;
f. He should not have been associated with the AFUR and the concerned entity, whose audit
is being reviewed, during the last three financial years and/or thereafter.
g. He should not have any disciplinary proceeding under the Chartered Accountants Act, 1949 pending
against him or any disciplinary action under the Chartered Accountants Act, 1949 / penal action under
any other law taken/pending against him during last three financial years and/or thereafter;
h. He should not be a member of current QRB/ICAI’s Central Council/Regional Council/Branch level
Management Committee; and
i. He should not himself be empanelled as a TR with the Quality Review Board.

Services of relevant industry experts


● The Board may also obtain services of relevant industry experts, if needed.
● These industry specific experts may provide guidance/ advice to the TRs, as may be required.
● These TRs and industry experts shall be entitled to payment of honorarium and reimbursement of
travelling expenses, including for their assistants, if any, at such rates as may be decided by the Board
from time to time.

GUIDELINES FOR THE TECHNICAL REVIEWERS


TR should also adhere to the various guidelines given to him by the Board, from time to time, including
a. TR shall himself make on-site visit, alongwith his Assistant/s, if any, to the AFUR for conducting the
review of audit working papers as defined under the relevant standards;
b. TR shall follow Technical Guide on conducting Quality Review as brought out by the QRB while
conducting the review;
c. TR, including his Assistant/s, will have access to or take abstracts of the records and documents
maintained by the AFUR in relation to the review; However, in order to maintain confidentiality, the
TR, including his Assistant/s, shall not make any copies/extracts of the AFUR’s Clients’ file or records
examined by them while conducting review, as part of their working papers;
d. TR shall provide detailed comments giving proper justification and explanation in respect of the various
matters required to be commented upon by TRs in the final report including its Appendices;
e. TR shall also refer other guidance provided by the Quality Review Board from time to time such as
Audit Quality Review Reports of the QRB appearing at the website of the QRB, other reports of
international bodies or any other guidance as may be provided by the QRB from time to time as well as
industry specific Technical Guide/s, if any, brought out by the ICAI while conducting the review;
f. TR shall be required to segregate his observations into those material and nonmaterial;
g. TR should build in a review process to be able to review audit documentation maintained by the AFUR
in electronic form in line with the requirements of SA 230; and
h. TR shall specifically include a suitable paragraph in the review report on the adequacy of fraud
reporting by the Statutory Auditors in their Independent Auditor’s Report.

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CONFIDENTIALITY
● Paramount Importance - Confidentiality of information pertaining to the quality review
assignments is of paramount importance.
● Ensure Confidentiality of Information etc. - Technical Reviewers should ensure that all
information, papers, materials, documents etc. relating to the company/audit firm, as selected and
assigned to them, that they will gain during the course of assignment are kept in strict confidence.
● Statement of Confidentiality - They are required to send duly signed statements of confidentiality
including by each one of their assistants in a prescribed format.
● NO Conflict of Interest - There should be no conflict of interest of all those connected with the
entire review process.
● Confidentiality applicable to all - All persons involved with the entire review process including
members of Board/Group, Technical Reviewers, his/her assistants and QRB secretariat shall maintain
confidentiality of information obtained during reviews and also appropriately disclose to the Board,
from time to time, their interests or that of the partners of their firm or their relatives, if any, in relation
to statutory audit firm being reviewed by Board or entity concerned whose audit was selected for review

REPORTING AND OTHER PROCEDURES


The final report shall be issued in the format as may be specified by the Board from time to time.

A clean report indicates that the TR is of the opinion that the statutory audit is being conducted in a manner
that ensures the quality of audit services rendered.

However, a reviewer may qualify the report due to one or more of the following:

● non-compliance with technical standards and other relevant guidance ;


● non-compliance with relevant laws and regulations as required under applicable auditing standard;
● quality control system design deficiency; or
● non-compliance with quality control policies and procedures.

The Quality Review Report should be issued on the reviewer's (individual) letterhead and signed by the
reviewer.

The report should be addressed to the Board and should be dated as of the date of the conclusion of the review.

Basic Elements of the Reviewer's Report:

The report should contain


(a) Elements relating to audit quality of companies:
1. A reference to the description of the scope of the review and the period of review of the audit firm
conducted along with existence of limitation(s), if any, on the review conducted with reference to the
scope as envisaged.
2. A statement indicating the instances of lack of compliance with technical standards and
other professional and ethical standards.
3. A statement indicating the instances of lack of compliance with relevant laws and
regulations.

(b) Elements relating to quality control framework adopted by the audit firm in conducting audit:

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● An indication of whether the AFUR has implemented a system of quality control with
reference to the quality control standards.
● A statement indicating that the system of quality control is the responsibility of the AFUR.
● An opinion on whether the AFUR's system of quality control has been designed to meet the
requirements of the quality control standards for attestation services and whether it was complied
with during the period reviewed to provide the reviewer with reasonable assurance of complying with
technical standards, other professional and ethical standards, other relevant guidance and relevant
laws and regulations in all material respects.
● Where the reviewer concludes that a modification in the report is necessary, a description of
the reasons for modification. The report of the reviewer should also contain the suggestions.
● A reference to the preliminary report.
● An attachment which describes the quality review conducted including an overview and
information on planning and performing the review.

Type of Report to be issued


In deciding on the type of report to be issued, a reviewer should consider the evidence obtained and should
document the overall conclusions with respect to the year being reviewed in respect of following matters:
1. whether the policies and procedures that constitute the reviewed firm's (AFURs) system of quality
control for its attestation services have been designed to ensure quality control to provide the firm
with reasonable assurance of complying with technical standards, other relevant guidance and other
relevant laws and regulations.
2. whether personnel of the reviewed firm (AFUR) complied with such policies and procedures in order
to provide the firm with reasonable assurance of complying with technical standards, other relevant
guidance and other relevant laws and regulations.
3. whether independence of AFUR is maintained in conducting an audit.
4. whether the AFUR has instituted adequate mechanism for training of staff
5. whether the audit firm (AFUR) ensures the availability of expertise and/or experienced individuals
for consultation.
6. whether the skill and competence of assistants are considered before assignment of attestation
engagement.
7. whether the progress of attestation service is monitored and work performed by each assistant is
reviewed by the service in-charge and necessary guidance is provided to assistants.
8. whether the audit firm (AFUR) has established procedure to record the audit plan, the nature, timing
and extent of auditing procedures performed and the conclusions drawn from the evidence obtained.
9. whether the audit firm (AFUR) maintains audit documentation as per the relevant standards
10. whether the audit firm verifies compliance with laws and regulations to the extent it has material
effect on financial statements.
11. whether the internal controls within the audit firm (AFUR) contribute towards maintenance of
quality of reporting.

CONSIDERATION OF THE REPORTS OF THE QUALITY REVIEW GROUPS


The Report on the quality of audit by the auditor of a Public Sector Undertaking (PSU)
● should be furnished to the Office of Comptroller and Auditor General of India (C&AG),
● on case to case basis,
● and the C&AG’s views, if any,
● shall be put-up before the Board along with the recommendations of the QRG.

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In all other cases,


● the QRG’s recommendations along with the
● decision of the Board
● on the quality of audit by the auditor of a PSU
● shall be furnished to the Office of the C&AG for information

The recommendations of the QRG on the quality of statutory audits by the auditors of entities (other than
those covered above) shall be placed before the Board for its consideration directly.

The Board may, after due consideration of the recommendations and comments of the Office of the C&AG,
wherever applicable, decide whether the recommendation made by the QRG should be accepted or otherwise.

The Board may, suo moto, take such further action, as it may deem appropriate. If the Board decides against the
recommendations made by the QRG in its report, the Board shall record the reasons for doing so.

ACTIONS THAT MAY BE RECOMMENDED BY THE QUALITY REVIEW


BOARD
The actions that the Board may take, based upon consideration of recommendations of the QRG, include one or
more of the following:-
a. Make recommendations to the Council of ICAI u/s 28B(a) of Chartered Accountants Act, 1949 for
referring the case to the Director (Discipline) of the Institute for consideration and necessary action
under the Chartered Accountants Act, 1949.
b. Issue advisory and guidance to the AFUR u/s 28B(c) of Chartered Accountants Act, 1949 for
improvement in the quality of services and adherence to various statutory and other regulatory
requirements. A copy of such advisory may also be sent to the ICAI for information.
c. Inform the details of the non-compliance to the regulatory body/ies relevant to the entity as may be
decided by the Board.
d. Intimate the AFUR as to the findings of the Report as well as action initiated as above.
e. In case of review arising out of a reference received from a regulatory body, inform the results of
review and the details of action taken to the concerned regulatory body.
f. Consider the matter complete and inform the AFUR accordingly.

MECHANISM FOR FOLLOW-UP OF REVIEW FINDINGS


Quality Review Board shall require AFUR to submit a compliance report to the Board within specified
period for adopting necessary measures to avoid recurrence/ to take corrective steps in respect of
advisories and guidance issued to AFUR by the QRB u/s 28B(c) of Chartered Accountants Act, 1949 for
improvement in the quality of services and adherence to various statutory and other regulatory requirements.

In case of lack of effective corrective actions by AFURs, next on-site review might be organised earlier.

Cases of continued non-compliance may be recommended to the Council of the ICAI for taking necessary
action.

Quality Review Board may also share results of such analysis with relevant stakeholders, as may be decided by
the Board.

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CHANGES TO THE REPORTING FORMATS/ QUESTIONNAIRE


The Board had specified the format for the Final Report, and the Quality Review Program General
Questionnaire containing questions concerning various aspects of an audit firm such as Quality control, ethical
requirements & audit independence; leadership and responsibilities; assurance practices; client relationships &
engagements; human resources, consultation; differences of opinion; engagement quality control review;
engagement documentation; audit planning & risk assessment; materiality; audit sampling & other selective
testing procedures; audit documentation; audit evidence; written representations; and Auditor’s report.

However, whenever the Quality Review Board is of such a view, in the light of international practices,
changes in domestic laws & regulations and through experience gained, it may, amend, or modify the
Quality Review Questionnaire/ reporting formats, from time to time, as it may deem appropriate.

Annexure
QRB and NFRA
Ministry of Corporate Affairs, has clarified to the Quality Review Board that in view of Sec.132 (2) of the
Companies Act, 2013 r/w Rule 9(4) of NFRA Rules, 2018, the issue of QRB reviewing audits of the
companies/bodies corporate specified under Rule 3 of the NFRA Rules, 2018 will only arise in case a reference is
so made to QRB by NFRA, and not otherwise.

Simply speaking, in case of companies mentioned in Rule 3 QRB will order review only when reference is made
by NFRA)

Rule 3 (1) of National Financial Reporting Authority Rules, 2018, as notified by Central Government on 13
November, 2018, inter alia, provides that the Authority (read NFRA) shall have power to monitor and enforce
compliance with accounting standards and auditing standards, oversee the quality of service under sub-section (2)
of section 132 or undertake investigation under sub-section (4) of such section of the auditors of the following class
of companies and bodies corporate, namely:-
a. companies whose securities are listed on any stock exchange in India or outside India;
b. unlisted public companies having paid-up capital of not less than rupees five hundred crores or having
annual turnover of not less than rupees one thousand crores or having, in aggregate, outstanding loans,
debentures and deposits of not less than rupees five hundred crores as on the 31st March of immediately
preceding financial year;
c. insurance companies, banking companies, companies engaged in the generation or supply of electricity,
companies governed by any special Act for the time being in force or bodies corporate incorporated by an
Act in accordance with clauses (b), (c), (d), (e) and (f) of sub-section (4) of section 1 of the Act;
d. any body corporate or company or person, or any class of bodies corporate or companies or persons, on a
reference made to the Authority by the CentralGovernment in public interest; and
e. a body corporate incorporated or registered outside India, which is a subsidiary or associate company of
any company or body corporate incorporated or registered in India as referred to in clauses (a) to (d), if the
income or net-worth of such subsidiary or associate company exceeds twenty percent of the consolidated
income or consolidated net-worth of such company or the body corporate, as the case may be, referred to
in clauses (a) to (d).

Rule 9(4) of NFRA Rules, 2018 provides that the Authority (read NFRA) may refer cases with regard to overseeing the
quality of service of auditors of companies or bodies corporate referred to in rule 3 to the Quality Review Board
constituted under the Chartered Accountants Act, 1949 (38 of 1949) or call for any report or information in respect of
such auditors or companies or bodies corporate from such Board as it may deem appropriate.

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Accordingly, QRB would now be able to initiate reviews of quality of audit services provided by members of the
Institute only in respect of entities other than those specified under Rule 3(1) of NFRA Rules, 2018, namely, private
limited companies, unlisted public companies below the thresholds specified under Rule 3(1) of NFRA Rules, 2018
and other entities not specified under Rule 3(1) of NFRA Rules, 2018; and those referred to QRB by NFRA under Rule
9(4) of NFRA Rules, 2018.
However, in the meanwhile, QRB has also been completing its on-going reviews of top listed and other public
interest entities which were in process

Technical Standards
As per the QRB, the term “Technical Standards” in the context of the Chartered Accountants (Procedures of
Meetings of Quality Review Board, and Terms and Conditions of Service and Allowances of the Chairperson and
Members of the Board) Rules, 2006 includes:

● Preface to the Statements of Accounting Standards;


● Preface to the Standards on Quality Control, Auditing, Review, Other Assurance and Related Services;
● The Accounting Standards notified under section 133 of the Companies Act, 2013;
● The Accounting Standards issued by the Institute of Chartered Accountants of India;
● The Framework for the Preparation and Presentation of Financial Statements issued by the Institute of
Chartered Accountants of India;
● The applicable Quality Control and Standards on Auditing issued by the Institute of Chartered
Accountants of India and those notified under the relevant statute;
● The Statements on Auditing issued by the Institute of Chartered Accountants of India;
● The Notifications/Directions/Guidelines issued by the Institute Accountants of India including those of a
self-regulatory nature;
● Other relevant legal and regulatory requirements.
● “Other Relevant Guidance” include:-
○ The Guidance Notes on accounting and auditing matters issued by the Institute of Chartered
Accountants of India;
○ The Code of Ethics issued by the Institute of Chartered Accountants of India.

Important areas of an audit in accordance with Standard on Quality Control -1 w.r.t Quality
Control

Important areas of an audit in accordance with Standard on Quality Control -1 w.r.t Quality Control

1. Whether the audit firm establishes and implements policies and procedure on all the element of system of
quality control

2. Whether the engagement quality control reviewer reviews at an appropriate time for the planning of an
audit, significant audit judgement, and expressions of an audit opinion.

3. Whether the audit firm assigns as the person responsible for the monitoring of the system of quality
control a person with appropriate experience for the role, vest the assigned person with sufficient and
appropriate authority.

4. Whether the audit firm obtains, at least annually, a confirmation letter concerning compliance with
policies and procedures for the maintenance of independence from all persons required to maintain
independence.

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5. Whether the audit firm performs the independence confirmation procedure set forth in its internal rules
before acceptance and continuance of an audit engagement, and when issuing the auditor’s report
appropriately confirms that there was no change in the status of independence.

6. Whether the audit firm develops and provides an education/ training program that fully takes into account
the knowledge, experience, competence and capabilities of the professional staff.

POWERS OF QUALITY REVIEW BOARD


To facilitate the discharge of its functions, Rule 6 of Chartered Accountants (Procedures of Meetings of Quality
Review Board, and Terms and Conditions of Service and Allowances of the Chairperson and Members of the Board)
Rules, 2006 provides:
● on its own or through any specialized arrangement set up under the Institute, evaluate and review the quality
of work and services provided by the members of the Institute in such manner as it may decide;
● lay down the procedure of evaluation criteria to evaluate various services being provided by the members of
the Institute and to select, in such manner and form as it may decide, the individuals and firms rendering
such services for review;
● call for information from the Institute, the Council or its Committees, Members, Clients of members or other
persons or organizations, in such form and manner as it may decide, and may also give a hearing to them
Provided that where the Board does not receive the information called for by it from any Member of the
Institute, the Board may request the Institute to obtain the information from the member and furnish the
same to the Board. Provided further that where the Board does not receive the information called for by it
from any company registered under the Companies Act, 1956 (now Companies Act, 2013), the Board may
request the Central Government in the Ministry of Corporate Affairs for assistance in obtaining the
information.
● invite experts to provide expert/technical advice or opinion or analysis on any matter or issue which the
Board may feel relevant for the purpose of assessing the quality of work and services offered by the members
of the Institute
● make recommendations to the Council to guide the members of the Institute to improve their professional
competence and qualifications, quality of work and services offered and adherence to various statutory and
other regulatory requirements and other matters related thereto.

Quality Review Cycle


The following quality review cycle of Audit firms may be followed generally or as may be decided by the Board:
1. Once in 3 years for Audit firms having 20 or more Partners
2. Once in 4 years for Audit firms having 10 or more but less than 20 Partners
3. Once in 5 years for Audit firms having less than 10 Partners.

Upto 3 audit engagements of an AFUR may be selected by the Board, as may be considered appropriate, during a
particular quality review cycle covering entities of varied industries, size, geographical spread and regulatory
concerns.

However, in the absence of any adverse finding in a past review, not more than one audit engagement of the same
engagement partner/ proprietor of an AFUR may be selected for quality review by the Board during a particular
quality review cycle.

However in case of any adverse findings in past review/s or in any other situation, QRB may conduct quality review of
any particular audit firm or of a particular engagement partner at more frequent interval and/or select more than 3
audit engagements.

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Chapter-8 Internal Audit, Management Audit, Operational


Audit

Meaning of Internal Audit


Internal Audit means “an independent management function, which involves a continuous and critical
appraisal of the 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 the entity’s strategic risk management
and internal control system.

Applicability of Provisions of Internal Audit - Section 138


(1) Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who
shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by
the Board to conduct internal audit of the functions and activities of the company.

(2) The Central Government may, by rule, prescribe the manner and the intervals in which the internal audit
shall be conducted and reported to the Board.

Rule 13 - Companies required to appoint Internal auditor


13. (1) The following class of companies shall be required to appoint an internal auditor which may be either an
individual or a partnership firm or a body corporate, namely:—
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:

Explanation. - For the purposes of this rule -


i. the internal auditor may or may not be an employee of the company;
ii. the term "Chartered Accountant" or "Cost Accountant" shall mean a "Chartered Accountant" or a "Cost
Accountant", as the case may be, whether engaged in practice or not.

(2) 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.

CA Final November 2017(Old) - (www.icai.org)

JKH Pvt Ltd. who is into the business of imparting coaching to CA students did not appoint any internal auditor for the year
ended 31st March, 2017. As on 31st March, 2016, the company had paid up capital of ₹ 50 lakhs and reserves of ₹ 10
crores. Its turnover for the 3 years preceding the year ended 31st March, 2017 was ₹ 75 crores, ₹ 145 crores and ₹ 260

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crores respectively. As an auditor of the company for the year ended 31st March, 2017, how would you deal with the
above?

Responsibility of Internal Auditor


● To maintain an adequate 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 himself of any of
the responsibilities placed upon him.
● Not to involve himself in the performance of executive functions in order that his objective outlook
does not get obscured by the creation of vested interest.
● To observe facts and situations and bring them to the notice of authorities who would otherwise
never know them; also, they 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 his knowledge must be kept up to date by his being
kept informed about all important occurrences and events affecting the business, as well as the
changes that are made in business policies.

Independence of Internal Auditor


Importance of Independence
● Internal auditor's independence is crucial at all times
● Independence helps in avoiding conflicts of interest and ensures objective assessments

Risks to Independence
● Management may seek active business support from the internal auditor, compromising their
independence
● Auditors must be cautious of situations that may hinder their objective judgement

Operational Responsibilities
● A limited operational role may be acceptable with due approvals and for a short duration

Communicating Limitations
● Internal auditors should communicate their limitations, such as:
○ Being unable to assume ownership or accountability of the process
○ Inability to take operational decisions that may be subject to future internal audit

Role of Audit Committee and Board


● In addition, 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.

Scope of Internal Auditor's Work


● Review of Internal Control System and Procedures.
● Review of Custodianship and Safeguarding of Assets.

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● Review of Compliance with Policies, Plans, Procedures and Regulations.


● Review of Relevance and Reliability of Information.
● Review of the Organisation Structure.
● Review of Utilisation of Resources.
● Review of Accomplishment of Goals and Objectives.

Integrity, Objectivity and Independence of Internal Auditor


1. Independence of Internal Auditor
● Core principle fundamental to internal audit function and activities
● Free from undue influences, both in mind and appearance
● Resist undue pressure or interference in scope, conduct, and reporting of assignments
● Established through organizational structure, position, and reporting of Chief Internal Auditor
● Supported by powers and authority derived from superiors
2. Integrity of Internal Auditor
● Honest, truthful, and high moral character
● Operate professionally and fairly in all dealings
● Avoid conflicts of interest and personal benefits from position
3. Objectivity of Internal Auditor
● Conduct work with impartiality and unbiased judgment
● Gather and evaluate facts and evidence without prejudice or bias
● Maintain objectivity in conclusions and reporting opinions

Qualities of Internal Auditor


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 operational performance and non-monetary,
operational controls. This requires a basic knowledge of the technology and commercial practices of
the enterprise.
4. He should also have a basic knowledge of commerce, laws, taxation, cost accounting, economics,
quantitative methods and EDP systems.
5. An understanding of management principles and techniques is another essential
qualification of an internal auditor as also the ability to deal with people.
6. By his conduct the internal auditor should provide an assurance to the management that
confidentiality of such information would be maintained.

Internal Audit report


Review and Assessment
● Carefully analyze conclusions drawn from audit evidence
● Base findings on assessed evidence in the report
● Suggest remedial action when needed
Fraud or Misappropriation Discovery
● If actual or suspected fraud or asset misappropriation is identified
● Promptly bring the issue to management's attention

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Reporting Results per Standard on Internal Audit (SIA) 370


1. Internal Audit Report Prepared at the end of a specific audit assignment
● Covers specific area, function, or part of the entity
● Highlights key observations and findings from audit procedures
● Issued to auditee and shared with local and executive management as agreed
2. Periodic Comprehensive Report
● Prepared by Chief Internal Auditor (or Engagement Partner for external service provider)
● Covers all internal audit activities during the plan period
● Typically submitted quarterly to the highest governing authority responsible for internal audits
(e.g., Audit Committee)
● Portions of Internal Audit Reports may be included in 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 the periodic (e.g.
Quarterly) reporting for the whole entity as per the Annual/Quarterly audit plan.

​Internal Audit Report: Timeliness, Basis, and Documentation


1. Timeliness
● Issued within a reasonable time frame from the completion of internal audit work
2. Basis of Internal Audit Report
● Prepared based on audit procedures conducted and evidence gathered
● Conclusions based on all findings, not just a few deviations or issues
● Acknowledge effective controls and prioritize matters based on risk and significance
3. Compliance with SIAs
● If conducted in compliance with Standards of Internal Audit, include a statement confirming
compliance
4. Content and Format
● Determined by professional judgment, recipient preferences, and assurance level provided (SIA
380 for assurance reports)
5. Documentation
● Maintain copies of draft and final internal audit reports, cross-referenced to specific
observations
● Management action plans may be countersigned by respective management personnel, if
appropriate.

Key elements of Internal Audit Report


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.

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Follow-up: Monitoring and Reporting of Prior Audit Issues


1. Continuous monitoring
● Chief Internal Auditor's Responsibility- Continuous monitoring of closure of prior audit issues
● Ensure timely implementation of action plans from past audits
● Use a formal, pre-agreed monitoring process with management and those charged with
governance
2. Action Taken Report
● Prepare "Action Taken Report (ATR)" of previous audits
● Track and evaluate corrective actions taken by auditee
3. Follow-up on Management Actions
● Report open and pending matters to management and those charged with governance (e.g.,
Audit Committee)
● Draw attention to any inaction within a reasonable time
● Ascertain reasons for inaction or unimplemented recommendations
4. Review of Implemented Recommendations
● Periodically review the extent of implementation of accepted recommendations
● Report to management on partially or fully unimplemented recommendations

Difference Between Internal And External Auditors


Basis Internal Audit / Auditor External Audit / Auditor

Objective Continuous and critical appraisal of the Reasonable Assurance that FS are free from
functioning of an entity with a view to MMS whether due to fraud or error. FS are
suggest improvements thereto and add prepared in all material respects as per AFRF.
value to and strengthen the overall
governance mechanism of the entity,
including the entity’s strategic risk
management and internal control
system.

Appointment Management Members

Mandatory / Mandatory for Companies mentioned Mandatory For all Companies


Optional For u/s 138 Read with rule 13 of the
Companies Companies (Accounts), Rules 2014.

May be Must not be an employee.


Employee

Period Continuous Once in a year

Independence Less More

Work Defined by the terms of engagement Defined by Law and Regulations cannot be
with Management. reduced at all.

Qualification Shall either be a chartered accountant Only a Chartered Accountant


Eligibility or a cost accountant, or such other

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professional as may be decided by the


Board to conduct internal audit of the
functions and activities of the company.

Users of the report User of the internal audit report is User of the external audit report is
Management. Stakeholders.

Management Audit

Meaning of Management Audit


● Management audit is a systematic examination of
○ decisions and actions of the management to analyse the performance.
● Management Audit is generally conducted by the employee of the company or by the independent
consultant and focused on
○ the critical evaluation of management as a team
○ rather than appraisal of individuals.
● The focus of Management Audit is on "Quality of Decision Making" rather than the effectiveness or
efficiency of operations.

Things that a management auditor should be aware of


● Purpose for which the organisation has been created.
● Management structure including delegation of authority, planning and budgeting.
● Reports required for proper management and the reports actually received.
● Internal controls.
● Nature of production of the business concerned in a broad way so that he can understand the flow and
content of work leading to production and their mutual relationships. Some ideas about the techniques,
formulas, raw materials and personnel requirements would be of direct assistance to the management
auditor.
● Production planning.
● Factory layout, design and installed capacity.
● Personnel policy and personnel management including requirements, training, welfare, incentives and
disincentives.
● Materials management including sources of important raw materials, receipt of materials of the quality
and quantity needed, storage, supervision and safe custody, insurance and the procedure for issue of
materials.
● Sales management and sales planning including advertisement policy.
● Decision making process.
● Books and records including cost accounting records, cost accounting system and financial accounting
policies.
● Financial management of the organisation.

Desirability of Management Audit (WHY?)


● Detecting and overcoming current managerial deficiencies.
● Spotting the managerial problems and related operational difficulties before the fact rather
than after the fact as with a financial audit.
● Tool to accomplish the objectives of the management.

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● Helpful in the case of ailing industries, to isolate the problems and account for their ailments.
● Management Audits are conducted prior to making investment in an entity, its merger or acquisition, or
as a part of planning before entity level strategic decision.

Organising the Management Audit


1. Devising the statement of policy
➢ The management’s support must be reflected clearly and categorically in the company’s highest
policy statement. The policy statement should be quite specific.
➢ The statement must categorically say that the management auditor is capable of reviewing
administrative and management controls over any activity within the company.

2. Location of audit function within the organisation


➢ Management auditors must ascertain that whether there is a separate department of audit is
established in the organisation or not and then coordinate accordingly.

3. Allocation of personnel
➢ Person assigned to audit must have good knowledge of auditing, controls, organisation and
management.
➢ Basic knowledge of technology and commercial practices and relevant laws must also be there.

4. Staff training programme


➢ A continuous training programme is necessary to achieve quality in performing audit
assignments.

5. Time and other aspects


➢ The time and cost will vary for each assignment, depending upon the nature of the assignment,
the number of auditors assigned to perform the work, and whether or not more specialists in a
particular field are required.

6. Frequency
➢ Frequency must be decided according to the nature of the organisation.
➢ In no case should the interval be allowed to exceed three years.

Conducting of Audit
1. Getting the facts through interviews.
2. Measuring performance through management audit questionnaire.

Management Audit Questionnaire


● A management audit questionnaire is an important tool for conducting the management audit.
● Such questionnaires aim at a
○ comprehensive and constructive examination of an organisation’s management and its assigned
tasks.
● Its primary objective is to
○ highlight weaknesses and deficiencies of the organisation.
● It includes a review of

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○ how well or badly the management functions of planning, organising, directing and controlling
are being performed.
● It will also help in determining the factors causing difficulties in achievement of organisational
objectives
● Possible Answers to Management Audit Questions

○ Yes: Acceptable performance; no written explanation needed


○ No: Unacceptable performance; written explanation required
○ Not applicable: The question does not apply

Concluding the management audit


● Discussion with management of different recommendations and consequences of the same.
● Preparation of Report covering in details the findings and the final recommendations.

Types of Management Audit Reports


Oral Reports
● In many situations, the reporting of results will be on an oral basis.
● To some extent, this is inevitable
○ since a part of the actual audit effort is carried on in conjunction with company personnel.
● In other cases, it is a result of emergency action needs.
● The matters covered by emergency oral reporting, should be followed up immediately by a written
report giving reference to oral reporting.

Interim written reports


In situations where it is deemed advisable to inform management of significant developments during the course
of the audit, or at least preceding the release of the regular report, there may be some kind of interim written
report.

Regular written reports


In the typical situation, the particular audit assignment will include the preparation of a formal written report.
The form and content of such written reports will vary widely, both as between individual audit assignments
and individual companies.

Summary written reports


● These summary reports are also referred to as ‘flash’ reports’.
● These reports summarise the various individual reports issued.
● They are especially useful to top level managers who do not actively review the individual reports.
● They are also useful to the general auditor in seeing his total reporting effort with more perspective and
on an integrated basis.

Organisation of the Written Report


Format - Though it is difficult to lay down a format applicable to all situations, yet the following general
guidelines may be observed:
1. Title The management audit report should have a short but descriptive title so that its subject matter
can be easily identified.

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2. Objectives - The management auditor may describe the objectives of the audit assignment.
3. Scope - The management auditor may give a brief description of the activities audited by him.
4. Findings, conclusions and opinions
➢ These may be given either department wise or in the order of importance.
➢ All the facts and data pertaining to the situation should be assembled, classified and analysed.
➢ Each finding should be discussed comprehensively and correlated with other findings.
➢ Conclusions and opinions should normally follow the findings.
➢ Tables or graphs may also be used if required.
5. Auditee’s views - The auditee’s views about audit conclusions or recommendations may also be
included in the audit report in appropriate circumstances.
6. Summary - A summary of conclusions and recommendations may be given at the end. This is
particularly useful in long reports.

Steps to Prepare the Management Audit Report


1. Planning: Determine the main message for the audit report and outline key points to communicate
effectively.
2. Supporting Information: Collect relevant audit evidence to sufficiently and convincingly support
conclusions.
3. Draft Report: Prepare and refine a draft report, ensuring effective presentation and identifying gaps or
superfluous information.
4. Final Report: Revise the draft, get approval from the head of management auditing, discuss conclusions
with management, and issue a signed, dated report.
5. Follow-up: Monitor management's actions in response to the audit report and draw attention to any
inaction within a reasonable time.
6. Assessing Management's Response: Evaluate reasons for non-implementation or non-action, initiate
further discussions if needed, and ascertain the appropriateness of management's reasons for closing
the issue.

Behavioral aspects encountered in a Management Audit


The nature and causes of behavioural problems that the management auditor is likely to face and possible
solutions to overcome these problems are as follows.

1. Staff/line conflict - The staff/line relationship is inherently prone to conflict. Management auditors are
staff. And line people in the sense all members of other departments of the organisation are likely to
regard the management auditor the same way as they regard other staff people. Management auditors
being specialists in their field may think that their approach and solutions are the only answers.

FYI - Staff and line are names given to different types of functions in organizations. A "line function" is one that directly
advances an organization in its core work. This always includes production and sales, and sometimes also marketing. A
"staff function" supports the organization with specialized advisory and support functions. For example, human resources,
accounting, public relations and the legal department are generally considered to be staff functions

2. Control - As the management auditor is expected to evaluate the effectiveness of controls, there is an
instinctive reaction from the auditee to have a certain amount of fear that the report of management
auditor will affect them negatively. This may antgonise the auditee. The cause of antagonism are as
follows.
a. Fear of criticism: Stemming from adverse audit findings.

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b. Fear of changes: In day-to-day working habits due to audit recommendations.


c. Punitive action: By superiors prompted by reported deficiencies.
d. Insensitive audit practices: Overly critical reports, focusing on deficiencies only, air of mystery
in audits, perception of auditors gaining personally from reporting deficiencies.
e. Hostile audit style: Cold and distant demeanor, lack of understanding of auditee's problems,
absence of empathy, smugness or superiority, excessive concentration on insignificant errors,
prosecutional tone when asking questions, greater concern with parading defects than helping
constructively to improve conditions.

3. Resistance to Change The other significant cause is that auditor’s study of existing systems and
procedures may give recommendations for changes of such systems. There is a certain built-in
resistance to change.

Solution to behavioural problems


Relations between the auditor and the auditee may improve if the auditor acts and is perceived as a
professional advisor and consultant. In any event, there is a need to demonstrate to the extent possible
that:
1. The audit is part of an overall programme mandated by higher- level authority to meet higher-level
organisational needs for both protection and maximum benefit.
2. The objective of the review is to provide maximum service in all feasible managerial dimensions.
3. The review will be conducted with minimum interference with regular operations of the operating
personnel.
4. The responsible officers will be kept fully informed and have an opportunity to review
findings and recommendations before any audit report is formally released.
5. Create an atmosphere of trust and friendliness so that audit reports will be understood in their
proper perspective.

Other points to be kept in mind to resolve or avoid Behavioural Problems-


1. ​Constructive criticism: Focus on valuable, tangible feedback to ensure suggestions are well-received and
improve auditee's performance.
2. Reporting methods: Use a friendly, firm tone, emphasizing improvement areas over listing
inefficiencies or deficiencies.
3. Participative approach: Engage auditees in discussions, fostering mutual trust, team spirit, and
receptiveness to recommendations.

Operational Audit

Meaning
Operational auditing is a systematic process of evaluating an organisation’s effectiveness, efficiency and
economy of operations under management’s control and reporting to appropriate persons the results of the
evaluation along with recommendations for improvement.

Why operational audit?


● Manager needs to know about the functioning of the areas which are not under their direct observation.
Becasue of Layers of delegation of responsibilities.

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● Departmental managers, routine reports, internal audit reports, and periodic investigations have
limitations in providing comprehensive information for effective decision-making.
● Limitation of traditional sources of information
1. Executives may be too preoccupied to see the bigger picture and identify brewing problems.
2. Managers are relied on for transmitting, rather than seeking or analyzing, information.
3. Information from managers may be biased or subjective.
4. Conventional internal audit reports lean towards accounting and are historical.
5. Annual audited accounts and routine reports have limitations despite providing a fair
evaluation of financial statements.

Types of Operational Audit


There are three broad categories of operational auditors: functional, organizational, and special assignments.
Functional Audits
● Business is categorised into functions.
● Audit is carried out function-wise
● A functional audit has the advantage of permitting specialization by auditors.

Organizational Audits
An operational audit of an organization deals with an entire organizational unit, such as a department, branch,
or subsidiary. An organizational audit emphasizes how efficiently and effectively functions interact.

Special Assignments
In operational auditing, special assignments arise at the request of management. There are a wide variety of
such audits. Examples include determining the cause of an ineffective IT system, investigating the possibility
of fraud in a division, and making recommendations for reducing the cost of a manufactured product.

(Control, Performance, Objectives, Organisational Structure)


Objectives of Operational Audit
Appraisal of Controls
One of the main objectives of operational audit is to continuous and critically appraise the controls and to
suggest improvements.

Evaluation of Performance
Evaluation of the performance of various tasks against the available benchmarks is done during operational
audit. For this purpose help of relevant experts may be taken by the operational auditor as per the
requirements.
Appraisal of Objectives and Plans
The operational auditor focuses on evaluating the effectiveness, efficiency, and economy of operations rather
than technical aspects (softwares used etc, specific technology used).

Performance evaluation can be based on productivity, personnel, workload, cost, and quality.
● Operational auditors can analyze input-output ratios for materials and labor to assess productivity.
● A sound personnel policy is crucial for optimum performance and proper utilization of resources.
● Workload measurement, such as volume and backlog of work, can be a useful area for operational
auditors.

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● Quality of work can be measured using quantitative indicators like customer complaints, errors, and
wastage.
● Cost is a key performance indicator, with proper classification and recording of costs being essential.

Appraisal of Organisational Structure


This is another important area for appraisal by the operational auditor because it is an important element of
internal control. It provides the line of relationships and delegation of authority and tasks. In evaluating
organisational structure, the aspects that may be considered by the operational auditor may be as follows:
● Is the organisational structure in line with management objectives?
● Whether the organisational structure is drawn up on the basis of matching of responsibility and
authority?
● Whether the line of responsibility from the top to the bottom is clearly detectable/visible from the
structure?
● Whether the delegation of responsibility and authority at each stage is clear and overlapping is
avoided?

Difference between Internal & Operational Audit:


Approach / Perception (Quantity, Quality)
Internal auditor is generally more concerned about monetary / quantitative aspects while an operational auditor
is concerned with qualitative aspects.

Protective (IA) and Constructive (OA)


Internal audit is a more of a protective function, operational audit is primarily seen as a constructive function.

Inclination (Function-Wise)
Inclination in internal audit is more towards finance and accounts related matters. In operational audit other
functions are also given due importance.

Issues (Indpendence, Extension)


Both operational auditor and internal auditor need to maintain necessary independence in their work, they
should not be part of installing systems and controls which are to be audited by them. Operational audit is a
relatively new concept as compared to internal audit. Sometimes, operational audit is also known as extension
of internal audit.

Differences Between Financial Auditing & Operational Auditing


Objective
● The objective of financial auditing is basically expressing opinion on the historical information,
whereas
● the operational auditing emphasizes on effectiveness & efficiency of operations for future
performance.

Scope
● Financial audits are restricted to the matters directly affecting the appropriateness of the presented
financial statements but

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● the operational auditing covers all the activities that are related to efficiency & effectiveness of
operations directed towards accomplishment of objectives of organization.

Reporting
● The financial audit report is sent to all stakeholders, bankers & other persons having stake in the
Organisation.
● However, the operational audit report is primarily for the management.

End task
● The financial audit's main objective is to report findings to the recipients however,
● operational auditing is not limited to reporting only but includes suggestions for improvement also.

Difference Between Management Audit(of) & Operational Audit(For)


Management or Operation audit to be suggested ?

One important aspect of management audit, which has made it distinct from operational audit, i.e.,
management audit is an "audit of the management", while operational audit is the "audit for the
management".

Management audit is concerned with the "Quality of managing", whereas operational audit focuses on the
"Quality of operations".

The basic difference between the two audits, then, is not in method, but in the level of appraisal.

In management audit, the auditor is to make his tests to the level of top management, its formulation of
objectives, plans & policies & its decision making.

It is not that he just verifies the operations

(supportive) (completing or enhancing something)


Thus, the two audits are complementary & supplementary to one another.

Qualities of Operational Auditor


(small or insufficient in
● In areas beyond accounting and finance, his knowledge ordinarily would be rather scanty
quantity or amount.) (having or showing an interest in
and this is a reason which should make him even more inquisitive.
learning things; curious.)

● He should ask the who, why, how of everything.


● He should try to visualise whether simpler alternative means are available to do a particular work.
(continuing firmly or obstinately in an opinion or course of action in spite of difficulty or opposition.)
● He should be persistent and should
possess an attitude of skepticism.
● He should not give up or feel satisfied easily.
● He should imbibe a constructive approach rather than a fault-finding approach and should give a
feeling that his efforts are to help attaining an improved operation and not merely fault finding.
● He should try to develop a team composed of people of different backgrounds. Involvement of technical
people in operational auditing is generally helpful.

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REVIEW OF SYSTEMS AND PROCEDURES


System
A 'system' is a collection of interconnected objects forming a cohesive whole.

A business organization operates within a multifaceted system, considering the needs and methods of various
stakeholders and environments while managing diverse operations.

To accomplish an objective by means of a system entails three main steps:


1. Design a system to achieve the main objectives.
2. Operate the system.
3. Check that the system is operating and producing as intended by its design, i.e. that the stated objective
is being achieved.

Procedures
● Procedures are the means by which policies are implemented.
● Most often, procedures entail the use of documents in accordance with precise instructions or methods
to be used.
● At lower levels in an organisation, formalised and authorised procedures to become more numerous and
of specific nature because of following factors:
○ There exists an economic advantage of specifying precise uniform action to be taken by a large
number of people and for repetitive jobs.
○ The need for more precise control over employees' activities which can only be achieved if there
are detailed prescriptions of how things are to be done
○ The element of discretion has to be reduced as far as possible.

Review of Systems and Procedures


Why?
● Reviewing these systems helps improve methods, break from old routines, reduce paperwork costs, and
eliminate waste, duplication, and inefficiencies while considering their purpose and design to best serve
the enterprise

Considerations for evaluation of systems


The evaluation of a system or a procedure actually includes three separate considerations.
● First, is the system or procedure meeting all of the current requirements?
● Second, is it operating effectively?
● And third, what is the degree of effectiveness?

Is the system or procedure meeting all of the current requirements?


To determine whether the system or procedure is meeting current requirements, the following among other
things should be considered:
● Is the system or procedure designed to promote the achievement of the company's objectives, and is it
accomplished effectively?
● Does the system operate within the organizational structure and provide efficient control methods for
optimal performance with minimal time and effort.
● Do the routines designated in the system or procedures indicate performance in a logical sequence?

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● Does the system or procedure provide the means for effective coordination between one department
and another?
● Have all required functions been established?
● Has the necessary authority been designated to carry out responsibilities?
● Can anv changes be made to improve effectiveness?

Question to be asked for study of system and procedures (Homework)


In the study of the systems and procedural functions, the auditor should ask himself:
1. Is the function properly located in the organisation?
2. Do the staff personnel have the necessary training and experience to perform the work?
3. Has a definite programme been established and has been taken for its attentive accomplishment?
4. Is productivity satisfactory?

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Corporate Governance

Chapter-9 Audit Committee and Corporate Governance

Corporate Governance
Corporate Governance is the system by which companies are directed and governed by the management.
Through Corporate Governance the management is able to ensure accountability, transparency and fairness in
the company operations, thereby ensuring that the interests of shareholders and all other stakeholders are
protected.

Legal structure of Corporate Governance


The Securities and Exchange Board of India (SEBI), issued the Securities and Exchange Board of India (Listing
Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”), with the objective of
streamlining and consolidating the provisions of various listing agreements in operation for different segments
of the capital markets, such as equity shares, preference shares, debt instruments, units of mutual funds, Indian
depository receipts, securitised debt instruments and any other securities that the SEBI may specify.

The LODR Regulations are divided into two parts - the substantive provisions are incorporated in the main
body while the procedural requirements are incorporated in the form of schedules.

Chapter IV (Regulation 15 to 27) of LODR Regulation addresses issued related to corporate governance.
● Regulation - 15 Applicability
● Regulation - 16 Definitions
● Regulation - 17 Board of Directors
● Regulation - 17A Maximum number of directorships
● Regulation - 18 Audit Committee
● Regulation - 19 Nomination and remuneration committee
● Regulation - 20 Stakeholders Relationship Committee
● Regulation - 21 Risk Management Committee
● Regulation - 22 Vigil mechanism
● Regulation - 23 Related party transactions
● Regulation - 24 Corporate governance requirements with respect to subsidiary of listed entity
● Regulation - 24A Secretarial Audit and Secretarial Compliance Report
● Regulation - 25 Obligations with respect to independent directors
● Regulation - 26 Obligations with respect to employees including senior management, key managerial
personnel, directors and promoters.
● Regulation - 27 Other corporate governance requirements.

We will cover regulations which are relevant for CA Final Exams in accordance with ICAI study material

Audit Commitee

What is a Committee?
A group of people appointed for a specific function by a larger group and typically consisting of members of that
group.

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Section 177 Read with Relevant Rules.


The Board of Directors of every listed public company and such other class or classes of companies, as may be
prescribed , shall constitute an Audit Committee.

Prescribed companies as per rules


● the Public Companies having paid-up share capital of ten crore rupees or more.
● the Public Companies having turnover of one hundred crore rupees or more
● the Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding
fifty crore rupees

However, following class of unlisted public companies shall not be covered:


1. a joint venture;
2. wholly owned subsidiary; and
3. a dormant company as covered u/s 455.

The paid-up share capital or turnover or outstanding loans, debentures and deposits, as the case may be, as
existing on the date of last audited Financial Statements shall be taken into account for the purposes of this
rule.

Section 139(11) provides that where a company is required to constitute an Audit Committee under section 177,
all appointments, including the filling of a casual vacancy of an auditor under this section shall be made after
taking into account the recommendations of such committee.

Members
● The Audit Committee shall consist of a minimum of three directors with independent directors forming
a majority.
● The majority of members of the Audit Committee including its Chairperson shall be persons with
ability to read and understand the financial statement.

Functions
Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board
which shall inter alia, include
i. the recommendation for appointment, remuneration and terms of appointment of auditors of the
company.
ii. review and monitor the auditor's independence and performance, and effectiveness of the audit process
iii. examination of the financial statement and the auditors' report thereon.

iv. approval or any subsequent modification of transactions of the company with related parties.
v. scrutiny of inter-corporate loans and investments.

vi. valuation of undertakings or assets of the company, wherever it is necessary


vii. evaluation of internal financial controls and risk management systems
viii. monitoring the end use of funds raised through public offers and related matters.

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Provided that the Audit Committee may make omnibus approval for related party transactions proposed to
be entered into by the company subject to such conditions as may be prescribed. -

Provided further that in case of transaction, other than transactions referred to in section 188, and where
Audit Committee does not approve the transaction, it shall make its recommendations to the Board

Provided also that in case any transaction involving any amount not exceeding one crore rupees is entered
into by a director or officer of the company without obtaining the approval of the Audit Committee and it is
not ratified by the Audit Committee within three months from the date of the transaction, such transaction
shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any
director or is authorised by any other director, the director concerned shall indemnify the company against
any loss incurred by it

Provided also that the provisions of this clause shall not apply to a transaction, other than a transaction
referred to in section 188, between a holding company and its wholly owned subsidiary company.

Powers
● Call for comments
○ The Audit Committee may call for the comments of the auditors about
■ internal control systems,
■ the scope of audit, including the observations of the auditors and review of financial
statement before their submission to the Board and
■ may also discuss any related issues with the internal and statutory auditors and the
management of the company.

● Authority to investigate & Obtain professional advice


○ The Audit Committee shall have authority to investigate any matter in relation to the items
specified in sub-section (4) (Functions of Audit Committee) or referred to it by the Board and for
this purpose
■ shall have power to obtain professional advice from external sources and
■ have full access to information contained in the records of the company.

Other Points
The auditors of a company and the key managerial personnel shall have a right to be heard in the meetings of
the Audit Committee when it considers the auditor's report but shall not have the right to vote.

The Board's report under sub-section (3) of section 134 shall disclose the composition of an Audit Committee
and where the Board had not accepted any recommendation of the Audit Committee, the same shall be
disclosed in such report along with the reasons therefor.

Misc. Points
Every listed company or such class or classes of companies, as may be prescribed, shall establish a vigil
mechanism for directors and employees to report genuine concerns in such manner as may be prescribed.

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The vigil mechanism shall provide for adequate safeguards against victimisation of persons who use such
mechanism and make provision for direct access to the chairperson of the Audit Committee in appropriate or
exceptional cases:

Provided that the details of the establishment of such mechanism shall be disclosed by the company on its
website, if any, and in the Board's report.

Audit Committee - Regulation 18 Securities and Exchange Board of India


(Listing Obligations and Disclosure Requirements) Regulations, 2015
Every listed entity shall constitute a qualified and independent audit committee in accordance with the terms of
reference, subject to the following:
a. The audit committee shall have a minimum three directors as members.
b. Atleast Two-thirds of the members of audit committee shall be independent directors and in case of a
listed entity having outstanding Superior Rights equity shares, the audit committee shall only comprise
of independent directors
c. All members of the audit committee shall be financially literate and at least one member shall have
accounting or related financial management expertise.

Explanation (1).- For the purpose of this regulation, "financially literate" shall mean the ability to read and
understand basic financial statements i.e. balance sheet, profit and loss account, and statement of cash flows.

Explanation (2).- For the purpose of this regulation , a member shall be considered to have accounting or related
financial management expertise if he or
● she possesses experience in finance or accounting, or
● requisite professional certification in accounting, or
● any other comparable experience or background which results in the individual's financial
sophistication,
● including being or having been a chief executive officer, chief financial officer or other senior officer
with financial oversight responsibilities.

d. The chairperson of the audit committee shall be an independent director and he shall be present at
Annual general meetings to answer shareholder queries.
e. The Company Secretary shall act as the secretary to the audit committee.
f. The audit committee at its discretion shall invite the finance director or head of the finance function,
head of internal audit and a representative of the statutory auditor and any other such executives to be
present at the meetings of the committee:

Provided that occasionally the audit committee may meet without the presence of any executives of the listed
entity.

Role of the audit committee.


● Reviewing, with the management, the annual financial statements and auditor's report thereon before
submission to the board for approval, with particular reference to
○ matters required to be included in the director's responsibility statement to be included in the
board's report in terms of clause (c) of sub-section (3) of Section 134 of the Companies Act, 2013;
○ changes, if any, in accounting policies and practices and reasons for the same;

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○ major accounting entries involving estimates based on the exercise of judgment by


management;
○ significant adjustments made in the financial statements arising out of audit findings;
○ compliance with listing and other legal requirements relating to financial statements;
○ disclosure of any related party transactions;
○ modified opinion(s) in the draft audit report;

● Reviewing the utilization of loans and/or advances from/investment by the holding company in the
subsidiary
○ exceeding rupees 100 crore or 10% of the asset size of the subsidiary, whichever is lower

Mandatorily review by Audit Committee


● The audit committee shall mandatorily review the following information
○ management discussion and analysis of financial condition and results of operations;
○ management letters / letters of internal control weaknesses issued by the statutory auditors;
○ internal audit reports relating to internal control weaknesses; and
○ the appointment, removal and terms of remuneration of the chief internal auditor shall be
subject to review by the audit committee.
○ Statement of deviations:
■ Quarterly statement of deviation(s) including report of monitoring agency, if applicable,
submitted to stock exchange(s).
■ Annual statement of funds utilized for purposes other than those stated in the offer
document/prospectus.

Powers of Audit Committee

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Meeting of Audit Committee


The Audit Committee shall meet at least four times in a year and not more than one hundred and twenty days
shall lapse between two meetings. The quorum shall be either two members or one third of the members of
the Audit Committee, whichever is greater, but there should be a minimum of two independent directors
present.

Resignation of Statutory Auditors from Listed Entities and their Material Subsidiaries.
Listed entities must disclose auditor resignation reasons to stock exchanges within 24 hours of receiving them,
as per SEBI LODR Regulations.

SEBI LODR Regulations lays down certain disclosures to be made part of the notice to the shareholders for an
AGM, where the statutory auditors are proposed to be appointed/re-appointed, including their terms of
appointment.

In accordance with the SEBI LODR Regulations, the conditions to be complied with upon the resignation of a
statutory auditor for a listed entity/material subsidiary with respect to limited review/audit report are as follows:
1. If the auditor resigns within 45 days from the end of a quarter of a financial year, then the auditor shall.
before such resignation, issue the limited review / audit report for such a quarter.
2. If the auditor resigns after 45 days from the end of a quarter of a financial year, then the auditor shall,
before such resignation, issue the limited review/ audit report for such quarter as well as the next
quarter.
3. if the auditor has signed the limited review audit report for the first three quarters of a financial year,
then the auditor shall, before such resignation, issue the limited review audit report for the last quarter
of such financial year as well as the audit report for such financial year.

Other conditions relating to resignation shall include:


1. Reporting of concerns with respect to the listed entity/its material subsidiary to the Audit Committee:
a. If facing concerns like non-cooperation or unavailable information from the management, the
auditor should immediately contact the Audit Committee Chairman, who must promptly
address the issue without waiting for quarterly meetings.
b. Upon proposing resignation, the auditor must notify the Audit Committee of all concerns and
relevant documents, and if due to non-receipt of information, they should provide details of the
requested information not given by management.
c. Upon receiving auditor's resignation proposal, the Audit Committee or board of directors
deliberates and communicates its views to both management and auditor.
2. Disclaimer in case of non-receipt of information in accordance with the Standards of Auditing as
specified by ICAI/ NFRA.

The practicing company secretary shall certify compliance by a listed entity on the above in the prescribed
annual secretarial compliance report.

Above provisions will not apply if the auditor is disqualified due to Section 141 of the Companies Act, 2013.

Obligations of the listed entity and its material subsidiary


● Format of information to be obtained from the statutory auditor upon resignation
● Co-operation by listed entity and its material subsidiary
● Disclosure of Audit Committee's views to the Stock Exchanges.

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Auditor will check the following also


1. Verify Audit Committee minutes and agenda papers for relevant information review.
2. Check if Management Discussion and Analysis report is part of the annual report.
3. Confirm the report includes discussion on segment reporting as per relevant accounting standards / IndAS.

Nomination and remuneration committee.


● The board of directors shall constitute the nomination and remuneration committee as follows:
○ the committee shall comprise of at least three directors ;
○ all directors of the committee shall be non-executive directors; and
○ at least two-thirds of the directors shall be independent directors

● The Chairperson of the nomination and remuneration committee shall be an independent director.

● Provided that the chairperson of the listed entity, whether executive or non-executive, may be
appointed as a member of the Nomination and Remuneration Committee and shall not chair such
Committee.

● The quorum for a meeting of the nomination and remuneration committee shall be either two members
or one third of the members of the committee, whichever is greater, including at least one
independent director in attendance.

● The Chairperson of the nomination and remuneration committee may be present at the annual general
meeting, to answer the shareholders' queries; however, it shall be up to the chairperson to decide who
shall answer the queries.

● The nomination and remuneration committee shall meet at least once in a year.

ROLE OF NOMINATION AND REMUNERATION COMMITTEE


Role of committee shall, inter-alia, include the following:
1. formulation of the criteria for
a. determining qualifications, positive attributes and independence of a director and
b. recommend to the board of directors a policy relating to, the remuneration of the directors, key
managerial personnel and other employees;
2. For every appointment of an independent director,
a. the Nomination and Remuneration Committee shall evaluate the balance of skills, knowledge
and experience on the Board and
b. on the basis of such evaluation, prepare a description of the role and capabilities required of an
independent director.
For the purpose of identifying suitable candidates, the Committee may:
a. use the services of an external agencies, if required;
b. consider candidates from a wide range of backgrounds, having due regard to diversity;
and c.
c. consider the time commitments of the candidates.
3. identifying persons who are qualified to become directors and who may be appointed in senior
management in accordance with the criteria laid down, and recommend to the board of directors their
appointment and removal.

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4. formulation of criteria for evaluation of performance of independent directors and the board of
directors;
5. whether to extend or continue the term of appointment of the independent director, on the basis of the
report of performance evaluation of independent directors.
6. devising a policy on diversity of board of directors;
7. Recommend to the board, all remuneration, in whatever form, payable to senior management.

Stakeholders Relationship Committee.


Purpose
The listed entity shall constitute a Stakeholders Relationship Committee to specifically look into various
aspects of interest of shareholders, debenture holders and other security holders.

Chairperson
The chairperson of this committee shall be a non-executive director.

Minimum Director Independent Directors


At least three directors,
● with at least one being an independent director, shall be members of the Committee and
● in case of a listed entity having outstanding SR equity shares, at least two thirds of the Stakeholders
Relationship Committee shall comprise of independent directors

Chairperson - AGM
The Chairperson of the Stakeholders Relationship Committee shall be present at the annual general meetings
to answer queries of the security holders.

Meeting
The stakeholders relationship committee shall meet at least once in a year.

Role
The role of the Stakeholders Relationship Committee shall be as specified in Schedule II.

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Auditor’s Procedure
● Auditor should verify Board meeting minutesto check if Stakeholders Relationship Committee, chaired
by a non-executive director, exists for shareholder and security holder interests.
● Further, the auditor should also ascertain from the minutes book of the Committee meetings whether
such committee is prima facie functioning.
● The auditor should also verify from the records of the Committee as well as from the certificate
obtained by the listed entity from SEBI and stock exchange(s), if any, as regards the investors’ grievances
pending up to the date of certificate of compliance of conditions of corporate governance.

Regulation 21 - Risk Management Committee.


● The board of directors shall constitute a Risk Management Committee.
● The Risk Management Committee shall have
○ minimum three members with
■ majority of them being members of the board of directors,
■ including at least one independent director and
● in case of a listed entity having outstanding SR equity shares,

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○ at least two thirds of the Risk Management Committee shall comprise


independent directors.

● The Chairperson of the Risk management committee shall be a member of the board of directors and
senior executives of the listed entity may be members of the committee.

● The risk management committee shall meet at least twice in a year.

● The meetings of the risk management committee shall be conducted in such a manner that on a
continuous basis not more than one hundred and eighty days shall elapse between any two consecutive
meetings.

● Quorum - 2 or 1/3rd of the members of the committee, whichever is higher, at least 1 member of the
board of directors in attendance.

● The Board of Directors shall define the role and responsibility of the Risk Management Committee and
may delegate monitoring and reviewing of the risk management plan to the committee and such other
functions as it may deem fit and such function shall specifically cover cyber security.

● It may be noted that the role and responsibilities of the Risk Management Committee shall mandatorily
include the performance of functions specified in Part D of Schedule II.

● The provisions of this regulation shall be applicable


○ to top 1000 listed entities, determined on the basis of market capitalisation, as at the end of the
immediate previous financial year.
○ a 'high value debt listed entity'.

● The Risk Management Committee shall have powers to


○ seek information from any employee,
○ obtain outside legal or
○ other professional advice and
○ secure attendance of outsiders with relevant expertise, if it considers necessary.

Regulation 17 - Board of Directors


Composition
Board of directors shall have an optimum combination of executive and non-executive directors
➢ with at least one woman director and (1WD)
➢ not less than fifty per cent of the board of directors shall comprise of non-executive directors:
(50% NED)
Top 1000 listed entities shall have at least one independent woman director.
The top 1000 entities shall be determined on the basis of market capitalisation, as at the end of the immediate
previous financial year;

Minimum Number of Independent Directors


Where the
● chairperson of the board of directors is a non-executive director,
○ at least one-third of the board of directors shall comprise of independent directors and

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● where the listed entity does not have a regular non-executive chairperson,
○ at least half of the board of directors shall comprise of independent directors :
Provided that where the regular non-executive chairperson is
● a promoter of the listed entity or
● is related to any promoter or
● person occupying management positions at the level of board of director or at one level below the
board of directors,
● at least half of the board of directors of the listed entity shall consist of independent directors.

"Related to any promoter" shall have the following meaning :


● if the promoter is a listed entity, its directors other than the independent directors, its employees or its nominees shall
be deemed to be related to it;
● if the promoter is an unlisted entity, its directors, its employees or its nominees shall be deemed to be related to it;

● Where the listed company has outstanding SR equity shares, at least half of the board of directors shall
comprise independent directors.
● The board of directors of the top 2000 listed entities shall comprise of not less than six directors.

A non-executive director who has attained the age of seventy-five years


No listed entity shall appoint a person or continue the directorship of any person as a non-executive director
who has attained the age of seventy-five years unless a special resolution is passed to that effect, in which case
the explanatory statement annexed to the notice for such motion shall indicate the justification for appointing
such a person.

Approval of shareholders for appointment for re-appointment.


The listed entity shall ensure that approval of shareholders for appointment for re-appointment of a person on
the Board of Directors or as a manager is taken at the next general meeting or within a time period of three
months from the date of appointment, whichever is earlier.

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Provided that a public sector company shall ensure that the approval of the shareholders for appointment or
re-appointment of a person on the Board of Directors or as a Manager is taken at the next general meeting.

Appointment or a re-appointment of a person who was earlier rejected


The appointment or a re-appointment of a person, including as a managing director or a whole-time director
or a manager, who was earlier rejected by the shareholders at a general meeting, shall be done only with the
prior approval of the shareholders.

Detailed explanation and justification by the Nomination and Remuneration Committee and the Board of
directors for recommending such a person for appointment or re-appointment must be there in statement
under section 102

Meeting
The board of directors shall meet at least four times a year, with a maximum time gap of one hundred and
twenty days between any two meetings.

Quorum
● The quorum for every meeting of the board of directors of the top 2000 listed entities shall be one-third
of its total strength or three directors, whichever is higher, including at least one independent director.
● The participation of the directors by video conferencing or by other audio-visual means shall also be
counted for the purposes of such quorum.

Compliance with law (Review)


The board of directors shall periodically review compliance reports pertaining to all laws applicable to the
listed entity, prepared by the listed entity as well as steps taken by the listed entity to rectify instances of
non-compliances.

Succession Plan
The board of directors of the listed entity shall satisfy itself that plans are in place for orderly succession for
appointment to the board of directors and senior management.

Code of Conduct
● The board of directors shall lay down a code of conduct for all members of board of directors and senior
management of the listed entity.
● The code of conduct shall suitably incorporate the duties of independent directors as laid down in the
Companies Act, 2013.
Remuneration
● RECOMMENDATION and APPROVAL - The board of directors shall recommend all fees or
compensation, if any, paid to non-executive directors, including independent directors and shall require
approval of shareholders in general meeting.

● APPROVAL NOT REQUIRED - The requirement of obtaining approval of shareholders in general


meeting shall not apply to payment of sitting fees to non-executive directors, if made within the limits
prescribed under the Companies Act, 2013 for payment of sitting fees without approval of the Central
Government.

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● STOCK OPTION - The approval of shareholders, shall specify the limits for the maximum number of
stock options that may be granted to non-executive directors, in any financial year and in aggregate.

● SPECIAL RESOLUTION - The approval of shareholders by special resolution shall be obtained every
year, in which the annual remuneration payable to a single non-executive director exceeds 50 per cent of
the total annual remuneration payable to all non-executive directors, giving details of the remuneration
thereof.

● NO STOCK OPTION - Independent directors shall not be entitled to any stock option.

● FEES TO PROMOTERS - The fees or compensation payable to executive directors who are promoters
or members of the promoter group, shall be subject to the approval of the shareholders by special
resolution in general meeting,
○ if (the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5
percent of the net profits of the listed entity, whichever is higher; or
○ where there is more than one such director, the aggregate annual remuneration to such
directors exceeds 5 percent of the net profits of the listed entity:

● Provided that the approval of the shareholders under this provision shall be valid only till the expiry of
the term of such director.

● For this purpose net profits shall be calculated as per section 198 of the Companies Act, 2013.

Minimum Information
The minimum information to be placed before the board of directors is specified in Part A of Schedule II.

Compliance Certificate
The chief executive officer and the chief financial officer shall provide the compliance certificate to the board
of directors as specified in Part B of Schedule II.

Risk Assessment
● The listed entity shall lay down procedures to inform members of the board of directors about risk
assessment and minimization procedures.
● The board of directors shall be responsible for framing, implementing and monitoring the risk
management plan for the listed entity.

Evaluation of independent directors


The evaluation of independent directors shall be done by the entire board of directors which shall include—
a. performance of the directors; and
b. fulfilment of the independence criteria as specified in these regulations and their independence from
the management:

Provided that in the above evaluation, the directors who are subject to evaluation shall not participate. :-)

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Notice
The statement to be annexed to the notice as referred to in sub-section (1) of section 102 of the Companies Act,
2013 for each item of special business to be transacted at a general meeting shall also set forth clearly the
recommendation of the board to the shareholders on each of the specific items.

17A Maximum number of directorships.


The directors of listed entities shall comply with the following conditions with respect to the maximum
number of directorships, including any alternate directorships that can be held by them at any point of time—
● A person shall not be a director in not more than seven listed entities.
● A person shall not serve as an independent director in more than seven listed entities.
● Any person who is serving as a whole time director/managing director in any listed entity shall serve as
an independent director in not more than three listed entities.
● For the purpose of this sub-regulation, the count for the number of listed entities on which a person is
a director/independent director shall be only those whose equity shares are listed on a stock exchange.

CODE OF CONDUCT [REGULATIONS 17(5), 26(3), 46(2) AND PART D OF


SCHEDULE VI
● The Board shall lay down a code of conduct for all Board members and senior management of the listed
entity.
● All Board members and senior management personnel shall affirm compliance with the code on an
annual basis.
● The Annual Report of the company shall contain a declaration to this effect signed by the CEO.
● The code of conduct shall be posted on the website of the company.
● The Code of Conduct shall suitably incorporate the duties of Independent Directors as laid down in the
Companies Act, 2013.

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Senior Management
● For this purpose, the term “senior management” shall mean personnel of the listed entity who are
members of its core management team excluding Board of Directors.
● Normally, this would comprise all members of management one level below the chief executive
officer/managing director/whole time director/manager (including chief executive officer/manager, in
case they are not part of the board) and
● shall specifically include company secretary and chief financial officer.

Auditor’s Responsibility / Duties

VIGIL MECHANISM [REGULATIONS 22, 46 AND PART C OF SCHEDULE VI


1. The listed entity shall establish a vigil mechanism/ whistle blower policy for directors and employees to
report genuine concerns.
2. This mechanism should also provide for adequate safeguards against victimization of directors) /
employee(s) or any other person who avail the mechanism and also provide for direct access to the
chairperson (INDEPENDENT DIRECTOR) of the Audit Committee in appropriate or exceptional
cases.
3. The details of establishment of such mechanism shall be disclosed by the company on its website and
in the Board's report.

Corporate governance requirements with respect to subsidiaries of listed


entities.
BOD At least one independent director on the board of directors of the listed entity shall be a
director on the board of directors of an unlisted material subsidiary, whether incorporated in
India or not. -

For the purposes of this provision, notwithstanding anything to the contrary contained in
regulation 16, the term "material subsidiary" shall mean a subsidiary, whose income or net
worth exceeds twenty per cent of the consolidated income or net worth respectively, of the
listed entity and its subsidiaries in the immediately preceding accounting year.

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"Material "Material subsidiary" shall mean a subsidiary, whose income or net worth exceeds ten per
Subsidiary as per cent of the consolidated income or net worth respectively, of the listed entity and its
subsidiaries in the immediately preceding accounting year.
Regulation 16"

Review of the The audit committee of the listed entity shall also review the financial statements, in
financial particular, the investments made by the unlisted subsidiary.

statements

MOM - BOD The minutes of the meetings of the board of directors of the unlisted subsidiary shall be
placed at the meeting of the board of directors of the listed entity.

Significant The management of the unlisted subsidiary shall periodically bring to the notice of the
transactions board of directors of the listed entity, a statement of all significant transactions and
arrangements entered into by the unlisted subsidiary.

Significant "Significant transaction or arrangement" shall mean any individual transaction or


transactions - arrangement
● that exceeds or is likely to exceed
Meaning and
● ten per cent of the total revenues or total expenses or total assets or total liabilities,
as the case may be,
● of the unlisted subsidiary for the immediately preceding accounting year.

Disposal of A listed entity shall not dispose of shares in its material subsidiary resulting in reduction of
Shares its shareholding to less than fifty per cent without passing a special resolution in its
General Meeting
● except in cases where such divestment is made under
○ a scheme of arrangement duly approved by a Court/Tribunal , or
○ under a resolution plan duly approved under section 31 of the Insolvency
Code and such an event is disclosed to the recognized stock exchanges
within one day of the resolution plan being approved

Selling, Selling, disposing and leasing of assets amounting to more than


disposing and ● twenty percent of the assets of the material subsidiary on an aggregate basis during a
financial year
leasing of assets
● shall require prior approval of shareholders by way of special resolution,
● unless the sale/disposal/lease is made
○ under a scheme of arrangement duly approved by a Court/Tribunal ,
○ or under a resolution plan duly approved under section 31 of the Insolvency
Code and such an event is disclosed to the recognized stock exchanges
within one day of the resolution plan being approved

Secretarial Audit and Secretarial Compliance Report of Listed Entity and its
Material Unlisted Subsidiaries [Regulation 24A]
● Every listed entity and its material unlisted subsidiaries incorporated in India shall
○ undertake secretarial audit and shall
○ annex a secretarial audit report given by a company secretary in practice, in such form as
specified, with the annual report of the listed entity.

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● Every listed entity shall submit a


○ secretarial compliance report in such form as specified, to stock exchanges, within
○ sixty days from end of each financial year.

Documents & Information to shareholders. REGULATION 36


The listed entity shall send the annual report in the following manner to the shareholders:
a. Soft copies of full annual report to all those shareholder(s) who have registered their email address(es)
either with the listed entity or with any depository
b. Hard copy of statement containing the salient features of all the documents, as prescribed in section 136
of Companies Act, 2013 or rules made thereunder to those shareholder(s) who have not so registered;
c. Hard copies of full annual reports to those shareholders, who request for the same.

The listed entity shall send annual report referred above), to the holders of securities, not less than twenty-one
days before the annual general meeting.

In case of the appointment of a new director or re-appointment of a director the shareholders must be provided
with the following information
a. a brief resume of the director;
b. nature of expertise in specific functional areas;
c. disclosure of relationships between directors inter se;
d. names of listed entities in which the person also holds the directorship and the membership of
Committees of the board - along with listed entities from which the person has resigned in the past
three years; and
e. shareholding of non-executive directors in the listed entity, including shareholding as a beneficial
owner.
f. In case of independent directors, the skills and capabilities required for the role and the manner in
which the proposed person meets such requirements.

ROLE OF NOMINATION AND REMUNERATION COMMITTEE


Role of committee shall, inter-alia, include the following:
formulation of the criteria for
a. determining qualifications, positive attributes and independence of a director

The auditor should ascertain from the communications sent, whether in the case of appointment of a new
director or re-appointment of a director, the shareholders have been provided with the information stipulated
above.

Transfer or transmission or transposition of securities.


The Board of Directors of a listed entity shall delegate the power of transfer of securities to a committee or to
the compliance officer or to the registrar to an issue and/or share transfer agents.

Provided that the board of directors and/or the delegated authority shall attend to the formalities pertaining to
transfer of securities at least once in a fortnight

Provided further that the delegated authority shall report on transfer of securities to the board of directors in
each meeting.

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The auditor should ascertain from the minutes book of the Board meetings whether the listed entity has
delegated the power of share transfer to an officer or a committee or to the registrar and share transfer agents.
The auditor should also verify from the records maintained to ascertain whether the delegated authority has
attended to share transfer formalities at least once in a fortnight. The auditor may verify whether any transfer
request are pending for more than a fortnight and are not attended to in terms of this Regulation.

Management Discussion and Analysis


This section shall include discussion on the following matters relevant to the entity
a. Industry structure and developments.
b. Opportunities and Threats.
c. Segment–wise or product-wise performance.
d. Outlook
e. Risks and concerns.
f. Internal control systems and their adequacy.
g. Discussion on financial performance with respect to operational performance.
h. Material developments in Human Resources / Industrial Relations front, including number of people
employed.

Details of significant changes (i.e. change of 25% or more as compared to the immediately previous
financial year) in key financial ratios, along with detailed explanations therefor, including:
● Debtors Turnover
● Inventory Turnover
● Interest Coverage Ratio
● Current Ratio
● Debt Equity Ratio
● Operating Profit Margin (%)
● Net Profit Margin (%)
● or sector-specific equivalent ratios, as applicable.

Details of any change in Return on Net Worth as compared to the immediately previous financial year
along with a detailed explanation thereof.

Management may present non-financial information which is beyond the auditor's expertise

The auditor may keep in mind SA 315 relating to "Identifying and Assessing tregulahe Risks of Material
Misstatement through Understanding the Entity and its Environment" and the fact that he is only required to
review the compliance with disclosure requirements and not verify the particular facts as disclosed by the
management.

The auditor should ascertain that the segment-wise or product-wise performance is consistent with what is
reported in financial statements complying with AS 17 (Segment Reporting)/ Indian Accounting Standard 108
(Operating Segments) and also as per provisions of Section 133, 134 and 143 of the Companies Act, 2013.

Other Disclosures - Disclosure and Transparency


The listed entity shall ensure timely and accurate disclosure on all material matters including the financial
situation, performance, ownership, and governance of the listed entity, in the following manner.

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- Information shall be prepared and disclosed in accordance with the prescribed standards of accounting.
- Channels for disseminating information should provide for equal, timely and cost efficient access to
relevant information by users.
- Minutes of the meeting shall be maintained explicitly recording dissenting opinions, if any.

Disclosure of events or information


● Every listed entity shall make disclosures of any events or information which, in the opinion of the
board of directors of the listed company, is material.
● Board of of directors of the listed entity shall authorize one or more Key Managerial Personnel for the
purpose of determining materiality of an event or information and for the purpose of making
disclosures to stock exchanges under this regulation and the contact details of such personnel shall be
also disclosed to the stock exchanges and as well as on the listed entity's website.
● Such disclosures shall be hosted on the website of the listed entity for a minimum period of five years
and thereafter as per the archival policy of the listed entity, as disclosed on its website.

Related Party Disclosure [Regulations 23, 27, 46 and Schedule V]


- SA 200 ILA.
- SA 315 - Significant Risk.
- SA 550.
- AS 18 / Ind AS 24.
- CARO - Clause (xiii).

Policy
The listed entity shall
● formulate a policy
○ on materiality of related party transactions and
○ on dealing with related party transactions
■ including clear threshold limits duly approved by the board of directors and
■ such policy shall be reviewed by the board of directors at least once every three years and
updated accordingly.

RPT to be considered material


A related party transaction shall be considered material,
● if the transaction(s) to be entered into individually or taken together with previous transactions during a
financial year,
○ exceeds
■ rupees one thousand crore or
■ ten per cent of the annual consolidated turnover of the listed entity as per the last
audited financial statements of the listed entity,
● whichever is lower

Approval of IDs
All related party transactions and subsequent material modifications shall require prior approval of the
independent directors in audit committee of the listed entity.

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Approval of AC
Audit committee may grant omnibus approval for related party transactions proposed to be entered into by the
listed entity subject certain conditions.

Disclosure to stock exchanges


● The listed entity shall submit to the stock exchanges disclosures of related party transactions in the
format as specified by the Board from time to time, and publish the same on its website.
● Provided that a ‘high value debt listed entity’ shall submit such disclosures along with its standalone
financial results for the half year.
● The listed entity shall make such disclosures every six months within fifteen days from the date of
publication of its standalone and consolidated financial results.
● The listed entity shall make such disclosures every six months on the date of publication of its
standalone and consolidated financial results with effect from April 1, 2023.

Additional Discsloures in Annual Report


As per Schedule V - Annual Report, the annual report shall contain the following additional disclosures relating
to Related Party:
1. The listed entity which has listed its non-convertible securities shall make disclosures in compliance
with the Accounting Standard on "Related Party Disclosures".
2. The disclosure requirements shall be as follows:

S.No. In the accounts of Disclosures of amounts at the year end and the maximum amount of
loans/ advances/ Investments outstanding during the year.

1. Holding Company ● Loans and advances in the nature of loans to subsidiaries by


name and amount.
● Loans and advances in the nature of loans to associates by
name and amount.
● Loans and advances in the nature of loans to firms/companies
in which directors are interested by name and amount.

2. Subsidiary Same disclosures as applicable to the parent company in the accounts


of subsidiary company.

3. Holding Company Investments by the loanee in the shares of parent company and
subsidiary company.

For the purpose of above disclosures directors’ interest shall have the same meaning as given in Section184 of
Companies Act, 2013.

Disclosures of transactions with Promoters etc


Disclosures of transactions of the listed entity
● with any person or entity belonging to the promoter/promoter group
● which hold(s) 10% or more shareholding in the listed entity, in the format prescribed in the relevant
accounting standards for annual results.

The above disclosures shall not be applicable to listed banks.

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Corporate Governance

Quarterly compliance report


The listed entity shall submit a quarterly compliance report on corporate governance in the format as specified
by the Board from time to time to the recognised stock exchange(s) within 21 days from the end of each quarter.
Details of all material transactions with related parties shall be disclosed therein. The report shall be signed
either by the compliance officer or the chief executive officer of the listed entity.

Other Disclosures
● Disclosures on materially significant related party transactions that may have potential conflict with the
interests of listed entity at large
● web link of policy on dealing with related party transactions;

Disclosure of Accounting Treatment


● Where in the preparation of financial statements, a treatment different from that prescribed in an
Accounting Standard has been followed, the fact shall be disclosed in the financial statements, together
with the management's explanation as to why it believes such alternative treatment is more
representative of the true and fair view of the underlying business transaction.
● In this regard, the auditor should refer to Sections 133, 134 and 143 of the Companies Act, 2013. Also,
the auditor should refer to the Compliance Certificate issued in accordance with Regulation 17(8).

Disclosures in relation to the Sexual Harassment of Women at Workplace


(Prevention, Prohibition and Redressal) Act, 2013 (Schedule V).
Amongst other matters, following should be disclosed in the section on Corporate Governance of the Annual
Report:
● number of complaints filed during the financial year
● number of complaints disposed of during the financial year
● number of complaints pending as on end of the financial year

REPORT ON CORPORATE GOVERNANCE [REGULATION 27 AND


SCHEDULE II]
● The listed entity shall submit a quarterly compliance report on corporate governance in the format as
specified by the Board from time to time to the recognised stock exchange(s) within 21 days from the
end of each quarter.
● The report shall be signed either by the Compliance Officer or the Chief Executive Officer of the listed
entity.

Duty of Auditor
● The auditor should ascertain whether
○ the Board of Directors have included in the Annual Report of the listed entity,
○ a separate section on corporate governance
■ with a detailed compliance report on corporate governance.
● Any data in the report on corporate governance should not be inconsistent with that contained in the
financial statements.

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Corporate Governance

STATEMENT OF DEVIATION(S) OR VARIATIONS) REGULATION 32 AND


PART C OF SCHEDULE I]
The listed entity shall submit to the stock exchange the following statements on a quarterly basis for public
issue, rights issue, preferential issue etc.:
a. Indicating deviations, if any, in the use of proceeds from the objects stated in the offer document or
explanatory statement to the notice for the general meeting, as applicable;
b. Indicating category-wise variation (capital expenditure, sales and marketing, working capital etc.)
between projected utilisation of funds made by it in its offer document or explanatory statement to the
notice for the general meeting, as applicable and the actual utilisation of funds.

The statements) shall be continued to be given till such time the issue proceeds have been fully utilised or the
purpose for which these proceeds were raised has been achieved.

Where an entity has raised funds through preferential allotment or qualified institutions placement, the listed
entity shall disclose every year, the utilization of such funds during that year in its Annual Report until such
funds are fully utilized.

The audit committee shall mandatorily review:


a. Quarterly statement of deviation(s) including report of monitoring agency, if applicable, submitted to
stock exchange(s) in terms of Regulation 32(1).
b. Annual statement of funds utilized for purposes other than those stated in the offer
document/prospectus/notice in terms of Regulation 32(7)

CEO and CFO Certification


The following compliance certificate shall be furnished by chief executive officer and chief financial officer
A. They have reviewed financial statements and the cash flow statement for the year and that to the best of
their knowledge and belief:
1. These statements
● do not contain any materially untrue statement or
● omit any material fact or
● contain statements that might be misleading;
2. These statements together
● present a true and fair view of the listed entity's affairs and
● are in compliance with existing accounting standards, applicable laws and regulations.

B. There are, to the best of their knowledge and belief,


● no transactions entered into by the listed entity during the year
➢ which are fraudulent, illegal or violative of the listed entity's code of conduct.

C. They accept responsibility


● for establishing and maintaining internal controls for financial reporting and
● that they have evaluated the effectiveness of internal control systems of the listed entity
pertaining to financial reporting and
● they have disclosed to the auditors and the audit committee, deficiencies in the design
or operation of such internal controls, if any, of which they are aware and
● the steps they have taken or propose to take to rectify these deficiencies.

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Corporate Governance

D. They have indicated to the auditors and the Audit committee


1. significant changes in internal control over financial reporting during the year;
2. significant changes in accounting policies during the year and that the same have been
disclosed in the notes to the financial statements; and
3. Instances of significant fraud involving management or employees with key roles in the internal
control system over financial reporting identified.

In the context of internal controls, the auditor should ensure that


● The management established an internal control framework with respect to financial reporting, which
should be assessed based on documentation of significant processes, risks, and controls.
● He evaluated the control assessment process, ensuring significant deficiencies and corrective actions
are communicated to the Audit Committee and auditors.
● He should check if significant accounting policy and internal control changes are communicated to the
Audit Committee and auditors.
● The auditor should review the Compliance Certificate issuance process adequacy, considering the above
matters and Audit Committee meeting minutes.
● In case of negative/adverse comments or exclusions/disclaimers in the Compliance Certificate, the
auditor should address them in the Audit Report and/or corporate governance compliance certificate.

AUDITORS’ CERTIFICATE
As per Schedule V, a listed entity shall obtain a compliance certificate from either the auditors or practicing
company secretaries regarding compliance of conditions of corporate governance and shall annex it to the
Directors’ Report.

Role of Risk Management Commitee


The role of the Risk Management Committee committee shall, inter alia, include the following
1. Create a detailed risk management policy (RMP) covering:
a. a framework for identifying internal and external risks, (in particular including financial,
operational, sectoral, sustainability (particularly, ESG related risks)
b. measures for risk mitigation, and
c. a business continuity plan.
2. To ensure that appropriate methodology, processes and systems (MPS) are in place to monitor and
evaluate risks associated with the business of the Company;
3. To monitor and oversee implementation of the risk management policy, including evaluating the
adequacy of risk management systems;
4. To periodically review the risk management policy, at least once in two years, including by considering
the changing industry dynamics and evolving complexity;
5. To keep the board of directors informed about the nature and content of its discussions,
recommendations and actions to be taken;
6. Review the appointment, removal, and remuneration of the Chief Risk Officer, and coordinate
activities with other committees when needed, as per the board's framework.

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Audit of Consolidated Financial Statements

Chapter-10 Audit of Consolidated Financial Statements

Basics
● 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.
● Section 129(3) mandates companies with subsidiaries, associates, or joint ventures to prepare
consolidated financial statements in the same form and manner as their own.
● Section 129(4) states that provisions for holding company's financial statement preparation, adoption,
and audit also apply to consolidated financial statements.
● The Board must approve and sign consolidated financial statements alongside standalone statements,
presenting both at the annual general meeting.
● The company must attach a separate statement (Form AOC-1) highlighting the financial statement
features of its subsidiary(ies) to its financial statement.
● Consolidation of financial statements must follow Schedule III of the Act and applicable accounting
standards, but companies exempt from preparing consolidated statements need only comply with
Schedule III provisions.

Requirements related to CFS not applicable


However, the requirement related to preparation of consolidated financial statements shall not apply to a
company if it meets the following conditions:
● A subsidiary doesn't need consolidated financial statements if it's wholly-owned, partially-owned with
no objection from all members after written intimation, and proof of delivery is available.
● 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
● its ultimate or any intermediate holding company files consolidated financial statements with the Registrar
which are in compliance with the applicable Accounting Standards.
● An investment entity need not present CFS if it measures all its subsidiaries at Fair value through P&L
○ Parent of Investment entity shall prepare CFS unless it's also an Investment entity.

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 investors 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.

Parent Ltd acquired 51% shares of Child Ltd during the year ended 31-3-2023. During the financial year
2023-24, 20% shares of Child Ltd were sold by Parent Ltd. Parent Ltd while preparing the financial
statements for the year ended 31-3-2023 and 31-3-20234 did not consider the financial statements of
Child Ltd for consolidation. As a statutory auditor how would you deal with it?

Provisions & Explanation

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Audit of Consolidated Financial Statements

AS 21 states that a subsidiary should be excluded from consolidation when control is temporary due to shares
being held exclusively for their near-future disposal, and should be accounted for according to AS 13
"Accounting for Investments".

✅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 is temporary,
● The auditor should verify that the intention of the parent, to dispose the subsidiary, in the near
future, existed at the time of acquisition of the subsidiary.
● The auditor should also verify that the reasons for exclusion are given in the consolidated financial
statements.

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 31.03.2019
and sold 20% shares during the year ended 31.03.2020. Parent Ltd did not consolidate the financial
statements of Child Ltd for the year ended 31.03.2019 and 31.03.2020.

Temporary Control and Consolidated Financial Statements


- Parent Ltd's control in Child Ltd is temporary, disposed off shares in the next year
- Parent Ltd not required to prepare consolidated financial statement as per AS 21
- Must comply with section 129(3) of Companies Act, 2013 and Schedule III provisions
- If preparing financial statements under Ind AS, Parent Ltd must follow Ind AS 110
- Exemption for 'temporary control' or 'severe long-term funds transfer restrictions' not available under Ind
AS 110
- Consolidation begins when control is obtained and ceases when control is lost (Paragraph 20 of Ind AS 110)

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;
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.

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Audit of Consolidated Financial Statements

Parent's Instructions for Consolidated Financial Statements


- Parent may issue instructions to component's management
- Instructions cover:
- Accounting policies
- Statutory and other disclosure requirements
- Identification and reporting on reportable segments
- Related parties and related party transactions
- Reporting timetable

Auditor's objectives in an audit of consolidated financial statements


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 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.
d. to report on matters given in section 143(3) clauses (a) to (j) 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.

Applicability of SAs etc


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 sufficient to plan the audit and
determine the nature, timing and extent of his audit procedures.
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.

Using Work of Another Auditor in Consolidated Financial Statements


When the principal auditor uses the work of another auditor for consolidated financial statements, it is a
separate assignment other than the audit of component, and the principal auditor must comply with the
requirements of SA 600.

Materiality Considerations in Consolidated Financial Statements Audit


● 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.

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Audit of Consolidated Financial Statements

● The principal auditor also computes materiality for each component and communicates to the
component auditor, if he believes is required for true and fair view on CFS.
● The principal auditor also obtains certain confirmations from component auditor like independence, code
of ethics, certain information required for consolidation and disclosure requirements etc.
● Materiality concept is considered when evaluating component auditor's observations.

Planning the Audit of Consolidated Financial Statements


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 IT related controls also the
controls 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 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.

Ensuring Completeness of Consolidated Financial Statements


● Parent must consolidate components in financial statements, excluding exceptions per relevant
accounting standards.
● Auditors obtain, review, and verify component listings, ensuring inclusion unless exclusion criteria are met.
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 statutory records maintained by the parent, for example registers under the Companies Act,
2013;
g. Identify the changes in the shareholding that might have taken place during the reporting period.

Basic Understanding of Ind AS 103- Business Combination


- Identifiable Net Assets
- Goodwill. (Value > INA)
- Gain from a bargain purchase (Value < INA)
- Non-controlling interest

Permanent Consolidation Adjustments


These adjustments are made on
● the first occasion or
● subsequently when there's a change in the shareholding of an entity which is consolidated. These are:

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Audit of Consolidated Financial Statements

a. Determination of Goodwill or capital reserve as per AS /IndAS


b. Determining equity attributable to Minority / Non-Controlling interest.

Auditor should verify the above calculations.


● Particular attention to determine pre-acquisition reserves of components. The date of investment is
important in this regard.
● Examine pre-acquisition reserves properly allocated between parent & minority/NCI.
● Verify changes in permanent consolidation adjustments on account of subsequent acquisition or
disposal of shares in components.

It may happen, in the case of one subsidiary, its goodwill & in the case of another Capital Reserve, parent may
net off both & show a single amount in the balance sheet as per the Financial Reporting Framework.

Auditor should ensure gross goodwill and capital reserves from subsidiaries are separately disclosed in notes,
per the Financial Reporting Framework

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.
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.
g. Adjust for significant transactions/events
● between component's balance sheet date and auditor's report date for group's consolidated
statements when component's and parent's balance sheet dates differ.
➢ (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.)
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.

Additional Disclosure Requirements for Parent and Consolidated Components


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
1. Amount of net assets and net assets as a percentage of consolidated net assets;
2. Amount of share in profit or loss and the percentage share in profit or loss as a percentage of
consolidated profit or loss;

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Audit of Consolidated Financial Statements

3. Amount in other comprehensive income (OCI) and the percentage of OCI as a percentage of
Consolidated OCI.

MANAGEMENT REPRESENTATIONS
SA 580 mandates obtaining written representations from management and, if needed, those charged with
governance, to ensure the parent's responsibility for accurate consolidated financial statements and their
approval.
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 current period consolidation
adjustments.

Reporting
When the Parent's Auditor is also the Auditor of all its Components
1. Auditor reports on adherence to accounting standards in consolidated financial statements.
2. Auditor considers SA 705 for reporting deviations from AFRF in the audit report.
3. Auditor opines on the true and fair view of the Group's financial position and results.
4. Auditor assesses the true and fair view of consolidated cash flow statements.
When the Parent's Auditor is not the Auditor of all its Components
1. Parent's auditor considers SA 600 when not auditing all components in consolidated financial
statements.
2. SA 706 requires disclosure, if considered necessary by the auditor, of magnitude of audited portion by
other auditors in the audit report.
3. Disclose aggregate amounts or percentages of unaudited (By Parent’s Auditor) assets, revenues, and cash
flows.
4. Present unaudited figures before consolidation adjustments.
5. Reference to other auditors indicates divided responsibility, not a qualification of the opinion.

When the Component (s) Auditor Reports on Financial Statements under an Accounting
Framework Different than that of the Parent.
1. Components in different geographies may use different accounting frameworks than the parent.
2. Parent's management converts components' financial statements for consolidation, with adjustments
audited by the principal auditor.
3. Alternatively Components can use parent's group accounting policies for financial statement
preparation.
4. Local component auditors issue audit reports on financial statements prepared under group accounting
policies.
5. Principal auditor ensures group accounting policies' compliance with parent's GAAP and decides
whether to rely on components' audit reports.

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Audit of Consolidated Financial Statements

When the Component(s) Auditor Reports under an Auditing Framework Different than that of
the Parent
1. Financial statement audits, including consolidated ones, are typically performed under Indian GAAS.
2. Components' financial statements should be audited under a framework corresponding to Indian GAAS
for consistency and parent auditor reliance.

Components Not Audited


1. Audits for components in consolidated financial statements can be performed by either the reporting
auditor or the components' auditor.
2. If some components remain unaudited, the reporting auditor should evaluate potential report
modifications using SA 705 guidance, considering qualitative and quantitative factors.
3. The evaluation is necessary because the auditor has not been able to obtain sufficient appropriate audit
evidence in relation to such consolidated amounts/balances.

Annexure

"Exclusions from Consolidated Financial Statements: Information in Parent and


Subsidiary Notes
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.
1. Source from which bonus shares are issued, e.g., capitalisation of profits or reserves or from securities
premium account.
2. Disclosure of all unutilised monies out of the issue indicating the form in which such unutilised funds
have been invested.
3. Disclosure required under Micro, Small and Medium Enterprises Development Act, 2006.
4. Statement of investments classifies trade and other investments, detailing invested companies' names,
investment nature, and extent.
5. 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.
6. Expenditure in foreign currency during the financial year on account of royalty, know-how, professional
and consultation fees, interest, and other matters.

Things to be reviewed by auditor for verifying adjustment entries


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. Ensure adequate disclosures are made per AS 21 for differing accounting policies when harmonizing is
impracticable.For CFS under Ind AS, auditors must verify adjustments made to group member's
financial statements for conformity with group's accounting policies per Ind AS 110.

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Audit of Consolidated Financial Statements

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
GAP 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.

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Audit of PSU

Chapter-11 Audit of Public Sector Undertaking

Definition of Government Company


Section 2(45) of the Companies Act, 2013, a “Government Company” is a company in which not less than 51% of
the paid-up share capital is held by the Central Government or by any State Government or Governments or
partly by the Central Government and partly by one or more State Governments, and includes a company which
is a subsidiary company of such a Government company.

In India, audit of the above government companies is performed by an independent constitutional authority, i.e.
Comptroller and Auditor General of India (C&AG), through the Indian Audit and Accounts Department.

Special status to the C&AG


The Constitution of India gives a special status to the C&AG and contains provisions to safeguard his
independence.

Article 148
● Appointment of C&AG by President
● Special procedure for removal of C&AG, only on the ground of proven misbehaviors or incapacity.
● Salary and other conditions of service to be determined by the Parliament.

Article 149
● Carry out duties and exercise powers related to Union and State accounts and other authorities or
bodies as prescribed by laws made by Parliament.
● The C&AG's (Duties, Powers and Conditions of Service) Act, 1971 defines these functions and powers in
detail.

Article 150
● On the advice of the C&AG, President to prescribe such form in which accounts of the Union and States
shall be kept.

Article 151
● 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 shall cause them to be laid before
Parliament/State Legislative Assemblies.

Term of C&AG
● 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

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Audit of PSU

Organisations subject to the audit of the 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 Government departments and offices including the Indian Railways and Posts
and Telecommunications.
● Public commercial enterprises controlled by the Union and State governments, i.e. government
companies and corporations.
● Non-commercial autonomous bodies and authorities owned or controlled by the Union or the States.
● Authorities and bodies substantially financed from Union or State revenues.

Audit Board Setup in Commercial Audit


● WHY?
○ Audit Boards are for conducting comprehensive audit appraisals of the working of Public Sector
Enterprises engaged in diverse sectors of the economy.
● Experts
○ Audit Boards associate them with experts in disciplines relevant to the appraisals.
● Discussion on findings and conclusions
○ 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.
● Results in Reports
○ The results of such comprehensive appraisals are incorporated by the Comptroller and Auditor
General in his reports.
● No Separate Legal Entity
○ 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 annual accounts and audit reports by Parliament is challenging due to their specialized
nature and limited time available for discussing national issues.
● 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),

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 svstems and
procedures.

Public Accounts Committee (PAC)


It is the duty of the Public Accounts Committee to satisfy itself:
1. that the moneys were disbursed legally on the service or purpose to which they were applied;
2. that the expenditure incurred was authorised;

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Audit of PSU

3. that re-appropriation has been made in accordance with the provisions made (i.e. distribution of funds).
4. 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 General either under the
directions of the President or by a Statute of Parliament.

Estimates Committee
The Committee examines the estimates with a view to
1. Report any potential cost savings, organizational improvements, increased efficiency, or administrative
reforms that align with the policy supporting the estimates.
2. suggest alternative policies;
3. examine whether the money is well laid out within the limit; and
4. suggest the form in which the estimates shall be presented to Parliament.

The Committee highlights policies that fail to achieve desired results or lead to waste without commenting on
policies approved by Parliament.

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-
1. to examine the reports and accounts of public undertakings.
2. to examine the reports of the C&AG on public undertakings.
3. 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.
4. to exercise such other functions allotted by the Speaker from time to time.

C&AG's Role - 'Friend, philosopher and guide' of the Committees.


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.
1. His Reports generally form the basis of the Committees' working, although they are not precluded from
examining issues not brought out in his Reports;
2. 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;
3. 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;
4. 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 sometimes 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.

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OBJECTIVE AND SCOPE OF PUBLIC ENTERPRISES AUDIT


1. Audit of PSUs not constrained 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 examines adherence to accepted financial propriety principles.
3. Comprehensive Audit - He sees
● whether the undertakings have fulfilled the objectives for which they have been established,
● whether value-for-money spent has been obtained,
4. Organisation's Decision are taken by Competent Authority
● The auditor evaluates management decisions by verifying that they were made by competent
authorities, considering all relevant aspects, information, and alternatives available at the time,
and aligning with the enterprise's aims and objectives.
5. Helping Government
● Enhancing efficiency and effectiveness by identifying financial and operational deficiencies,
system inadequacies, performance shortfalls, and determining the causes of deviation from
acceptable performance standards.
6. Highlighting Issues of Efficient and Economic Operations
● Financial performance connects to physical performance, emphasizing efficient resource
management and operations, with audit increasingly seen as a tool for improvement.
7. Fiscal and Managerial Accountability: In the broader context, Government audit encompasses two main
elements, viz.,
● Fiscal Accountability: It includes audit of provisions of funds, sanctions, compliances and
propriety; and
● Managerial Accountability: It includes audit of efficiency, economy and effectiveness (This is often
referred to as efficiency-cum-performance audit).

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

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Audit of PSU

The Three parties - Auditor, Responsible Party and Intended Users.


1. 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 (CAG) and the Indian Audit and Accounts
Department (IAAD) functioning under him, constitute the Supreme Audit Institution of India
2. Responsible Party
● The relevant responsibilities are determined by constitutional or legislative arrangement.
● Generally, auditable entities and those charged with 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.
3. Intended Users
● Intended users are the individuals, organizations or classes thereof for whom the auditor
prepares the audit report.

Subject matter, criteria and subject matter information.


1. Subiect matter
● This refers to the information, condition or activity that is measured or evaluated against
certain criteria.
2. Criteria
● These are the benchmarks used to evaluate the subject matter.
3. Subject matter information
● This refers to the outcome of evaluating or measuring the subject matter against the criteria.

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, (RP will make financial statements or information to be audited) 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. (Auditor is himself doing the work and making reports for the RP)

Examples
1. Financial audits are always attestation engagements, as they are based on financial information
presented by the responsible party.
2. Performance audits and compliance audits are generally direct reporting engagements.

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.

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Audit of PSU

The principles are categorized into two distinct groups as below


1. General Principles
2. Principles related to the Audit Process

General Principles Principles related to the Audit Process

● Ethics & Independence Planning the Audit


● Professional Judgement, due care and ● Establish the terms of the audit.
skepticism ● obtain understanding of the entity.
● Quality Control ● Conduct Risk assessment of problem analysis.
● Audit Team Management & Skill Audit ● Identify risks of fraud.
Risk ● Develop an audit plan.
● Materiality
● Documentation Conducting the Audit
● Communication ● Perfom the planned audit procedures to obtain
audit evidence.
● Evaluate audit evidence and draw conclusions.

Reporting & Follow-up


● Prepare a report based on the conclusions reached.
● Follow-up on reported matters as relevant.

Steps Involved in Audit of Government Companies - ROLE OF C&AG


The following steps are involved in the audit of government companies:
a. Appointment of Auditors under Section 139(5) and 139(7)

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Audit of PSU

b. 143(5) C&AG may direct manner in which the audit should be conducted

c. 143(6)

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Audit of PSU

d. Test Audit

In the case of government companies, though the appointment of statutory auditors is done by the C&AG, the
remuneration is left to the individual companies to decide based on certain guidelines given by the C&AG in
this regard.

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.

PERFORMANCE AUDIT
A performance audit is an
● Objective, systematic and independent examination
● of the performance of a government organization, program, activity, or function
● in order to provide information

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○ to improve public accountability and


○ facilitate decision-making by parties with responsibility to oversee or initiate corrective action.

Conducted By
● 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.

Promotes Accountability
This audit promotes accountability by assisting
● TCWG 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.

Performance Audits usually address the issues of Economy Effectiveness Efficiency


Performance Audits usually address the issues of Economy Effectiveness Efficiency
● Economy
○ It is minimising the cost of resources used for an activity, having regard to appropriate quantity,
quality and at the best price.
● 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.
○ 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. Optimize resources for timely, quality goods or services production and delivery.
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.
● Effectiveness
○ It is the extent to which obiectives 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. Evaluate if objectives of the policy and means for policy / public sector programs align
b. Determine the extent to which a program achieves a desired level of program results;
c. Determine policy's social and economic impacts through evidence.
d. Identify factors hindering performance or goal achievement.
e. Evaluate program's relationship to other related programs for complementarity or
redundancy.

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Audit of PSU

f. assess the adequacy of the management control system for measuring, monitoring and
reporting a programme's effectiveness;
g. assess compliance with laws and regulations applicable to the program; and
h. determine whether management has considered alternatives for carrying out the
program that might yield desired results more effectively or at a lower cost;
i. identify ways of making proarammes work more effectively.

CASE STUDY (SOURCE : ICAI Study Material www.icai.org)


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.

The Performance Auditor shall also have to


● evaluate the economy, efficiency and effectiveness in the welfare systems to be audited.
● 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.
● point out lacuna, if any in the existing legal frame work or enforcement mechanism to strengthen the
objective of legislation.

Study actual compensation levels required considering local living conditions;

Report discrepancies between statute and required wages for government action.

Planning for Performance Audit


1. Understanding the entity/programme
2. Defining the objectives and the scope of audit
3. Determining audit criteria
4. Deciding audit approach
5. Developing audit questions
6. Assessing audit team skills and whether outside expertise required
7. Preparing Audit Design Matrix
8. Establishing time table and resources
9. Intimation of Audit programme to audit entities

Understanding the entity/programme


It is the starting point for planning individual performance audit. It is done by using
1. Entity documents
● Review documents to understand entity administration, functions, policies, and performance.
2. Legislative documents
● Examine legislative documents, parliamentary materials, and committee reports for insights.

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Audit of PSU

3. Policy documents
● Documents of Planning Commission, Ministry of Finance etc
4. Past audits
● Past financial and performance audits of the entity provide a major source of information and
understanding.
5. Academic/special research
● Review independent evaluations, academic research, and comparable studies by other
governments and SAI.
6. Media coverage
● Print and electronic media - their systematic documentation on regular basis in a transparent
manner.
7. 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.

Defining the Objectives and the Scope of Audit


Define audit objectives for clarity, quality assurance, and consistency in performance audits.

Determining Audit Criteria


Audit criteria are standards to assess program performance for economy, efficiency, and effectiveness.
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.
vi. general management and subject matter literature and research papers.

Deciding the 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 procedures
■ Review systems for planning, conducting, checking, and monitoring activities using
relevant documents.
○ Case studies
■ A case study is a descriptive analysis of an entity, scheme or a programme.
○ Use of the 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.
○ Surverys
■ Surveys: collecting population data to assess events and conditions, supplementing audit
findings and conclusions.

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Audit of PSU

○ Analysis of results
■ it requires the auditor to carry out actual output-input analysis to determine the
efficiency of the programme.
○ Quantitative analysis
■ Examining financials like, revenue, earning etc or implementation data, using sampling
techniques for high-volume data.

Developing audit questions


Create a comprehensive list of questions, with detailed hierarchy, after defining audit objectives and criteria.

Assessing audit team skills and whether outside expertise required


● Ensure auditors have aptitude, training, and proper guidance.
● Develop a sound understanding of the audit subject.
● Determine required expertise during planning, maintaining Accountant Gneeral’s responsibility.

Preparing Audit Design Matrix Establishing time table and resources


● Create Audit Design Matrix for structured audit study.
● ADM highlights data collection, analysis, and evidence sources.
● Well-designed ADM ensures effective audits and high assurance.

Audit Objective Audit Questions Audit Criteria Evidence Data Collection and Analysis Method

Establishing time table and resources


● Determine timetable, resources, and select audit team.
● Monitor progress, ensure timely completion, and address variations.
● Build time for approval, and possible delays.

Intimation of Audit Programme to Audit Entities


● Inform entities about upcoming performance audits, including scope, team, and schedule.
● Refine audit objectives as needed, documenting and approving changes.
● Ensure audit program flexibility and adapt to contingencies.
● Share refinements, findings, and experiences among audit teams.

COMPREHENSIVE AUDIT
A comprehensive audit in the context of Public Sector Undertakings (PSUs) in India refers to a thorough and
holistic examination of a PSU's financial statements, internal controls, management practices, operational
efficiency, and adherence to regulations and policies. This type of audit aims to provide a complete assessment
of the entity's financial health, effectiveness, and compliance with applicable laws and guidelines.

An efficiency-cum-performance audit.Helps in locating the area of weakness and extravagance for


managements’ information.

The areas covered in comprehensive audit vary from enterprise to enterprise depending on the nature of the
enterprise, its objectives and operations. However, in general, the covered areas are those of investment
decisions, project formulation, organisational effectiveness, etc.

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Audit of PSU

Some of the issues examined in comprehensive audit are:


a. overall capital cost of the project
● 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 underutilisation of
installed capacity or shortfall in performance and, if so, what has caused it?
c. Has the planned rate of return been achieved?
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. If the enterprise has an adequate system of repairs and maintenance?
h. Are procedures effective and economical?

PROPRIETY AUDIT
Definition and Principles
Propriety audit stands for
● verification of transactions
○ on the tests of
■ public interest,
■ commonly accepted customs and
■ standards of conduct.
● Instead of too much dependence on documents, vouchers and evidence, it shifts the emphasis to the
substance of transactions.
● 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.

It is hard to frame any precise rules for regulating the course of audit against propriety. However, some general
principles have been laid down, which have for long been recognised as standards of financial propriety.
These principles are:
1. 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;
2. that the authority exercises its power of sanctioning expenditure to pass an order which will not directly
or indirectly accrue to its own advantage;
3. that funds are not utilised for the benefit of a particular person or group of persons and
4. that, apart from the agreed remuneration or reward, no other avenue is kept open to indirectly benefit
the management personnel, employees and others.

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Audit of PSU

Relevant Provisions in the Companies Act, 2013


1. Section 143(1) requiring enquiry into certain specified matters.
2. Section 143(6) and 143(7) requiring a supplementary audit and test audit respectively in respect of the
Government companies on matters specified.
3. Section 148 relating to Cost Records and Audit.
4. Additional information in Part Il of Schedule III.

Propriety Elements under CARO, 2020


Relevant clauses - (iii), (iv), (viii), (ix), (x), (xi), (xiii), (xv), (xviii)

Propriety Audit-Problems
1. Propriety audit's distinct nature makes formulating verifiable auditing propositions challenging.
2. Norms of propriety differ between government and private sector transactions.
3. Propriety audit propositions can be built if entities formulate their propriety norms.
4. Propriety evaluation involves considering objectives and circumstances, like travel choices.
5. Auditors must objectively judge commercial decisions in the context they were made.

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.
● Compliance audit is concerned with:
○ Regularity- adherence of the subject matter to the formal criteria emanating from relevant laws,
regulations and agreements applicable to the entity.
○ Propriety- observance of the general principles governing sound financial management and the
ethical conduct of public officials.
Compliance auditing is generally conducted either-
1. in relation with the audit of financial statements,
2. or separately as individual compliance audits,
3. or in combination with performance auditing.

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;
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.

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Audit of NBFC

Chapter-12 Audit of Non-Banking Financial Companies

Definition of NBFC
● A financial institution which is a company;
● 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;
● 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."

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.

Differences 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:
● NBFC cannot accept demand deposits, however some NBFCs can accept Term Deposits;
● NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on
itself;
● deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation (DICGC) is not
available to depositors of NBFCs, unlike in case of banks.
● No Minimum Exposure to Priority Sector required by NBFCs.

Registration and Regulation of NBFC


Under Section 45–IA of the Reserve Bank of India (Amendment) Act, 1997, 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.
● having a net owned fund (NOF) of ₹ 2 Crore.

A company incorporated under the Companies Act and desirous of commencing business of nonbanking
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.

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. (Core investment companies are
NBFCs that invest in shares for the purpose of owning a stake in a company, rather than for trading.)

Categorisation of NBFCs
NBFCs registered with RBI are categorized as follows
a. Deposit Accepting and Non-Deposit accepting NBFCs;

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Audit of NBFC

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, For example)
i. Infrastructure Finance Company (IFC)
ii. NBFC- Non - Operative Financial Holding Company (NOFHC)
iii. Non-Banking Financial Company-Micro Finance Institution (NBFC-MFI)

All NBFCs are either deposit taking or non-deposit taking. If they are non-deposit taking, ND is suffixed to
their name (NBFC-ND).

All NBFCs - ND with an asset size of Rs. 500 crore and more as per the last audited balance sheet will be considered as a systemically
important NBFC-ND (NBFC-ND-SI).

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 Companies 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
● Micro Finance Companies
● Securitisation and Reconstruction Companies
● Mutual Benefit Companies
● Mortgage Guarantee Companies
● Core Investment Companies which is not a Systemically Important Core Investment Company,
● Alternative Investment Fund (AIF) Companies.

Capital Requirements
● Capital Adequacy Ratio - Ratio of capital in relation to its risk weighted assets.
● Every applicable NBFC 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, at any point of time, shall not be less than 10%..
● 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 %.

Risk Weight “0” - ZERO Percentage Weight


1. Cash and bank balances including fixed deposits and certificates of deposits with banks
2. Approved securities

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Audit of NBFC

3. Loans and advances fully secured against deposits held.


4. Loans to staff
5. Income tax deducted at source (net of provision)
6. Advance tax (net of provision)
7. Interest due on Govt security
8. Fund based claims on CG
9. Direct loan / credit / overdraft exposure and investment in State Government securities
10. CG Guaranted claims

Risk Weight 20% - Twenty Percentage Weight


1. Bonds of public sector banks
2. State Government guaranteed claims, which have not remained in default / which are in default for a
period not more than 90 days.

Risk Weight - 100% - Others

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 nonperforming and remaining unrealised shall be
reversed.

Asset Classification and Provisioning


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:

1. Standard assets;
2. Sub-standard assets;
3. Doubtful assets; and
4. Loss assets.

● 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.
● 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 provisioning requirements as given shall apply to every applicable NBFC (except NBFC-MFIs):

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Audit of NBFC

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Audit of NBFC

AUDIT PROCEDURES
The following are the necessary steps involved
Ascertaining the Business of the Company
● The audit of a NBFC starts with reviewing its Memorandum and Articles of Association.
● Auditors should understand the company's main business activities through studying its business policy.
● Verifying the company's principal business activity is crucial for its classification as a NBFC.
● The company's classification impacts compliance with NBFC Public Deposit Directions.

Evaluation of Internal Control System


● The management's duty includes maintaining an adequate accounting system and internal controls.
● An auditor should understand the accounting system and related internal controls of the NBFC.
● The auditor should evaluate the effectiveness of the NBFC's recovery system.
● Ascertain whether the NBFC has an effective system of periodical review of advances in place which
would facilitate effective monitoring and follow up.
● Absence of a review system can lead to a high level of NPAs in the NBFC.

Registration with the RBI and NOF Requirement


● All NBFCs must register with RBI and maintain a minimum of ₹ 2 crore in net owned funds (NOF).
● Auditors must obtain the NBFC's RBI registration certificate or the filed application form.
● Auditors must verify the NBFC's compliance with RBI registration and minimum NOF maintenance.
● NBFCs holding public deposits must invest a specified percentage in liquid assets as per RBI's directive.
● To ensure compliance, RBI requires quarterly investment reports from these companies.
● The quarterly return must be signed by an NBFC official and submitted within a specified timeframe.
● The auditor must confirm the NBFC's investment in liquid assets and regular submission of quarterly
returns to the RBI.

NBFC Acceptance of Public Deposit Directions (Non-Banking Financial Companies


Acceptance of Public Deposits (Reserve Bank) Directions, 2016)
1. Check whether NBFC is properly classified. Auditors assess NBFC's classification under RBI
regulations.If unclassified, determine it based on multiple factors. Post-classification, compliance with
public deposit rules is checked
2. Ceiling on quantum of public deposits An auditor should verify the NBFC's credit rating and ensure the
amount of public deposits held aligns with it. Obtain a copy of the credit rating assigned to NBFC. If the
NBFC's credit rating changes, the amount of public deposits must also adjust accordingly, and the RBI
must be informed.If a NBFC's credit rating drops below a certain level, it must take immediate action.
a. It must stop accepting new deposits and renewing existing ones.
b. Existing deposits continue until their maturity date.
c. The NBFC must also report these changes to the RBI within 15 days.
d. Additionally, if a deposit matures, it can only be renewed with the explicit and voluntary consent
of the depositor.
3. Test check the interest and other calculations such as brokerage to ascertain that the NBFC has not paid
in excess as required.
4. 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 containing all the required fields.
5. Ensure the NBFC's deposit register is accurate and payments are timely, noting any delays or defaults.

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Audit of NBFC

6. Confirm if the NBFC's investments in approved liquid assets are safely stored with a scheduled bank, as
per RBI's directions.
7. Check whether the NBFC has filed its prescribed returns in a timely manner.
8. Verify if NBFCs not accepting public deposits have a board resolution confirming they won't accept any
such deposits during the year.

NBFC Prudential Norms -


1. Verify if the NBFC is complying with prudential norms including income recognition, investment
accounting, asset classification, and credit concentration.
2. Ensure NBFCs granting demand/call loans have a board-approved policy in place
3. An auditor should verify NBFC's compliance with norms of creating provision on loans and advances.
4. Auditor should ensure that income from NPAs is recognised on realisation, not accrual basis.
5. Ensure NPAs from previous year still qualify as such or have become regular, adhering to the Directions.

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.
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, 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.

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
1. 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.

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Audit of NBFC

2. 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.
3. Physically verify all shares & securities held by NBFC. Verify certificate from bank/institution where
securities are kept.
4. Verify whether the NBFC has not advanced any loans against the security of its own shares.
5. Check if investments valued as per NBFC Prudential Norms & adequate provision for fall in market value
made as per Directions.
6. Verify Board Minutes for purchase/sale of investments. Ascertain if acquired investments are
current/long-term investments via resolution or management certificate.
7. Check NBFC's loan & advance classification (including bills purchased & discounted) into standard,
sub-standard, doubtful & loss assets.
8. Verify adequacy of provision for bad & doubtful debts as per NBFC Prudential Norms.
9. Obtain balance confirmations from the concerned parties.
10. 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.
11. Verify Board Minutes for purchase/sale of investments. Ascertain if acquired investments are
current/long-term investments via resolution or management certificate.
12. Auditor to verify security obtained & agreements made with parties for advances. Ascertain security
nature & value and borrower/guarantor's net worth to determine extent of realisability.

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)

AUDITOR’S DUTY to Report to Board of Directors under RBI Directions


Separate report to BOD
In addition to the Report made by the auditor under Section 143 of the Companies Act, 2013 on the accounts of
a non-banking financial company examined for every financial year the auditor shall also make a separate
report to the Board of Directors of the Company on the matters specified

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-

In the case of all non-banking financial companies:


1. The auditor shall examine whether the company has obtained a Certificate of Registration (CoR) from
the RBI.
2. 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.
3. Whether the non-banking financial company is meeting the required net owned fund requirement.

Ensure NBFC submits auditor's certificate confirming its business and eligibility to hold a Certificate of
Registration by December 30th annually.

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Audit of NBFC

In the case of a non-banking financial companies accepting/holding public deposits


1. Whether public deposits and other borrowings of the NBFC, including unsecured non-convertible
debentures/bonds and shareholder loans, comply with the limits set by the Reserve Bank Directions.
2. Whether excess public deposits held by the NBFC are regularised as per the Reserve Bank Directions.
3. Confirm if the disclosed capital adequacy ratio is correctly determined and compliant with the minimum
CRAR (capital-to-risk weighted assets ratio) as per Reserve Bank Directions.
4. Whether there is any violations of public deposit acceptance rules per NBFC Acceptance of Public
Deposits Directions, 2016.
5. 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;
6. 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.
7. Whether the company has complied with the liquid assets requirement as prescribed by the Bank in
exercise
8. 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;
9. 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;
10. 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.

In the case of a non-banking financial company not accepting public deposits


1. Whether the Board of Directors has passed a resolution for non-acceptance of any public deposits;
2. Whether the company has accepted any public deposits during the relevant period/year;
3. 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;
4. In respect of Systemically Important Non-deposit taking NBFCs (NBFC NDSI)

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Audit of NBFC

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.
5. Whether the NBFC is correctly classified as an NBFC-MFI (Micro Finance Institution) per Reserve
Bank's Directions.

In the case of a company engaged in the business of non-banking financial institution not
required to hold CoR subiect to certain conditions
Ensure that a company, advised not to hold CoR by RBI, is complying with stipulated conditions.

Reasons to be stated for unfavourable or qualified statements


In case of an unfavourable or qualified statement in the auditor's report, reasons must be provided; if an opinion
cannot be formed on any item, this fact and the reasons must be stated.

Obligation of auditor to submit an exception report to the RBI


Where, in the case of a non-banking financial company, the statement regarding any of the items referred to
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
(NBFC APD RBD, 2016)
c.
i. Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company
(Reserve Bank) Directions, 2016 and (NBFC NSI ND)

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Audit of NBFC

ii. Non-Banking Financial Company - Systemically Important Non-Deposit taking Company and
Deposit taking Company (Reserve Bank) Directions, 2016. (NBFC SI ND and DT)

The auditor is obliged to report any unfavourable or qualified statements and non-compliances to the relevant
Regional Office of the RBI's Department of Non-Banking Supervision, where the company's registered office is
located.

The auditor's duty is to report only violations of the RBI Act, 1934, and related Directions, Guidelines,
instructions, without stating compliance with these provisions.

Applicability of Indian Accounting Standards (Ind AS) on NBFCs


NBFCs must comply with Indian Accounting Standards (Ind AS) per the Companies (Indian Accounting
Standards) Rules, 2015 and its 2016 amendment:
1. From 1 April 2018: Listed/unlisted NBFCs with net worth of ₹500 crore or more, including their
holding, subsidiary, joint venture, or associate companies.
2. From 1 April 2019: All other listed NBFCs, unlisted NBFCs with a net worth of ₹250 crore or more but
less than ₹500 crore, and their related entities.
Net worth is calculated based on standalone financial statements as on 31st March 2016 or the first audited
financial statements ending after that date.

Differences 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.
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 disclosed
in the notes as stipulated by the relevant statute.

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Audit of NBFC

Compliance with CARO 2020


Paragraph 3(iii)
a. 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
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 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)]

Paragraph 3(xvi)
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)]

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Audit of Insurance Companies

Chapter-13 Audit of Insurance Companies


Basics
● Insurance is a contract between an insurer and an insured, where the insurer agrees to pay a sum of
money to the insured if an uncertain event happens.
● The insurer is the party that bears the risk, and the insured is the party whose risk is covered.
● Insurance contracts are of two types: indemnity and benefit. Indemnity contracts reimburse the insured
for the actual cost of the loss, while benefit contracts pay a fixed amount.

EXAMPLES
1. Sum assured in a life insurance is a benefit contract as the value of loss of life cannot be computed but
is a lumpsum amount.
2. Health insurance contract which re-imburses for the actual hospital bills (re-imbursement contract) but
instead of pre-imbursing the actual cost, if the insurance company pays a lumpsum amount of ₹ 500 per
day of hospitalization, then that contract is a benefit contract.

Distinction between Life Insurance and General Insurance


Life Insurance General Insurance

Life Insurance can be seen as an investment General Insurance, mostly, doesn’t give any maturity
apart from insurance as it offers maturity benefits but promises payout in case of loss due to
benefits after specific tenures unavoidable circumstances

Term may be fixed or variable Term is fixed (usually 1 year).

Pay-outs are certain either as claims or maturity Pay-outs are uncertain as claims may or may not arise.
benefits

Multi-purpose (e.g. investment, tax benefits, Solely for the purpose of insurance.
insurance).

LEGAL FRAMEWORK
● The Regulator for Insurance Companies is Insurance Regulatory & Development Authority of India
(IRDAI).
● Insurance auditors must be familiar with the insurance industry's regulations and the IRDAI's rules and
regulations.
● Various aspects relating to audit are dealt with around the framework of the following statutes and
rules made thereunder:
○ The Insurance Act, 1938 as amended by the Insurance Laws (Amendment) Act, 2015 (including
Insurance Rules, 1939);
○ The Insurance Regulatory and Development Authority Act, 1999 as amended by the Insurance
Laws (Amendment) Act, 2015;
○ The Insurance Regulatory and Development Authority Regulations framed under the IRDA,
Act, 1999;
○ The Companies Act, 2013; and
○ IRDA Investment Regulations, 2013 (as amended from time to time).

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Audit of Insurance Companies

○ IRDAI Preparation of Financial Statements and Auditors Report Regulations 2000.


○ Various regulations/guidelines/notifications issued by IRDAI from time to time.

Relevant statutory provisions


Insurer
Section 2(9) of the Insurance Act, 1938 defines the term ‘Insurer’ as:
a. an Indian Insurance Company, or
b. a statutory body established by an Act of Parliament to carry on insurance business, or
c. an insurance co-operative society, or
d. a foreign company engaged in re-insurance business through a branch established in India.

Policy Holder
Section 2(2) of the Insurance Act, 1938 defines the term policy holder as a person to whom the whole of the
interest of the policy holder in the policy is assigned once and for all, but does not include an assignee thereof
whose interest in the policy is defensible or is for the time being subject to any condition.

Prohibition of Insurance Business by Certain Persons


Third proviso to section 2C(1) of the Insurance Act, 1938 (inserted by the IRDA Act, 1999) prohibits persons
other than an Indian insurance company to begin to transact the insurance business after the commencement
of the IRDA Act, 1999.

Assuming risk without receipt of funds.


An insurer cannot take on any risk related to insurance business where the premium is usually paid within
India unless certain conditions are met.
Those conditions are:
1. The premium payable has been received by the insurer.
2. The premium payable is guaranteed to be paid by a designated person in a prescribed manner and within a
prescribed timeframe.
3. A deposit of a specified amount has been made in advance in a prescribed manner.
In the case of risks for which premium can be ascertained in advance, the risk may be assumed not earlier than
the date on which the premium has been paid in cash or by cheque to the insurer.

Registration of Indian Insurance Companies


1. Section 3 of the Insurance Act, 1938 mandates insurers to obtain a registration certificate before
starting operations in India.
2. An Indian insurance company is one where foreign investors, hold less than forty-nine percent of the
paid-up equity capital.
3. The amendment allows foreign insurance companies to participate in reinsurance through an Indian
branch.
4. The term “re-insurance” means the “insurance of part of one insurer's risk by another insurer who accepts
the risk for a mutually acceptable premium”.

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Audit of Insurance Companies

Requirements as to the Minimum Paid-up Capital and Minimum Solvency Ratio


● The minimum paid-up equity share capital of an Indian insurance company carrying on insurance
business should be ₹ 100 crores excluding preliminary expenses incurred in the formation and
registration of company.
● As per the IRDAI’s mandate, the minimum solvency ratio insurance companies must maintain is 1.5 to
lower risks. In terms of solvency margin, the required value is 150%.
● Solvency Ratio is the excess of assets over liabilities of an Insurance Company.
● Higher the solvency ratio, stronger will be the financial capability of the company to deal with any surge
in claims.
● If, at any time, an insurer or re-insurer does not maintain the required level of solvency margin, he is
required to submit a financial plan to the Authority indicating the plan of action to correct the
deficiency.
● If, on consideration of the plan, the Authority finds it inadequate, the insurer has to modify the
financial plan.
● If an insurer or re-insurer fails to comply with the prescribed requirement of maintaining excess of
value of assets over amount of liabilities, it shall deemed to be insolvent and may be wound up by the
Court on an application made by the authority.
● The Insurance Act requires every insurer to furnish a statement of his assets and liabilities
○ Every Insurer is required to prepare a statement of value of assets in “Form IRDA-Assets-AA.”
○ A statement of the amount of liabilities in case of general insurance business is to be prepared
in “Form HG” and
○ A statement of Solvency Margin in “Form KG”
○ The statement of assets, liabilities and solvency margin are to be certified by an auditor and
filed by the insurance company with the Authority along with the audited accounts and
statements.

Form And Contents Of Financial Statements


Every insurer, in respect of insurance business transacted and in respect of shareholder’s funds, is required to
prepare
● a Balance Sheet,
● a Profit and Loss Account,
● a separate Account of Receipts and Payments,
● a Revenue Account for each year in accordance with the Regulations as may be specified.
● Separate accounts relating to funds of shareholders and policyholders.

Regulations are issued for the preparation of the financial statements and auditor’s report of companies
carrying on insurance business. The Regulations contain three schedules.
● Schedule A is applicable to companies carrying on Life Insurance business.
● Schedule B is applicable to Companies carrying on General Insurance business.
● Schedule C to the Regulations lays down the matters to be dealt with by the auditor’s report of an
insurance company. Schedule C is applicable to insurers carrying on general insurance business as well
as life insurance business.

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Audit of Insurance Companies

Audit Of Accounts
● Under section 12 of the Insurance Act, 1938, the financial statements of every insurer are required to be
audited annually by an auditor.
● Section 2(4) of the Insurance Act, 1938 defines the term ‘auditor’ as a person qualified under the
Chartered Accountants Act, 1949 to act as an auditor of a company.
● The auditor, auditing financial statements, holds rights, duties, liabilities, and faces penalties as per
Companies Act, 2013.
● The provisions of section 12 of the Insurance Act, 1938 apply only in a case where the financial
statements of the insurer are not subject to audit under the Companies Act, 2013.

Appointment of Auditors
● The Comptroller and Auditor General of India appoints statutory auditors for General Insurance
Corporation and its subsidiaries, like other public sector insurance companies. (For example, in the case
of New India Assurance Company Ltd., United India Insurance Company Ltd.).
● However, in the case of others, auditor is appointed at the AGM after ensuring that the auditor satisfies
the compliance requirements with the relevant sections of the IRDAI Guidelines on Corporate
Governance.
● These guidelines pose certain restrictions on the number of insurance companies a statutory auditor
can audit.
● Currently, an auditor can conduct audit only for 3 insurance companies and not more than 2 life or 2
general.
● The Guidelines also mandate a mandatory joint audit for all insurance companies.

Remuneration of Auditors
The remuneration of auditor of an insurance company is to be fixed in accordance with the provisions of
section 142 of the Companies Act, 2013 in the general meeting or in such a manner as the company in general
meeting may determine.

Rights and duties of Branch Auditors


1. Public sector insurance companies' divisional offices prepare trial balances for financial statements.
2. Divisions are audited and treated as branches under the Companies Act, 2013.
3. Branch auditors have the same rights and obligations as statutory auditors.
4. Private companies centralize accounting, preparing accounts at the Head office.

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Audit of Insurance Companies

Direction of C&AG

Applicability of CARO, 2020


The additional reporting requirement under Companies (Auditor’s Report) Order, 2020 is exempted for an
insurance company as defined under the Insurance Act, 1938.

REQUIREMENTS OF THE INSURANCE ACT, 1938 VIS A VIS THE


COMPANIES ACT, 2013
1. Insurance companies also need to make disclosures under the Companies Act, 2013.
2. Insurance companies' financial statements are valid even if they don't disclose non-required details by
the Insurance Act, 1938. In simpler terms, it means that an insurance company's financial reports are
considered to be providing a "true and fair view" even if they omit certain details, as long as those
details are not required to be disclosed by the insurance-specific laws.
3. Companies Act, 2013 applies to insurance companies, unless it conflicts with the Insurance Act, 1938 or
IRDA Act, 1999.

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Audit of Insurance Companies

AUDITING IN AN INFORMATION TECHNOLOGY ENVIRONMENT


1. The Information Technology environment does not materially affect the scope and objectives of an
audit.
2. Auditors need to familiarize with the IT environment and understand transaction workflows in
insurance companies.
3. The auditor may select a few transactions of each type and trace them through the system, i.e., identify
the audit trail.
4. By tracing transactions through the system, auditors can understand transaction flow and verify
processing results.
5. Auditors should get management's written confirmation on IT system changes and review each system's
efficacy separately.

TAX AUDIT
● It is necessary for every insurance companies to get their accounts audited under Section 44 AB of the
Income-tax Act, 1961.
● For this purpose, the tax auditor(s) may be appointed by the company itself by means of a resolution of
the Board of Directors or by the Chairman/ Managing Directors if so authorised in this behalf.
● The company is expected to fix separate remuneration for the auditor(s) appointed for this purpose.
● The Form of tax audit report applicable would be Form 3CB and the prescribed particulars would have
to be given in Form 3CD, in accordance with Rule 6G of the Income Tax Rules, 1962, pursuant to
Section 44AB of the Income Tax Act, 1961.
● Prescribed audit forms under Section 44AB
○ Form 3CA
■ In respect of a taxpayer carrying on a business or profession and who is already
mandated to get his accounts audited under any other law (ie. law other than income tax
law).
○ Form 3CB
■ In respect of a taxpayer carrying on a business or profession but who is not required to
get his accounts audited under any other law. A proprietorship entity or partnership
firm, having a turnover of more than 1 crore and not opting for presumptive income
scheme, is not required to get its accounts audited under any other law except income
tax. So, it will furnish Form 3CB.
○ Along with either of the forms mentioned above, the tax auditor shall also furnish Form 3CD
which forms part of the audit report and contains the prescribed particulars.

Types of Life Insurance Products


Term / Protection
Term life Insurance is traditional form of Life Insurance Product. Term Insurance generally takes care of pure
income replacement needs rather than Capital appreciation requirements. Term Insurance covers the policy
holder for specific period and pays the death benefits only if the policy holder dies during the policy period.

Endowment/ Pure Endowment


Endowment policies cover the risk for a specified period and at the end of the policy the sum assured is paid back
to the policyholder along with all bonus accumulated during the policy term.

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Audit of Insurance Companies

Money Back Plan


Money Back policies are type of Endowment policies which provides periodic payments of partial benefits
during the term of policy so long as the policy holder is alive. Peculiar nature of these policies is that, in event
of death at any time during policy term, the death claim would comprise of full sum assured without deduction of
any survival benefit amounts. Also, bonus is calculated on sum assured.

Whole Life Insurance Product


It provides cover through out the life time of the person. Unlike Endowment plans they do not carry any maturity
value and sum assured is paid to the family in case of unfortunate death of the policyholder.

Unit Linked Insurance Plan (ULIP)


Unit Linked Insurance Plans are such Insurance plans where the value of the policy changes as per the
underlying Investment Assets. It allows protection and flexibility in Investment. The Premium paid is used for the
purchase of units in Investment assets.

Pension or Retirement Plans


A pension plan is retirement solution where policyholder decides the retirement age and agrees to pay premium
till the time of the retirement and thereafter he has option to commute the a part of his fund value and take an
annuity for the balance. Pension plan provides Income protection as well as the Life Cover.

Annuities
Annuity is a contract where Insurer in return for the payment at regular intervals till fixed date make series of
agreed payments at regular intervals from fixed date.

Group Insurance
Group Insurance is an insurance that covers a group of people, who are the members of the societies, employees
of an organisation or professionals in common group.

Audit of Accounts of Life Insurance Companies


Actuarial Process
The job of actuary or actuarial department in any Life Insurance Company involves, detailed analysis of data to
quantify risk. The actuarial department is calculating and modelling hub of the Company. Within the department
fundamentals of Insurance business is determined from pricing to policy valuations techniques.

Role of Auditor
● Auditors in the Audit report are required to certify, whether the actuarial valuation of liabilities is duly
certified by the appointed actuary, including to the effect that the assumptions for such valuation are in
accordance with the guidelines and norms, if any, issued by the authority and/or the Actuarial Society of
India in concurrence with the IRDA.
● Auditors generally rely on the Certificate issued by the Appointed Actuary, certifying the Policy
liabilities. However, Auditor may discuss with the Actuaries with respect to process followed and
assumptions made by him before certifying the Policy liabilities.

Actuarial department broadly concentrates following key areas of Insurance business:


● Product Development/ Pricing analysis

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Audit of Insurance Companies

● Model Development.
● Statutory Valuations and reserving.
● Business Planning.
● Solvency management.
● Management reporting on various business valuations and profitability models of the Life Insurance
business.

Underwriting
Meaning
● The process of verifying the level of risk in each new entrant is called ‘selection’ or ‘underwriting’.
● The underwriter assesses the risk and determines the premium to be charged.
● The underwriting process is therefore a balance between accepting enough risk to make a profit, but not
so much that it endangers the insurance company's financial stability.

Role of Auditor.
● While verifying the process of underwriting, the objective of the Audit should be to review the process of
acceptance of risk through the underwriting process, and evaluate and test the effectiveness of internal
controls in place to ensure timely and accurate Insurance policy, adherence to the IRDA Act and Rules
and regulations made thereunder.

Reinsurance
● Reinsurance is a risk mitigating tool adopted by Insurer whereby the risk underwritten by one Insurer is
transferred partially to another Insurer.

Role of Auditor
● The primary objective of the audit should be to check and confirm that reinsurance premium calculation
and payment is in accordance with the agreement with the reinsurer.
● Necessary provision has been made for outstanding reinsurance premium and is properly accounted for in
books of accounts under respective heads.

The audit in this regard would normally cover the followings areas of the reinsurance:
● Verification of agreements entered with the reinsurer.
● Updating/ renewals of agreements and verifying whether Insurer has adhered to the terms and
conditions of the agreement.
● Verification of payments made to the reinsurer and verifying whether adequate provisions are carried out
in books.

Free Look Cancellation (FLC)


Policyholders' Rights and Refunds as per IRDA Regulations
● Under clause 6(2) of IRDA (Protection of Policyholders Interest) Regulations, 2002:
● The insurer is obligated to inform the policyholder of a 15-day review period upon receipt of the policy
document.
● This period allows the policyholder to review the terms and conditions of the policy.
● Should the policyholder disagree with any terms or conditions, they have the right to return the policy,
stating the reasons for their objections.
● In such a case, the policyholder is entitled to a refund of the premium paid.

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Audit of Insurance Companies

● The refund is subject to deductions, which include a proportionate risk premium for the coverage period
and the expenses incurred by the insurer on medical examination of the proposer and stamp duty
charges.
● FLC requests can be received through any mode e-mail, fax and letters depending on insurer’s policy. In
case of written letters, the signature of the policy holder should be matched with the original proposal
form.
● FLC refund is paid either by cheque or in case the policy holder wants direct credit, then consent for
direct credit along with cancelled cheque for bank account details is submitted.

Role of Auditor
The primary objective of the audit is to check and confirm that FLC requests are received within 15 days from
receipt of policy document by the policy holder, verification of signatures of the policy holder and processing of
FLC request within TAT defined by the insurer. Also checking of appropriate accounting entries are recorded for
refund.

Policy Lapse and Revival


Policy Lapse Definition
"Lapse" refers to a policy discontinuation due to nonpayment of premium dues. As per section 113(2) of the
Insurance Act,1938, a policy with a surrender value should remain active to the extent of the paid-up sum
assured.

Policy Maintenance
To keep a life insurance policy "in force," policyholders need to pay premiums on time. If a payment is missed,
a 15/30 days "grace period" is provided to make the payment, failing which the policy lapses.

Effects of Lapsation
Lapsation impacts all stakeholders: policyholders, agents, and insurers. A lapsed policy ceases to provide
protection, forfeits the benefits, and costs more to renew. Agents lose renewal premium commission on lapsed
policies.

Policy Revival
The policy's terms allow for its revival during the policyholder's lifetime if the premium isn't paid within the
grace period. Some insurers may not allow revival if the policy has been lapsed for over five years due to potential
hefty premium arrears.

Insurer's Responsibility
Insurers should monitor renewal premium receipt within due dates. Most insurers track policy lapsation over
the Policy Management System (PMS), which monitors premium due dates once the policy data is input.

Auditor's Role
The audit's main objective is to ensure due dates are properly recorded and monitored, policies are marked
"lapsed" upon non-receipt of renewal premium, and that sufficient checks and documents are in place for policy
revival.

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Audit of Insurance Companies

Policy Surrender
● Definition of Policy Surrender - Surrendering an insurance policy refers to voluntarily ending the
insurance contract before its term expires.
● Initiation of Surrender - The process of surrender is initiated by the policy holder.
● Eligibility for Surrender - A policy becomes eligible for surrender after 3 years from its start, given that
3 years' premium has been paid within due dates.
● Process for Surrender - The policy holder must submit a surrender request form, the original policy
document, and a discharge voucher at the branch or processing center.
● Condition for Surrender - The policy can be surrendered only when the insured person is alive.

Role of Auditor
The primary objective of the audit is to check and confirm that surrender requests are received from the policy
holder only, and that adequate controls are in place to ensure proper verification process for checking the
authenticity and validity of request. Check whether surrender amount is paid only to the policy holder and is
paid only as per terms and conditions mentioned in the policy document and appropriate accounting entries are
passed.

Premium Collection, Accounting and reconciliation


Recognising the premium income
● Premium accounting refers to recognizing the premium earned by the insurer as income in the
accounting system.
● Income is recognized as:
1. New business premium – premium received for the first policy year and
2. Renewal premium – premium received for subsequent policy years.
● Premium received but not identifiable against any policy would be treated as ‘unallocated premium’/
‘suspense amount’
● Further following points should be noted while recognizing the premium:
1. When the new policy is issued by the Insurer, new business premium is recognised on the
realisation of premium. Generally, Policy is underwritten only after the receipt of the first
premium. However, in certain cases, policies are issued awaiting realisation of premiums, for
e.g. policies are issued subject to realisation of cheques issued by the Insured. Auditors are
required to check these cases and ensure proper accounting of the same.
2. Renewal income is recognized
a. on realization of the premium amount or
b. when premium is due but not received up to the end of grace period.
3. Auditors should also evaluate various sub-processes, employed by the Insurance Companies in
accounting of premiums like collection of premium from the policy holders, booking of
premium, banking, accounting and reconciliation of the same.

Audit of Premium Income


Following are the certain illustrative points, Auditors are required to follow during the Audit of Accounting of
Premiums

Collection of Premium
● The premium collections are credited to separate bank account and no withdrawals are normally
permitted from that account for meeting general expenditure.

Neeraj Arora 13.10


Audit of Insurance Companies

● Check whether there is daily reconciliation process to reconcile the amounts collected, entered into the
system and deposited into the bank.
● Check that there is appropriate mechanism to ensure all the collections are deposited into the Bank on
timely basis.

Calculation of Premium
● Check that Accounting system, employed by the Company, calculates premium amounts and its
respective due dates correctly.

Recognition of Income
● Check that premium is recognised only on the basis of ‘Issued Policies’ and not on underwriting dates.
● Check that there is inbuilt mechanism the system all the premium collected are correctly allocated all
various components of the Policies.

Accounting of ‘Advance Premium’


● Check, whether system has capability to identify regular and advance premium.
● Check whether there is a process of applying advance premium to a contract when premium is due.

Reporting of Premium figures to IRDA/ Management


● Check the methodology for generation of MIS from the system and there is no manual intervention.
● Check the procedure for Maker/ Checker before finalising the MIS.
● Check whether there is a reconciliation process between premium Income as per financials and as
reported.

Other Areas
● Check whether there are appropriate SOPs developed by the Companies and are strictly followed by all
the departments/ branches of the Company.
● Ensure duly approved Delegation of Authority parameters matrix already in place for authorisation
limits.
● Premium recognition and refund of premium are independent processes with adequate segregation of
duties amongst the personnel.
● Check that the Company conducts premium reconciliation on daily basis.
● Check the robustness of interface between administration and accounting system.
● Auditors may also refer to IRDA (Preparation of Financial Statements & Auditors Report of Insurance
Companies) Regulations, 2000 for premium accounting.

Auditors should evaluate various sub-processes, employed by the Insurance Companies in accounting of
premiums like collection of premium from the policy holders, booking of premium, banking, accounting and
reconciliation of the same. In view of above, you are required to briefly discuss some illustrative points,
auditors are required to follow during the Audit of Accounting of Premiums in case of Life Insurance
Companies
(RTP, Nov 2018, NA)

OR

Neeraj Arora 13.11


Audit of Insurance Companies

What are the steps to be taken while verifying the Premium of Life Insurance Company?
(ICAI Study Mat)

Claims
Checking of accuracy of processing and accounting of claims lodged with the Insurer, is the primary objective of
Audit of Life Insurance Companies.

Claims payouts in insurance companies would include:


● - Death Claims
● - Maturity Claims
● - Health Claims
● - Rider Claims
● - Policy Claims
● - Annuities
● - Survival Claims
● - Surrenders benefits.

Following are the certain illustrative points, Auditors are required to follow during the Audit of Claims
1. Auditor should review the standard policy document template to ensure that the policy document
prescribes the minimum documentary evidence needed to support a claim.
2. Ensure that the Insurer maintains a register or record of claims, in which every claim is entered along
with the date of the claim and date on which the claim was discharged.
3. In case the claims are rejected, the reasons for the rejections should be closely reviewed.
4. Check whether all claims received are registered and enter into the system.
5. It should be ensured that there is a system of collecting appropriate KYC documents, as required, and
discrepancies, if any, are intimated to the policyholders within 15 days of intimation.
6. It should be ensured that all the processed claims are accounted into the system properly.
7. It should be ensured that Claims cost includes the Claims settlement Cost.
8. Liability of claims should be booked net of reinsurance.

Investments
The Investment portfolio of Life Insurance companies comprise of Shareholders’ funds and Policyholders’ funds.
Policyholders’ funds can further be segregated as linked and non-linked. Investment regulations are however
prescribed separately for the following investment categories:
1. Linked Funds
2. Pension and Annuity Funds
3. Controlled Funds

IRDA (Investment) regulations, 2000 gives details of the pattern in which Funds of the Life Insurance business,
should be kept invested at any given point of time.

The overall functioning of the Investment function should include the following independent functions:
● Investments front office / dealing desk
● Investments mid office - Compliance, Risk Management, Reporting, Reconciliations
● Treasury - Cash Management, Deal settlement, Broker empanelment, Custody

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Audit of Insurance Companies

● Investment accounting - Fund accounting, NAV computation and declaration.

Role of Auditor: The Auditor during his review of Investment Department should mainly consider the
following:

Investment Management and Policy Review


1. Review the Investment management structure to ensure adequate segregation of duties between
Investment Front office, Mid Office and Back office.
2. Review of insurer's Investment policy.

Compliance and Regulations


3. Compliance of all Investment regulations, various other circulars specified by IRDAI and other
regulations specified in the Insurance Act, 1938.
4. Review of insurer's Standard Operating Procedures which are prescribed by the IRDA Regulations and are
required to cover the entire gamut of investment related processes and policies.

System and Process Review


5. Review of insurer's Cash Management System to track funds available for Investment considering the
settlement obligations and subscription and redemption of units, etc.
6. Ensure that the system is able to automatically monitor various Regulatory limits on Exposure and Rating
of debt instruments.

Risk Management and Control


7. Insurer's risk management policies and processes to manage investment risk such as Market risk,
Liquidity risk, etc.
8. Controls over NAV computation and declaration.

Write a short note on: Auditor’s considerations while reviewing of Investment Department of Life Insurance
Company.
(RTP, Nov 2019, NA)

OR

ABC & Co., Chartered Accountants are the Auditors of Just Care Life Insurance Company Limited. Enumerate the
steps to be taken by the auditor while verifying the "Investment".
(ICAI Study Mat)

Commission payable to Agent


● - Insurance agents typically solicit insurance business.
● - Agents are remunerated via commissions.
● - Commissions are calculated as a percentage of collected premiums.
● - Agency commission forms a large part of insurance expenses.
● - Commission is paid for generating new business.
● - It is also paid for settling renewal premiums.

Role of Auditor: The Auditor during his review of Commission paid to Agents should mainly consider the
following:

Neeraj Arora 13.13


Audit of Insurance Companies

● - Review the insurer's system for accurate, timely commission calculation.


● - Evaluate if the commission payment system aligns with premium collection.
● - Confirm that commission payment adheres to Insurance Act limits.
● - Verify claw-back of commission on cancelled policies.
● - Assess the completeness of the commission processing system.

You have been appointed to carry out the audit of Blue Heaven Life Insurance Company Ltd. for the year 2021-22.
During the course of audit, you observed that the commission payable to agents constituted a major expense in
operating expenses of the Company. Enumerate the audit concerns that address to the assertions required for
the Auditor to ensure the continued existence of internal control as well as fairness of the amounts in accounting
of commission payable to agents.
(MTP1, May 2022, 5 marks) (MTP2, May 2023, 5 marks)
OR
As an auditor of Life Insurance Company, how will you verify the ‘Commission Payable’ to its Agents?
(ICAI Study Mat)

Operating Expenses
Verification of operating Expenses related to Insurance Business (Expenses of Management):
i) Operating expenses relating to insurance business should be mentioned as a separate line item in
revenue account in FORM A-RA and details of the same to be given in Schedule 3 where these expenses
are broadly classified in 14 heads.
ii) As per schedule A, the following shall be disclosed by way of notes to the Balance Sheet.Operating
expenses relating to insurance business: basis of allocation of expenditure to various segments of
business.
iii) Any major expenses (Rs 5 lacs or in excess of 1% of net premium, whichever is higher) are required to be
shown separately.
iv) Any other expenses are required to be disclosed under the head ‘Others’.

Role of Auditor:
a) The auditor should ensure that these expenses are first aggregated and then apportioned to the Revenue
Account of each class of business on a reasonable and equitable basis.
b) The accounting policy should clearly indicate the basis of apportionment of these expenses to the
respective Revenue Accounts (i.e., Participating and Nonparticipating policies and in between Linked
and Non- Linked business) along with the certificate that all expenses of management, wherever
incurred, directly or indirectly, read with the accounting policy, have been fully debited to the respective
Revenue Account as expenses.

Different types of operating expenses and role of auditors


1. Legal and Professional Charges
As far as legal and professional charges are concerned, attention is drawn to the head ‘Claims Incurred’
under Schedule 2 where it is clearly stated that fees, legal and other expenses should form part of claim
cost, and therefore, are not to be included under the head Legal and Professional Charges.

Role of Auditor
The auditor should ensure that all other expenses which are not covered under the claims cost are
required to be included under this head.

Neeraj Arora 13.14


Audit of Insurance Companies

2. Employees’ Remuneration and Welfare Benefits


○ - Employees' remuneration includes all payments for their services.
○ - Reimbursement of employees' medical expenses is included here.
○ - Premiums for employees' health cover are part of remuneration.
○ - Healthcare policy costs not for employees go under 'claims cost'.
○ - Company-incurred medical treatment costs for employees are included.
○ - Non-training expenses should be shown separately.
○ - Incentives paid to employees of the company who have solicited insurance policies is also debited in
this account and not to the commission account.

Role of Auditor
The auditor is required to ensure the compliance of above.

3. Interest and Bank Charges


● All expenses incurred towards maintenance of Bank Account, interest and other charges levied
by bankers to the normal course of business other than bank expenses relating to investments
(interest, bank charges, custodial charges, etc.) are shown under the head, “Interest and Bank
Charges”.
● Any other interest charged on the borrowings which could not form part of the Revenue
Account not to be included under this head.

4. Depreciation
● Charging of depreciation is governed by Schedule II to the Companies Act, 2013. In addition,
compliance of relevant Accounting Standard is also to be taken care.

5. Interest, Dividend and Rent


- Insurance enterprises earn through interest, dividend, and rent.
- These earnings are apportioned between Revenue Account and Profit and Loss Account.
- Allocation basis should be clear in the company's accounting policy.
- Interest or dividend from policyholders' funds goes to the Revenue Account.
- Interest from loans, deposits, and rental income reflects in Profit and Loss Account.

Audit of Accounts of General Insurance Business


Premium
Verification of Premiums
Verification of Premiums -Verification of premium is of utmost importance to an auditor. The auditor should
the following procedures for verification of premium.

Internal Controls and System Review


1. Check internal controls and compliance for collection and recording of premiums.
2. Review systems for risk assessment, policy issuance, and issuing premium receipts

Document Management and Verification


3. Ensure serial numbering of cover notes for each business class.
4. Confirm maintenance of chronological Premium Registers with accurate figures.

Neeraj Arora 13.15


Audit of Insurance Companies

Premium Collection and Accounting


5. Check timely collection of periodic premium instalments.
6. Ensure appropriate accounting for premium instalments due before and after balance sheet date.
7. Verify collections remitted by agents after cut-off date.

Premium Refunds and GST Compliance


8. Confirm recovery of agency commission on refunded premiums.
9. Verify charging and collection of GST on total premium.

What are the steps to be taken while verifying the Premium of a General Insurance Company?
(ICAI Study Mat)

Claims
Short Note
● Claim is a demand for policy benefit due to an insured event.
● General insurance claims are mainly indemnity, reimbursing the policyholder's loss.
● Company's claim cost includes all expenses incurred in claim settlement.
● Internal controls ensure only bonafide claims are paid, not exceeding loss or sum insured.
● Claims cost components: claims for incurred losses, anticipated claims, and settlement costs.
● Liability includes future payments for unpaid reported claims and claims incurred but not reported.
● Accounting estimate includes claims cost adjusted for salvage value if realization is certain.
● Liability for outstanding claims should be accounted for in Direct, Inward Reinsurance, and Co-Insurance
Business.

Registers and Records


The following register and records are generally prepared in respect of claims:
1. Claims Intimation Register;
2. Claims Paid Register;
3. Claims Disbursement Bank Book;
4. Claims Dockets, normally containing the following records:
➢ Claim intimation, claim form, particulars of policy, survey report, Photograph showing damage,
repairer’s bills, letter of subrogation, police report (in case of theft), fire service report, claim
settlement note, claim satisfaction note, salvage report, salvage disposal note, claims discharge
voucher, etc.;
5. Report of quality assurance team; and
6. Salvage register.

The Claim Account is debited with all the payments including repair charges, fire-fighting expenses, police
report fees, survey fees, amount decreed by the Courts, travel expenses, photograph charges, etc.

Your audit assistant seeks your help in checking the claim liability of Bharat Insurance Co. Ltd. and wants to know
the registers and records which they should obtain and review in this regard.
(ICAI Study Mat)

Neeraj Arora 13.16


Audit of Insurance Companies

Claims Provisions
Auditor should gather claim information from divisions/branches, apply statistical sampling techniques for
verification. Outstanding liability at year-end is determined at divisions/branches where liability originates,
further provision is considered by Head Office. The auditor should satisfy himself that the estimated liability
provided for by the management is adequate keeping in view the following:

Claims Provision and Liability


1. Provision should be made for all unsettled claims at year-end based on claims lodged/communicated.
2. Auditor should ensure provision has been made for claims for which the company is legally liable.

Claim Settlement and Adjustment


3. Provision should not exceed the insured amount, other than specific orders from authorities and courts.
4. Provision should consider post balance sheet events, e.g., payments by other insurance companies,
further surveyor reports etc.

Legal Considerations and Contingencies


5. Provision should be made according to legal advice if claim is under litigation.
6. No contingent liability should be carried for any claim intimated.
7. Provisions should be retained for guarantees given by the company to courts for claims under litigation.

Amrapali & Co., Chartered Accountants are the Auditors of Natural Care General Insurance Company Limited. As
on March 31, 2019 the Management made a provision for claims outstanding. Enumerate the steps to be taken by
the Auditor while verifying the "Claims Provision
(RTP, May 2020, NA)

Claims Paid
Aspects in respect of claims paid to be examined by the auditors are as follows:
Co-Insurance and Reinsurance
1. Check co-insurance claims booked only for company's share, balance debited to other insurers.
2. In co-insurance arrangements, ensure share of premium received if claims paid on advice from other
insurers.
3. Reconcile figures of claims communicated for reinsurance with trial balance.

Claim Settlement and Documentation


4. Verify claims payments duly sanctioned by appropriate authority & acknowledged by claimants.
5. On final settlement of claims, claimant given unqualified discharge note.

Accounting and Compliance


6. Claims not paid if premiums not received as per Section 64 (VB) of the Insurance Act.
7. Salvage recovery duly accounted for & letter of subrogation obtained as per procedure.
8. Pure advances/deposits with Courts etc. not treated as claims paid, held as assets until claim disposal,
provision made for outstanding claims.

You are the Auditor of Good Luck General Insurance Company. You want to ensure that there exists good system
that effectively serves the requirements of true and fair accounting of claim-related expenses and liabilities.

Neeraj Arora 13.17


Audit of Insurance Companies

Suggest how this can be ensured.


(SA, May 2018, 5 marks) (ICAI Study Mat) - HINT - Verification of Claims Paid

Commission/Brokerage
Regulatory Compliance
1. Ensure that commission/brokerage is not paid in excess of the limits specified by IRDAI.
2. Ensure that commission/brokerage is paid as per rates with the agent and rates filed with IRDAI.
3. Ensure that the agent/broker is not blacklisted by IRDAI and is not terminated for fraud etc.

Agent/Broker Management
4. Ensure that commission/brokerage is paid to the agent/broker who has solicited the business.
5. Scrutinise agents' ledger and the balances, examine accounts having debit balances, if any, and obtain
information on the same. Necessary rectification of accounts and other remedial actions have to be
considered.

Accounting and Verification


6. Vouch disbursement entries with reference to the disbursement vouchers with copies of commission bills
and commission statements.
7. Check whether the vouchers are authorised by the officers-in-charge as per rules in force and income tax
is deducted at source, as applicable.
8. Check commissions that the company was obligated to pay during the period being audited have been
accurately recorded in the company's financial records.

You have been appointed to carry out the audit of ‘The Blue Insurance Company Ltd.’ for the year 2019-20. In the
course of your audit, you observed that the commission paid to agents constituted a major expense in operating
expenses of the Company. Enumerate the audit concerns that address to the assertions required for the Auditor
to ensure the continued existence of internal control as well as fairness of the amounts in accounting of
commission paid to agents
(SA, Nov 2018, 4 marks) (MTP2, May 2021, 4 marks) (RTP, Nov 2021, NA) (ICAI Study Mat)
OR
While auditing Secure Insurance Ltd., you observed that the major proportion of expense of the company is the
remuneration/commission paid to its insurance agents. As the auditor of the company, what audit procedure
would you adopt for verification of such expense?
(MTP1, Nov 2018, 4 marks)

Cash and Bank Balances


Cash and Bank balances at Branch Office/Divisional Office level also constitute significant items related to
balance sheet. The auditor should apply the following audit procedures for verification of claims.
Physical Verification and Management Certification
1. Auditor should physically verify cash balance, cheques in hand, imprest, stamp duty balance.
2. Obtain management certificate for these balances at the balance sheet date.
3. If physical verification on balance sheet date isn't possible, verify cash in hand at a later date through
backward calculations.

Neeraj Arora 13.18


Audit of Insurance Companies

Handling of Fiscal Year-End Transactions


4. Verify if late collections of cash & cheques on the last working day of the fiscal year are booked as Cash in
Hand and Cheques in Hand, respectively.
5. Check cheque dates to ensure they belong to the correct accounting period.
Bank Account Auditing
6. Perform a test check on bank transactions.
7. Check Bank Reconciliation statement and long outstanding entries.
8. Obtain confirmation of Bank Balances for all operative and inoperative accounts.

Outstanding Premium and Agents’ Balances


The following are the audit procedures to be followed for verification of outstanding premium and agents’
balances.
Investigation of Outstanding Premium Accounts
1. Inquire reasons for long outstanding credit balances in outstanding premium accounts.
2. Examine the reasons for policies not being issued or the outstanding premium not adjusted.

Scrutiny and Analysis of Account Balances


4. Examine inoperative balances and their treatment with reference to company rules.
5. Enquire into the reasons for retaining old balances.

Verification and Collection of Outstanding Premiums


6. Verify old debit balances requiring provision or adjustment.
7. Check age-wise, sector-wise analysis of outstanding premium.
8. Verify whether outstanding premiums have since been collected.

ARHAM Limited is engaged in the business of Insurance for the last 27 years. KUSHAL & Co., a firm of Chartered
Accountants are the statutory auditors of this company and have been required to perform the audit of all the
divisions and head office for the financial year 2020-2021. At the planning state CA K, Engagement Partner has
identified outstanding premium and agents’ balances as a focus area. Guide CA K by explaining key audit
procedures to be performed for verification of outstanding premium and agent’s balance.
(RTP, May 2022, NA)

Unexpired Risks Reserve (URR)


When an insurance policy is sold, the premium is typically paid in advance for a specific period of coverage.
However, the insurance company does not immediately recognize the full premium as revenue because the
coverage period extends beyond the current accounting period. Premium (revenue) is recognised proportionally
over the policy period as the coverage is provided.
The Unexpired Risks Reserve is established to represent the unearned portion of the premiums received. It is a
liability on the insurer's balance sheet because the company still owes the policyholders the coverage for the
remaining period of the policies.
1. Unexpired Risks Reserve is needed as policies extend beyond the account closing date, leaving
unexpired liability under these policies.
2. There are two methods to create this reserve:
a. 1/365 method based on proportionate number of risk days remaining, or
b. taking URR directly on 50% of premium.

Neeraj Arora 13.19


Audit of Insurance Companies

3. According to Section 64V of the Insurance Act, 1938, for solvency margin compliance, a proper value
should be placed on every liability item of the insurer.
4. As per income tax provisions, insurance companies get a deduction of 50% of net premium income for
Fire and Miscellaneous Business and 100% for Marine Insurance business.

Reinsurance
1. Reinsurance transaction is an agreement where a 'ceding company' passes a certain specified risk or
liability to a 'reinsurer'.
2. A 'ceding company' is the original insurer who accepts and cedes the risk to the reinsurer. The insured
does not get any rights under a reinsurance contract and can only claim from the original insurer.
3. There are two main types of reinsurance contracts: facultative reinsurance and treaty reinsurance.

Facultative Reinsurance
Facultative reinsurance refers to a contract that covers one specific risk and is stated in the reinsurance policy.
Each risk is considered individually, and each transaction is negotiated separately. It provides freedom to the
ceding company to offer and the reinsurer to accept. However, its main drawbacks are the high volume of work
and the time required to cover the risk.
It is, however, still used even today, mainly when:
1. automatic covers have already been exhausted.
2. the risk is excluded from the Treaties.
3. the insurer does not want his reinsurance treaties overburdened with particularly heavy and abnormal
risks.
4. the insurer has no automatic cover at his disposal in a particular branch, where he issues policies rarely.
5. when technical guidance or consultation with the reinsurer is required at each risk acceptance stage
(when dealing with risks that have unique complexities or require specialized knowledge. )
, or in businesses where the number of risks is small, like atomic energy installations, oil rigs, etc.

The Splendid General Insurance Company has entered into reinsurance contract with Adi Reinsurance Co. Ltd.
against the risk of fire only. Adi Reinsurance Co. Ltd. is one of the largest reinsurers in India. Identify the type of
reinsurance contract between Splendid General Insurance Company and Adi Reinsurance Co. Ltd.
a) Treaty Reinsurance.
b) Proportional Treaty Reinsurance.
c) Non-Proportional Treaty Reinsurance.
d) Facultative Reinsurance
(MTP2, May 2022, 1 mark)

Vishudh & Co. is the auditor of JIN Insurance Company. The insurance company is also involved in reinsurance
business and necessary provision for reinsurance premium has been made in the books of accounts. The
insurance company is into re-insurance whereby their contract relates to one particular risk and is expressed in
the reinsurance policy. Each transaction is negotiated individually, and each party has a free choice i.e. for the
insurance company to offer and the re-insurer to accept. What kind of a re-insurance business is the insurance
company into?
a) Facultative Reinsurance.
b) Stop loss treaty reinsurance.
c) Auto-fac reinsurance.
d) Proportional treaty reinsurance.
(RTP, May 2021, NA) (MTP1, Nov 2022, 1 mark)

Neeraj Arora 13.20


Audit of Insurance Companies

Treaty Reinsurance
● Treaty reinsurance is a type of contract between the ceding company and the reinsurer, outlining the
parameters of the reinsurance agreement such as monetary limits, geographical range, or type of business.
● Both parties are obligated to adhere to these terms.
● Insurers usually prepare statements of treaty reinsurances either quarterly or biannually, which is
shared with the reinsurer to reconcile claims related information.
● Reinsurers may pay in advance for larger claims, termed as 'advance against claim', which is adjusted
once the claim is settled. The treaties can be classified into proportional and non-proportional.
● Proportional treaties are based on a predetermined ratio of sum insured, premium and losses.
● Non-Proportional treaties distribute liability based on losses, not on the sum insured.
● The following are the other characteristics of non-proportional treaties:
1. Premium is not calculated on each cession, but on the whole portfolio of the ceding
company.
2. The premium rate is predetermined.
3. Cost of reinsurance can vary substantially each year, depending on the premium income,
loss ratio and reinsurance marked situations.
4. Normally no commission is paid.

Verification of Reinsurance Inward


Under IRDA regulations, insurers need a clear underwriting policy for inward re-insurance. Acceptance
decisions should be by experienced individuals. As an auditor, verify compliance with these rules.

Re-Insurance Underwriting Adherence


1. Check that re-insurance Inward underwriting adheres to norms of Insurance Act, 1938 and IRDA
Regulations.
2. Verify domestic inward acceptances follow the approved program.

Policy Verification and Control System


3. Verify the policy for booking accounts is consistently applied and disclosed.
4. Confirm that a proper control system is in place for monitoring agreements and periodical accounting
statements.

Audit of Claims and Premiums


5. Check the receipt of proper closing returns for premiums and claims for facultative acceptances.
6. Check provision for 'Incurred but Not Reported (IBNR)' claims on an actuarial estimation basis.

Adherence to Accounting Standards and Reconciliation


7. Evaluate recognition of foreign currency transaction aligns with Accounting Standard-11.
8. Confirm reconciliation of closing balances of the re-insurer's accounts.

Verification of Reinsurance Outward


The following steps may be taken by the auditor in the verification of re-insurance outward:
Cession Compliance and Calculations
1. Check the pattern of re-insurance underwriting for outward cessions meets applicable parameters and
guidelines.

Neeraj Arora 13.21


Audit of Insurance Companies

2. Verify if cessions have been made according to stipulations for various risk categories.
3. Verify commission on cession calculations adhere to agreement terms with re-insurers.

Re-Insurance Account Examination


4. Review the balance with re-insurers on cessions and match sub ledger balances with general ledger
balances.
5. Review individual accounts for balances that need provisioning / write off or write back.

Claims and Recoveries


6. Examine if cash loss recoveries have been claimed and accounted regularly.
7. Evaluate recognition of foreign currency transaction aligns with Accounting Standard-11.
8. Verify if balances with re-insurers are supported by obtained confirmations.

Enumerate the steps to be taken by an auditor for the verification of Reinsurance outward by a General Insurance
Company.
(ICAI Study Mat)

Co-Insurance
1. Co-insurance: When an insured chooses multiple insurers for the same risk. A leader receives the
premium, issues a policy with a co-insurance clause, and settles claims.
2. Co-insurance balances: Accounted as “Amounts due to / due from” other insurance companies, settled in
regular meetings and statement exchanges.
3. Co-insurance accounting: System should accommodate co-insurance requirements; accounting practices
are industry and insured-specific.
4. Auditor's responsibility: Verify risks are covered as per terms and conditions with adequate consideration
and proper settlement.
5. The Insurance Council may recommend the following norms while entering into coinsurance
agreement:
● Settlement of commission
● Collection and Remittance of Indirect Taxes.
● Standard practices for settlement of dues
● Settlement of claims
● Reinsurance arrangement for the risk booked
● Exceptional booking and the circumstance thereof deviating from the Council’s understanding

Trade Credit Insurance


1. Insurance for suppliers against non-payment by buyers, either domestic or export.
2. Protects against insolvency, protracted default, or political risk.
3. Trade Credit Insurance transaction: A transaction between two parties for supply of goods or services
on open and agreed terms.
4. Trade Credit Insurance policy: A conditional insurance contract related to an underlying trade
transaction, requiring correct fulfilment for credit cover.

Basic Requirements of a Trade Credit Insurance Product: An insurer shall offer trade credit insurance product
only if all requirements mentioned below are met -

Neeraj Arora 13.22


Audit of Insurance Companies

1. Policyholder's loss is non-receipt of trade receivable arising out of a trade of goods or services.
2. Policyholder is a supplier of goods or services in consideration for a fair market value.
3. Policyholder's trade receivable does not arise out of factoring arrangement or any other similar
arrangement.
4. Policyholder has a customer (i.e. Buyer) who is liable to pay a trade receivable to the policyholder in
return for the goods and services received by him from the policyholder, in accordance with a policy
document filed with the insurer.
5. Policyholder undertakes to pay premium for the entire Policy Period
6. Any other requirement that may be specified by the Authority from time to time.

You are an auditor of Fair Insurance Company Ltd. which offers variety of risk management products to business
entities wishing to protect their business activities against losses due to various probable risks. Fair Insurance
Company Ltd. is in the process of offering to Guru Ltd., a multinational group having worldwide market, “Trade
Credit Insurance Policy” to cover domestic risk export risk and political risk. You as an auditor of Insurance
Company have been requested to ensure that all the requirements have been met by Fair Insurance Company
Ltd. before Trade Credit Insurance Product is offered to Guru Ltd. List down those requirements.
(MTP2, May 2022, 5 marks) (MTP1, Nov 2022, 5 marks)

Procedure to determine ‘Value of Investments’


Real estate investment property (Historical Cost, Revaluation at least once in 3 year)
● The value of investment property shall be determined at historical cost, subject to revaluation at least
once in every 3 years.
● The change in the carrying cost of the investment property shall be taken to revaluation reserve.
● Record gains/losses from real estate changes to 'Revaluation Reserve' in equity.
● On sale, the gains or losses previously recorded in the Revaluation Reserve are included in the
calculation of the profit or loss on the sale of the investment.
● Authority may dictate amount from revaluation reserve for policyholder bonuses. Except for policyholder
distribution, revaluation reserve cannot be distributed to shareholders.
● The insurer shall assess at each balance sheet date whether any impairment of the property has occurred.
● Impairment loss recognized as an expense immediately unless the asset is revalued.
● Impairment loss of a revalued asset treated as revaluation decrease. If impairment loss exceeds
revaluation reserve, excess recognized as an expense.

Debt Securities
Debt securities, including government securities and redeemable preference shares, shall be considered as ‘held
to maturity’ securities and shall be measured at historical cost subject to amortization.

Equity Securities and Derivative Instruments that are traded in markets


● Listed equity securities & derivatives in active markets measured at fair value on balance sheet date.
● Fair Value - the lowest of the last quoted closing price at the stock exchanges where the securities are
listed shall be taken.
● Unrealised gains/losses from fair value changes taken to equity under 'Fair value change account'.
● Authority may direct amount release from this account for policyholder bonuses. No other amount shall
be distributed to shareholders out of Fair Value Change Account
● Debit balance in this account reduced from profits for dividends.
● The insurer shall assess, on each balance sheet date, whether any impairment has occurred.

Neeraj Arora 13.23


Audit of Insurance Companies

● Impairment loss is recognized as expense in Profit & Loss Account.This loss is the difference between
fair value and acquisition cost.Any previous impairment loss recognized reduces this difference.
● Any reversal of impairment loss earlier recognized in Revenue/Profit and Loss Account shall be recognized
in Profit and Loss Account.

Unlisted and other than actively traded Equity Securities and Derivative Instruments
● Unlisted and infrequently traded listed equities are measured at historical cost.
● Provisions are made for value reduction in these investments.
● Provisions may be reversed if value increases based on external evidence.
● The raised carrying amount shouldn't exceed the original cost due to provision reversal.
● A security shall be considered as being not actively traded, if as per guidelines governing mutual funds
laid down by SEBI, such a security is classified as "thinly traded".

CAB Insurance Company Ltd. was incorporated on 01.07.2020. Company is mainly in the area of health insurance
and planning to expand in other fields of general insurance. You have been appointed as Chief Financial Officer
(CFO) of the Company. The company has made investment as per guidelines in real estate investment property
and Equity Securities and Derivatives. Guide CFO as to how the same should be valued?
(SA, July 2021, 4 marks)

Neeraj Arora 13.24


Audit Under Fiscal Laws

Chapter-14 Audit Under Fiscal Laws

Audit of Public Trusts


Basics
● Trusts and institutions can be tax exempt under sections 11 and 12.
● Conditions under section 12A must be met for exemption.
● 12A inter alia provides - where the total income of the trust or institution as computed under this Act
without giving effect to the provisions of section 11 and section 12 exceeds the maximum amount which
is not chargeable to income-tax in any previous year, the accounts of the trust or institution for that vear
have been audited by an accountant.

Audit Program for Audit of Public Trust


An auditor should conduct routine checking during the course of audit of a public trust, in the following
manner:
i) Check the books of account and other records having regard to the system of accounting and internal
control;
ii) Vouch the transactions of the trust to ensure that:
● the transaction falls within the ambit of the trust;
● the transaction is properly authorized by the trustees or other delegated authority as may be
permissible in law;
● all incomes due to the trust have been properly accounted for on the basis of the system of
accounting followed by the trust;
● all expenses and outgoings appertaining to the trust have been recorded on the basis of the
system of accounting followed by the trust;
● amounts shown as applied towards the object of the trust are covered by the objects of trust as
specified in the document governing the trust.
iii) Obtain trial balance on the closing date duly certified by the trustee;
iv) Obtain Balance Sheet and Profit & Loss Account of the trust authenticated by the trustees and check the
same with the trial balance with which they should agree.

Draft an audit programme for conducting the audit of a Public Trust registered under section 12A of the
Income-tax Act, 1961.
(ICAI Study Mat)

Tax Audit Under Section 44AB


Turnover limit for the purpose of Tax Audit For Business and Profession
The provisions relating to tax audit under section 44AB of the Income Tax Act, 1961 applies to
● every person carrying on business, if his total sales, turnover or gross receipts in business exceed Rs 1
crore and in case of
● every person carrying on a profession, if his gross receipts from profession exceed Rs 50 lakhs in any
previous year

Neeraj Arora 14.1


Audit Under Fiscal Laws

However, in the case of a person carrying on business whose aggregate of all amounts received including amount
received for sales, turnover or gross receipts during the previous year, in cash, does not exceed 5% of the said
amount and aggregate of all payments made including amount incurred for expenditure, in cash, during the
previous year does not exceed 5% of the said payment), the limit of Rs 1 crore shall change to Rs 10 crore.

Provided further that for the purposes of this clause, the payment or receipt, as the case may be, by a cheque
drawn on a bank or by a bank draft, which is not account payee, shall be deemed to be the payment or receipt, as
the case may be, in cash; or

Specified Professions
● legal,
● medical,
● engineering or
● architectural profession or
● accountancy or
● technical consultancy or
● interior decoration or
● authorised representative
● film artist
● profession of company secretary
● information technology professionals

Section 44AE BB BBB


Person carrying on the business shall, if the profits and gains from the business are deemed to be the profits
and gains of such person under
● Section 44AE (Special provision for computing profits and gains of business of plying, hiring or leasing
goods carriages.)
○ i.e., ₹ 1000 per ton of gross vehicle weight or unladen weight in case of each heavy goods vehicle
and ₹ 7,500 for each vehicle, other than heavy goods vehicle, for every month or part of the
month for which the vehicle is owned by the assessee
○ Heavy Goods Vehicle - It means any goods carriage, the gross vehicle weight of which exceeds
12000 kilograms. (12 Tonnes))
● Section 44BB (Special provision for computing profits and gains in connection with the business of
exploration, etc., of mineral oils.) or
● section 44BBB (Special provision for computing profits and gains of foreign companies engaged in the
business of civil construction, etc., in certain turnkey power projects.)
as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits
and gains of his business, as the case may be, in any previous year,

44ADA
Person carrying on the profession shall, if the profits and gains from the profession are deemed to be the profits
and gains of such person under section 44ADA, and he has claimed such income to be lower than the profits and
gains so deemed to be the profits and gains of his profession and his income exceeds the maximum amount which
is not chargeable to income-tax in any previous year, or

44AD
Person carrying on the business shall,

Neeraj Arora 14.2


Audit Under Fiscal Laws

● if the provisions of sub-section (4) of section 44AD are applicable in his case and
● his income exceeds the maximum amount which is not chargeable to income-tax in any previous year,

Sub section (4) of section 44AD of the Income Tax Act, 1961 states that where an eligible assessee declares profit
for any Previous Year in accordance with the provisions of this section 44AD and he declares profit for any of
the 5 Assessment Years relevant to the Previous Year succeeding such Previous Year not in accordance with the
provisions of subsection (1) of section 44AD, he shall not be eligible to claim the benefit of the provisions of this
section for 5 Assessment Years subsequent to the Assessment Year relevant to the Previous Year in which the
profit has not been declared in accordance with the provisions of sub-section (1) of section 44AD.

Applicability of 44AD
1. Available only for eligible business
a. any business except the business of plying, hiring or leasing goods carriages referred to in
section 44AE; and
b. Whose total turnover or gross receipts in the relevant previous year does not exceed an amount of
2 crores.
2. Available only to eligible assessee (R-I/HUF/PF - NOT LLP – No Ded. u/s 10 or Part C of C-VI-A)
a. An individual, Hindu Undivided Family or a partnership firm,
i. who is a resident,
ii. but not a limited liability partnership firm.
b. who has not claimed deduction under any of the
i. Sections 10A, 10AA, 10B, 10BA or
ii. Deduction under any provisions of Chapter VIA under the heading “C. - Deductions in
respect of certain incomes” in the relevant assessment year i.e. the following deductions
should not be taken.-Section 80-IA, 80-IAB, 80-IB, 80-IC, 80-ID, 80-IE, 80JJA, 80JJAA,
80QQB, 80RRB.
c. Companies, AOP, BOI are also not eligible for 44AD.
3. This scheme cannot be availed by (Specified Profession – Com/Brokerage – Agency Business)
a. a person carrying on specified profession as referred to in section 44AA;
b. a person earning income in the nature of commission or brokerage; or
c. a person carrying on any agency business.

No Tax Audit
The provisions for tax audit under Section 44AB are not applicable in the case of an assessee who comes within
the purview of
● Section 44B (Special provision for computing profits and gains of shipping business in the case of
non-residents.)or
● Section 44BBA(Special provision for computing profits and gains of the business of operation of aircraft
in the case of non-residents.)

Meaning of Certain Terms


● "accountant" shall have the same meaning as in the explanation below sub-section (2) of Section 288:
● The expression “specified date” in relation to the accounts of the previous year or years relevant to any
assessment year means the date one month prior to the due date for furnishing the return of income under
section 139(1).

Neeraj Arora 14.3


Audit Under Fiscal Laws

● The due date for filing return of income in case of assessees who are required to get their accounts
audited is 31st October of the relevant assessment year. Hence, the specified date for tax audit would be
30thSeptember of the relevant assessment year

Computation of Turnover to determine eligibility of Tax Audit


The following points merit consideration as stated in the Guidance note on Tax Audit issued by the Institute of
Chartered Accountants of India-
● Discount allowed in the sales being in the nature of trade discount will be deducted from the turnover.
● Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing
charge and is not related to turnover. The same should not be deducted from the turnover.
● Special rebate allowed to a customer can be deducted from the sales if it is in the nature of a trade
discount. If it is in the nature of commission on sales, the same cannot be deducted from the turnover
● Price of goods returned should be deducted from the turnover even if the return are from the sales made
in the earlier years.
● Sale proceeds of any shares, securities, debentures, etc., held as investment will not form part of turnover.
However, if the shares, securities, debentures etc., are held as stock-in trade, the sale proceeds thereof
will form part of turnover.

Audit required under any other law


● It may also be noted that in a case where such person is required by or under any other law to get his
accounts audited, it shall be sufficient compliance with the provisions of this section if such person gets
the accounts of such business or profession audited under such law before the specified date and
furnishes by that date the report of the audit as required under such other law and a further report by an
accountant in the form prescribed under this section.
● Thus, for example, the provision regarding compulsory audit does not imply a second or separate audit
of accounts of companies whose accounts are already required to be audited under the Companies Act,
2013.
● The provision only requires that companies should get their accounts audited under the Companies Act,
2013 before the specified date and in addition to the report required to be given by the auditor under
the Companies Act, 2013 furnish a report for tax purposes in the form to be prescribed in this behalf by
the CBDT.

What constitutes an Audit report


Tax auditor shall furnish his report in a prescribed form which could be either Form 3CA or Form 3CB where:
● Form No. 3CA is furnished when a person carrying on business or profession is already mandated to get
his accounts audited under any other law.
● Form No. 3CB is furnished when a person carrying on business or profession is not required to get his
accounts audited under any other law.
● In case of either of the aforementioned audit reports, the tax auditor must furnish the prescribed
particulars in Form No. 3CD, which forms part of the audit report.

Concession Ltd. is engaged in the business of manufacturing of threads. The company recorded the turnover of
Rs 10.13 crore during the financial year 2022-23 before adjusting the following:

Particulars Amount (Rs)

Neeraj Arora 14.4


Audit Under Fiscal Laws

Discount allowed in the Sales Invoice Rs 8,20,000

Cash discount (other than allowed in Cash Rs 9,20,000


memo/ sales invoice)

Trade discount Rs 2,90,000

Commission on Sales Rs 6,00,000

Sales Return (F.Y. 2021-22) Rs 1,60,000

Sale of Investment Rs 6,60,000

You are required to ascertain the effective turnover to be considered for the prescribed limit of tax audit under the
relevant Act and guide the company whether the provisions relating to tax audit applies
(RTP, May 2018, NA) (MTP1, May 2019, 6 marks) (MTP2, Nov 2021, 6 marks) (ICAI Study Mat)

Mr. Abhinandan engaged in business as a sole proprietor presented the following information to you for the FY
2022-23. Turnover expected to be made during the year Rs. 1024 lacs. Goods returned in respect of sales made
during FY 2021-22 is Rs. 20 lacs not included in the above. Cash discount allowed to his customers Rs. 1 lac for
prompt payment. Special rebate allowed to customer in the nature of trade discount Rs. 5 lacs. Further, the
aggregate of all amounts received including amount received for sales, turnover or gross receipts during the
previous year, in cash, does not exceed five per cent of the said amount and aggregate of all payments made
including amount incurred for expenditure, in cash, during the previous year does not exceed five per cent of the
said payment. Kindly advise him whether he has to get his accounts audited u/s 44AB of the Income Tax Act, 1961
(MTP1, May 2021, 4 marks)

Mr. A engaged in business as a sole proprietor presented the following information to you for the FY 2022-23.
Turnover expected to be made during the year Rs 1124 lacs. Goods returned in respect of sales made during FY
2021-22 is Rs 20 lac not included in the above. Cash discount allowed to his customers Rs 1 lac for prompt
payment. Special rebate allowed to customer in the nature of trade discount Rs 5 lac. Kindly advise him whether
he has to get his accounts audited u/s 44AB of the Income Tax Act, 1961.
(ICAI Study Mat)

UT & Co. is a Chartered Accountant Firm, that provides consultancy services. Recently, it got queries from different
clients with respect to applicability of tax audit provisions to their businesses.
In response to such queries, UT & Co., asked from them details such as turnover, total receipts and total payments
made during the year respectively along with mode of receipt/payment, whether filing return of Income under
normal tax provisions or presumptive tax provisions such as section 44AD, 44AE, etc.
So, in the trailing mail, UT & Co., got the aforesaid details from different clients, which it classified into following
categories for ease of framing an opinion, as follows:

Client Sr. Turnover % of Cash % of Cash Remarks


No. (Rs in Receipts in Payments
crore) Total in Total
Receipts Payments

1 9.5 5% 5% Has been filing return as per the regular


provisions of income tax

2 1.8 7% 4% Has declared business income as per


presumptive taxation under section 44AD of
the Income-tax Act, 1961.

3 0.85 6% 4% Has declared business income as per

Neeraj Arora 14.5


Audit Under Fiscal Laws

presumptive taxation under section 44AD of


the Income-tax Act, 1961 during last 2 previous
years but during current previous year has
declared income lower than as per section
44AD and the total income is less than basic
exemption limit.

4 3.2 8% 6% Has declared business income as per


presumptive taxation under section 44AE of
the Income-tax Act, 1961 during last 4 previous
years but during current previous year has
declared income lower than as per section
44AE and the total income is less than basic
exemption limit.

On behalf of UT & Co., please provide your opinion, along with reasons, as a consultant in case of aforesaid clients
that whether tax audit is applicable to them or not?
(RTP, Nov 2021, NA)

Billimoria & Billimoria, a partnership firm, is engaged in providing engineering consultancy services to insurance
corporates in automobile sector. The firm conducts risk inspection of vehicles and submit their reports to
insurance companies. Both the partners are Chartered Engineers. The Firm is one of your regular tax audit clients.
The following information is culled out from the account books of the company for financial year 2022-23 by the
firm:

Particulars Rs in crore

Turnover 8.50
Receipt on account of sales/debtors 6.00
Cash receipt from debtors 0.10
Expenditure during year 7.00
Cash expenditure 0.21
Cash loan repayment ​0.05

The partner of said firm informs you that due to changes in income-tax laws, their firm is not liable for audit under
section 44 AB of Income tax Act (commonly called as tax audit). How would you deal with the matter? Is
contention of partner in accordance with law?
(RTP, Nov 2022, NA)

Comment with respect to computation of total sales, turnover or gross receipts in business exceeding the
prescribed limit under Section 44 AB of Income Tax Act, 1961.
(i) Discount allowed in the sales invoice
(ii) Cash discount
(iii) Price of goods returned related to earlier year
(iv) Sale proceeds of fixed assets.
(ICAI Study Mat)

Examine the applicability of tax audit provisions in the following cases:


a. DB Pvt. Ltd. has total turnover of Rs 10.25 crore for the FY 2022-23.
b. ABC & Co. (a partnership firm) engaged in trading of electronic goods is expecting a turnover of Rs 165
lacs for the FY 2022-23. (Assume the partnership firm would not be able to ensure that the aggregate of
all amounts received including amount received for sales, turnover or gross receipts during the previous
year, in cash, does not exceed 5% of the said amount and aggregate of all payments made including
amount incurred for expenditure, in cash, during the previous year does not exceed 5% of the said
payment).

Neeraj Arora 14.6


Audit Under Fiscal Laws

c. Mr. Anand Khater, a Commission Agent is expecting commission receipts of Rs 137 lacs during the FY
2022-23 (Assume he would not be able to ensure that the aggregate of all amounts received including
amount received for sales, turnover or gross receipts during the previous year, in cash, does not exceed 5%
of the said amount and aggregate of all payments made including amount incurred for expenditure, in
cash, during the previous year does not exceed 5% of the said payment).
d. Mr. Vishal Raka, owning an Agency of Samsung Mobile for the city of Pune and expects the turnover of Rs
87 lacs during the FY 2022-23.
(ICAI Study Mat)

Penalty for Not Getting the Accounts Audited as Required u/s 44AB
According to section 271B, if any person who is required to comply with section 44AB fails to get his accounts
audited in respect of any year or years as required under section 44AB, the Assessing Officer may impose a
penalty. The penalty shall be lower of the following amounts
a. 0.5% of the total sales, turnover or gross receipts, as the case may be, in business, or of the gross receipts
in profession, in such year or years.
b. ₹ 1,50.000.
However, according to section 273B, no penalty shall be imposed if reasonable cause for such failure is proved.

Income Computation and Disclosure Standards (ICDS): Section 145 of the


Income Tax Act, 1961 deals with the Method of Accounting.
● Under section 145(1), income chargeable under the heads “Profits and gains of business or profession” or
“Income from other sources” shall be computed in accordance with either the cash or mercantile system
of accounting regularly employed by the assessee.
● Section 145(2) empowers the Central Government to notify in the Official Gazette from time to time,
income computation and disclosure standards to be followed by any class of assessees or in respect of
any class of income.
● Accordingly, the Central Government had, in exercise of the powers conferred under section 145(2),
notified ten income computation and disclosure standards (ICDSs) to be followed by all assesses (other
than an individual or a HUF who is not required to get his accounts of one previous year audited in
accordance with the provisions of section 44AB), following the mercantile system of accounting, for the
purposes of computation of income chargeable to income-tax under the head “Profit and gains of
business or profession” or “ Income from other sources”. from the A.Y. 2017-18.
● In the case of conflict between the provisions of the Income‐tax Act, 1961 and the notified ICDSs, the
provisions of the Act shall prevail to that extent.
● Assessees who are following cash system of accounting need not follow the ICDSs

The Central Government has prescribed 10 Income Computation and Disclosure Standards (ICDSs) as under
A. ICDS I relating to Accounting Policies.
B. ICDS II relating to Valuation of Inventories
C. ICDS III relating to Construction Contracts.
D. ICDS IV relating to Revenue Recognition.
E. ICDS V relating to Tangible Fixed Assets.
F. ICDS VI relating to the Effects of Changes in Foreign Exchange Rates.
G. ICDS VII relating to Government Grants.
H. ICDS VIII relating to Securities.
I. ICDS IX relating to Borrowing Costs.
J. ICDS X relating to Provisions, Contingent Liabilities and Contingent Assets.

Neeraj Arora 14.7


Audit Under Fiscal Laws

CA Sumati has been appointed as a tax auditor under section 44 AB of the Income-tax Act, 1961, of M/s Pal &
Company, a partnership firm, following cash basis of accounting. CA Sumati made the qualification that ICDS
were not followed by the entity while maintaining books of accounts. Whether qualification made by CA Sumati is
correct? Explain the provisions of the applicability of ICDS with reference to Sec 145(2) of the Income Tax Act, 1961.
(RTP, May 2022, NA)

Significance of Working Papers in Section 44AB Audit Reports


Section 44AB audit report helps assess the assessee's correct income. Tax auditor must be able to explain arising
questions. The auditor should keep necessary working papers. These papers provide evidence relied upon during
audit. Such working papers should include his notes on the following, amongst other matters:
a. work done while conducting the audit and by whom;
b. explanations and information given to him during the course of the audit and by whom;
c. decision on the various points taken;
d. the judicial pronouncements relied upon by him while making the audit report; and
e. certificates issued by the client/management representation letter.
While issuing the tax audit report under section 44AB of the Income Tax Act 1961, the Auditor should generate
appropriate UDIN (Unique Document Identification Number) and refer the same in its report.

Revision of Tax Audit Report


CBDT has updated Rule 6G to allow for revision of the audit report in case of any payments made post
submission of the report that requires a recalculation of disallowance under sections 40 or 43B. The revised
report, signed and verified by a Chartered Accountant, should be furnished before the end of the assessment
year related to the report.

Further, when the accounts are revised in the following circumstances, the tax auditor may have to revise his
tax audit report also.
I. Revision of accounts of a company after its adoption in the annual general meeting.
II. Change in law with retrospective effect.
III. Change in interpretation of law (e.g.) CBDT Circular, Notifications, Judgments, etc.

The Tax Auditor should state it is a revised report, clearly specifying the reasons for such revision with a
reference to the earlier report.
TP Ltd. a government company engaged in providing tourism services, has failed to get its accounts audited by
Statutory Auditor for the financial year 2022-23. You have been appointed as Tax Auditor for the same period and
management provided the unaudited financial statements which have been adopted in the Annual General
Meeting. Subsequently, the Statutory Auditor while auditing observed that there is a material misstatement in
providing depreciation on fixed assets due to which financial statements have been revised. Now the company is
requesting you to revise the tax audit report. You are required to state whether Tax Audit Report can be revised
and if so, under what circumstances?
(SA, Nov 2022, 4 marks)
OR
You are doing the tax audit of a Limited Company. After submission of Tax Audit Report, management notices
that there was apparent mistake of law and due to this mistake, revised the final accounts. As a tax auditor,
company seeks your opinion whether the tax audit can also be revised or not.
(RTP, Nov 2018, NA)
OR
State whether a Tax audit report can be revised and if so, state those circumstances.

Neeraj Arora 14.8


Audit Under Fiscal Laws

(ICAI Study Mat)

FORM NO. 3CD - STATEMENT OF PARTICULARS REQUIRED


TO BE FURNISHED U/S 44AB
PART - A
Clause 1
Name of the assessee

Clause 2
Address

Clause 3
Permanent Account Number (PAN)

Clause 4 -
Whether the assessee is liable to pay indirect tax like excise duty, service tax, sales tax, goods and service tax,
customs duty, etc. if yes, please furnish the registration number or GST Number or any other identification
number allotted for the same

Audit Points
● Ask the assessee whether he is liable to pay indirect tax like excise duty, service tax, VAT, customs duty,
(or GST) etc.
● Obtain from the assessee representation indicating various indirect tax laws applicable to him.
● Obtain copy of registration certificates for all the locations issued by GST/Excise/VAT/Service Tax
Authorities.
● The auditor should also ensure that the details furnished while checking the registration number pertains
to the assessee only. For this auditor can check returns and docuements furnished by the assesee.
● If the assessee is liable to pay any indirect tax but he has not got himself registered then bring out this fact
as a qualification/observation in the main audit report in Form No. 3CA/3CB.

Clause 5
Status

Clause 6
Previous year from ....to .....

Clause 7
Assessment year

Clause 8
Indicate the relevant clause of section 44AB under which the audit has been conducted

Neeraj Arora 14.9


Audit Under Fiscal Laws

Clause 8A
Whether the assessee has opted for taxation under section 115BA/115BAA/115BAB/ 115BAC/ 115BAD.

PART - B
Clause 9
a. If firm or association of persons, indicate names of partners/ members and their profit sharing ratios.
b. If there is any change in the partners or members or in their profit sharing ratio since the last date of
the preceding year, the particulars of such change.

Clause 10
a. Nature of business or profession (if more than one business or profession is carried on during the
previous year, nature of every business or profession)
b. If there is any change in the nature of business or profession, the particulars of such change.

Clause 11
a. Whether books of account are prescribed under section 44AA, if yes, list of books so prescribed.
b. List of books of account maintained and the address at which the books of account are kept.
(In case books of account are maintained in a computer system, mention the books of account generated
by such computer system. If the books of account are not kept at one location, please furnish the
addresses of locations along with the details of books of account maintained at each location.)
c. List of books of account and nature of relevant documents examined.

Audit Points
● In case of professionals, requirements of section 44AA read with rule 6F of the Income Tax Rules, 1962,
should be kept in mind.
● In case of corporate assessee, the books of accounts required to be maintained are contained in the
relevant statute.
● Obtain a schedule indicating the list of books of accounts maintained. It should be duly certified by a
responsible officer of the company/entity.
● Obtain details as to place where books are maintained
● Enquire whether books are maintained on a computer system. If yes, obtain a list of books generated by
such system.

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Clause 12
a. Whether the profit and loss account include any profits and gains assessable on presumptive basis, if
yes, indicate the amount and the relevant sections (44AD, 44AE, 44AF, 44B, 44BB, 44BBA, 44BBB,
Chapter XII-G, First Schedule or any other relevant section.)

Clause 13
a. Method of accounting employed in the previous year
b. Whether there had been any change in the method of accounting employed vis-a-vis the method
employed in the immediately preceding previous year.
c. If answer to (b) above is in the affirmative,give details of such change, and the effect thereof on the profit
or loss.

Serial Number Particulars Increases in Profit (₹) Decreases in Profit(₹)

d. Whether any adjustment is required to be made to the profits or loss for complying with the provisions of
income computation and disclosure standards notified under section 145(2).
e. If answer to (d) above is in the affirmative, give details of such adjustments:

Increases in Decreases in Net Effect (₹)

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Profit (₹) Profit(₹)

ICDS I Accounting
Policies

ICDS II Valuation of
Inventories

ICDS III Construction


Contracts

ICDS IV Revenue
Recognition

ICDS V Tangible Fixed


Assets

ICDS VI Changes in
Foreign
Exchange Rates

ICDS VII Governments


Grants

ICDS VIII Securities

ICDS IX Borrowing Costs

ICDS X Provisions,
Contingent
Liabilities &
Contingent
Assets

Total

f. Disclosure as per ICDS:

ICDS I Accounting Policies

ICDS II Valuation of Inventories

ICDS III Construction Contracts

ICDS IV Revenue Recognition

ICDS V Tangible Fixed Assets

ICDS VII Governments Grants

ICDS IX Borrowing Costs

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Audit Under Fiscal Laws

ICDS X Provisions, Contingent Liabilities and ContingentAssets

ABC Ltd., is consistently following Accounting Standards as required under section 133 of the Companies Act, 2013.
During your tax audit under section 44AB of the Income Tax Act, 1961, the Board of Directors informed you that
profits of the Company is properly arrived at and the Accounting Standards applicable to it have been followed
consistently and as such, there need not be any adjustments to be made as per Income Computation and
Disclosure Standards notified under section 145 of Income Tax Act, 1961. Based on the requirements of Law in this
regard, examine the validity of the stand of Management in this regard.
(SA, May 2018, 5 marks)

Clause 14
a. Method of valuation of closing stock employed in the previous year.
b. In case of deviation from the method of valuation prescribed under section 145A, effect thereof the
profit or loss, please furnish:

Serial Number Particulars Increases in Profit (₹) Decreases in Profit(₹)

Clause 15
Give the following particulars of the capital asset converted into stock-in-trade:
a. Description of capital asset;
b. Date of acquisition;
c. Cost of acquisition;
d. Amount at which the asset is converted into stock-in-trade.

Overview of Section 45(2) - Capital gains in case of conversion of a capital asset into stock-in-trade
● Conversion of Capital assets into stock in trade is considered as transfer. - Section 2(47)
● As per Section 45(2), In case of conversion of a capital asset into, or its treatment, by the owner, as
stock-in-trade of a business carried on by him, the profits or gains arising shall be chargeable to tax as
Capital gains, where –
● Full value of consideration = Fair market value of the asset on the date of such conversion or
treatment.
● Year of taxability = Previous year in which such stock-in-trade is sold or otherwise transferred
by him.
● Indexation, if any - In this case, transfer takes place in the year of conversion, so CII of the year
of conversion is used for computation of capital gains,

Clause 16
Amounts not credited to the profit and loss account, being:
a. The items falling within the scope of section 28;
b. The proforma credits, drawbacks,refund of duty of customs or excise or service tax or refund of sales tax
or value added tax where such credits, drawbacks or refunds are admitted as due by the authorities
concerned;
c. Escalation claims accepted during the previous year;
d. Any other item of income ;

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Audit Under Fiscal Laws

e. Capital receipt, if any.

Clause 16(a)
● Verify if the assessee earned income under section 28 and if earned whether it is credited to profit and
loss If not, then report the fact.
● Auditors must scrutinize books for any unaccounted receipts under section 28.
● Ensure that such income has been correctly computed by allowing the expenditure that is statutorily
allowable and ignoring the expenditure not so allowable.
● Pay particular attention to check whether the assessee has obtained any benefit or perquisite referred to
in section 28(iv) and whether value thereof has been credited to the profit and loss account. Quantify the
value of such benefit and ensure that the amount involved is credited to the profit and loss account,
otherwise state the fact against this clause.

Clause 16(b)
1. Enquire if any proforma credits, drawbacks, customs/excise duties refunds, or sales tax/service tax/VAT
refunds have been accepted by the authorities. If so, obtain a detailed schedule from the assessee.
2. Cross-check the schedule's details against claim documents, correspondence, and assessment orders,
ensuring claims are admitted by the relevant authorities.
3. "Admitted by the authorities" refers to claims admitted prior to the closing of accounts.
4. Confirm that the accounting of these claims aligns with the assessee's regularly followed accounting
method.
5. Ensure all admitted claims are credited to the Profit and Loss account. Any exceptions should be reported.
6. If the cash accounting method is used, this should be stated in the report.

Question: A duty drawback amounting to Rs 5 lac related to a number of export consignments was identified but
has not been accounted for in the Statement of Profit and Loss. This amount was confirmed by the customs
authorities in March 20XX and was later electronically deposited into the company's bank account in the next
fiscal year. What actions should the auditor take in this scenario?

Answer: The auditor has identified a duty drawback of Rs 5 lac that has been acknowledged by the customs
authorities, but not recorded in the Statement of Profit and Loss. The company is required to keep its accounts on
an accrual basis in line with section 128 of the Companies Act, 2013. The auditor should report the unaccounted
drawback in the Statement of Profit and Loss under clause 16(b) of Form 3CD.

Clause 16(c)
1. Inquiry applies to real estate, construction, EPC, and infrastructure businesses.
2. Auditors should sample check contracts for escalation clauses.
3. If escalation claims exist, verify claims made during the audit year.
4. Obtain a schedule detailing escalation claims made in the previous year.
5. Check claims accepted by clients or customers of the assessee.Ensure claims were accepted as due in the
previous year.Verify if only part of a claim was accepted.
6. Check if accepted claims have been accounted for.Confirm claim amounts are credited to the Profit and
Loss account.
7. If unaccounted claims exist, report the fact and the amount.
8. For cash accounting system, working of claims isn't significant until received. Auditors should state the
fact and amount involved in such cases.

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Clause 16(e) - Instances of Capital Receipt


i) Capital subsidy received in the form of Government grants, which are in the nature of promoters’
contribution i.e., they are given with reference to the total investment of the undertaking or by way of
contribution to its total capital outlay. For e.g., Capital Investment Subsidy Scheme.
ii) Government grant in relation to a specific fixed asset where such grant is shown as a deduction from the
gross value of the asset by the concern in arriving at its book value.
iii) Compensation for surrendering certain rights.
iv) Profit on sale of fixed assets/investments

Audit Procedures
● 1. Capital receipts aren't usually credited to the Profit and Loss account.
● 2. Auditors should carefully check transactions that generate capital receipts.
● 3. Inquire if the assessee received any capital amounts during the previous year.
● 4. Review financial statements, especially reserve accounts, for such receipts.
● 5. Determine if the assessee credited these receipts to the Profit and Loss account.
● 6. Ensure that any such receipts are accounted for in line with the assessee's accounting method.

Clause 17
Where any land or building or both is transferred during the previous year for a consideration less than value
adopted or assessed or assessable by any authority of a State Government referred to in Section 43CA or 50C,
please furnish:

Details of property Consideration received Value adopted or Whether provisions of


or accrued assessed or accessible second proviso to sec
43CA(1) or 4th proviso to
Sec. 56(2)(x) applicable?
(Yes/No)

Auditor’s Consideration
1. Obtain a list of all properties transferred by the assessee in the previous year.
2. Verify this from the statement of profit and loss or balance sheet.
3. Ascertain received or accrued consideration from the assessee's books of accounts.
4. Obtain a copy of the registered sale deed for registered properties.
5. If unregistered, verify documents from relevant authorities or obtain third-party confirmations.
6. If unable to obtain relevant documents, state this in the 3CA/CB reports.

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Clause 18
Particulars of depreciation allowable as per the Income-tax Act, 1961 in respect of each asset or block of assets,
as the case may be, in the following forms:
a. Description of asset/ block of assets.
b. Rate of Depreciation.
c. Actual cost of written down value, as the case may be.
ca Adjustment made to the written down value under section 115BAC/115BAD (for assessment year 2021-22
only).
cb Adjustment made to written down value of Intangible assets due to excluding value of goodwill of a
business or profession.
cc Adjusted written down value.

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d Additions/ deductions during the year with dates; in the case of any addition of an asset, date put to use;
including adjustments or account of-
i. CENVAT credits claimed and allowed under the Central Excise Rules 1944, in respect of assets
acquired on or after 1st March, 1994,
ii. Change in rate of exchange of currency, and
iii. Subsidy or grant or reimbursement, by whatever name called.
e Depreciation allowable.
f Written down value at the end of the year.

Amount to be ignored while calculating actual cost.


Where the assessee incurs any expenditure for acquisition of any asset or part thereof in respect of which
● a payment or aggregate of payments made to a person
● in a day,
● otherwise than by
● an account payee cheque drawn on a bank or
● an account payee bank draft or
● use of electronic clearing system through a bank account,
● exceeds ten thousand rupees,
such expenditure shall be ignored for the purposes of determination of actual cost.

Gain or loss due to change in rate of exchange


As per section 43A, the gain, arising at the time of making payment in respect of an imported machinery, due to
change in rate of exchange of foreign currency, has to be reduced from the actual cost of machinery, and
depreciation would be computed on such reduced cost. In case of loss such loss shall be added in the cost of the
machinery.

Components of Actual Cost


● Its purchase price, duties and taxes, and any directly attributable expenditure on making the asset ready
for its ultimate use will be included

Clause 19
Amounts admissible under sections

Section Amount debited to profit and loss Amounts admissible as per the provisions of the
account Income-tax Act, 1961 and also fulfils the condition, if
any specified under the relevant provisions of
Income tax Act, 1961 or Income Tax Rules, 1962 or
any other guidelines, circular, etc, issued in this
behalf.

32AC

32AD

33AB

33ABA

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35(1)(i)

35(1)(ii)

35(1)(iia)

35(1)(iii)

35(1)(iv)

35(2AA)

35(2AB)

35ABB

35AC

35AD

35CCA

35CCB

35CCC

35CCD

35D

35DD

35E

Clause 20
a. Any sum paid to an employee as bonus or commission for services rendered, where such sum was
otherwise payable to him as profits or dividend [Section 36(1)(ii)].
b. Details of contributions received from employees for various funds as referred to in section 36(1)(va):

Serial no. Nature of fund Sum received Due date for The actual The actual
from payment amount paid date of
employees payment to the
concerned
authorities

The provisions of section 43B shall not apply and shall be deemed never to have been applied for the purposes
of determining the "due date" under this clause - 36(1)(va)

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Clause 21
21(a) - Please furnish the details of amounts debited to the profit and loss account, being in the nature
of capital , personal, advertisement expenditure etc.

Nature Serial No. Particulars Amount


in (₹)

Capital expenditure

Personal expenditure

Advertisement expenditure in any souvenir, brochure, tract, pamphlet


or the like published by a political party

Expenditure incurred at Clubs being Entrance fees and subscriptions

Expenditure incurred at Clubs being cost for club services and


facilities used

Expenditure by way of penalty or fine for violation of any law for the
time being force

Expenditure by way of any other penalty or fine not covered above

Expenditure incurred for any purpose which is an offence or which is


prohibited by law

21(b) - Amounts inadmissible under section 40(a):


1. As payment to non-resident referred to in sub-clause(i).
a. Details of payment on which tax is not deducted:
I. Date of Payment
II. Amount of payment
III. Nature of Payment
IV. Name and address of the payee
b. Details of payment on which tax has been deducted but has not been paid during the previous year or in
the subsequent year before the expiry of time prescribed under section 200(1)
I. Date of payment
II. Amount of payment
III. Nature of payment
IV. Name and address of the payee
V. Amount of tax deducted
2. As payment referred to in sub-clause (ia)
a. Details of payment on which tax is not deducted:
I. Date of payment
II. Amount of payment
III. Nature of payment
IV. Name and address of the payee
b. Details of payment on which tax has been deducted but has not been paid on or before the due date
specified in sub section(1) of section 139.
I. Date of payment

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Audit Under Fiscal Laws

II. Amount of payment


III. Nature of payment
IV. Name and address of the payee
V. Amount of tax deducted
VI. Amount out of (V) deposited, if any
3. Under sub-clause (ic) wherever applicable
4. Under sub-clause (iia)
5. Under sub-clause(iib)
6. Under sub-clause (iii)
I. Date of payment
II. Amount of payment
III. Name and address of the payee
7. Under sub-clause (iv)
8. Under sub-clause (v)

21(c) - Amounts debited to profit and loss account being, interest, salary, bonus commission or
remuneration inadmissible under section 40(b)/40(ba) and computation thereof;

21(d) - Disallowance/ deemed income under section 40A(3);


Disallowance under section 40A(3)
Where –
● assessee incurs an expenditure, which is allowable and claimed as deduction; and
● the payment or aggregate of payments made to a person in a day in respect of such expenditure, otherwise
than by an account payee cheque drawn on a bank or account payee bank draft or electronic clearing
system or through such other electronic mode as may be prescribed, exceeds Rs. 10,000;
then, no deduction shall be allowed in respect of such expenditure.
● Enhanced limit to Rs. 35,000 in case of goods transport agencies: In the case of payment made for plying,
hiring or leasing goods carriages, the aforesaid limit shall be Rs. 35,000 instead of Rs. 10,000.
● However, Rule 6DD prescribes certain cases and circumstances where the above mentioned
expenditures will be allowed as deduction even if payment is made in Cash.
Auditor’s Work
On the basis of the examination of books of account and other relevant documents/ evidence, whether the
expenditure covered under section 40A(3) read with rule 6DD (RULE 6DD is exception to 40A(3)) )were made by
account payee cheque drawn on a bank account payee bank draft. If not, please furnish the details;

Serial no. Date of payment Nature of Amount Name and Permanent Account Number of the Payee,
payment if available

Dis-allowance to be made in the year of payment for expenditure incurred in earlier years Section 40A(3A)
Where-
● Assesee took deduction of an expense in a year on accrual basis.
● subsequently, during any subsequent year, the assessee makes payment in respect thereof, otherwise than
by an account payee cheque drawn on a bank or account payee bank draft or electronic clearing system or
through such other electronic mode as may be prescribed; and
● the payment or aggregate of payments so made to a person in a day exceeds Rs. 10,000;

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Audit Under Fiscal Laws

then, the payment made shall be deemed to be the profits and gains of business or profession and accordingly
chargeable to income-tax as income of the subsequent year.

Auditor’s Work
On the basis of the examination of books of account and other relevant documents/ evidence, auditor has to
check whether the payment referred to in section 40A(3A) read with rule 6DD were made by account payee
cheque drawn on a bank or account payee bank draft. If not, please furnish the details of amount deemed to be
the profits and gains of business or profession under section 40A(3A);

Serial no. Date of payment Nature of Amount Name and Permanent Account
payment Number of the Payee, if available

21(e) - Provision for payment of gratuity not allowable under section 40A(7);

Audit Procedures
- Check contribution is made to recognised gratuity fund.
- Trust deed.
- Order of commissioner of income tyax granting approval.
- Rules of Gratuity fund.
- Calculations.
- Check payments made out of Provisions.

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Audit Under Fiscal Laws

21(f) - Any sum paid by the assessee as an employer not allowable under section 40A(9);

Audit Procedures
- Obtain particulars of payments made.
- Divide the payments in allowed and disallowed category.
- Check accounts for confirm the partriculars received.
- Check accounts to identify any payment details of which is not given by assessee.
- Check staff welfare account

21(g)- Particulars of any liability of a contingent nature;


- Refer relevant accounting standard to determine what constitutes a contingent liability.
- Obtain a schedule indicating contingent liabilities being debited to profit and loss account.
- Scrutinise the correspondence relating to cases pending in courts of law.
- If particulars relating to contingent liabilities are not available then a suitable note should be given
under this clause.
- The reporting should be done in the following format:

S.No. Nature of Year in Total amount Amount Reasons for Remarks


claim which claim debited to debit
raised P&L A/c

21(h)- Amount of deduction inadmissible in terms of section 14A in respect of the expenditure
incurred in relation to income which does not form part of the total income;
- Verify if the assessee's total income includes tax-exempt income.
- Examine if the assessee claimed expenses against such income.
- Scrutinize expense accounts, especially interest, for expenses linked to exempt income.
- Even if an assessee claims no expenditure related to income not part of the total income, section 14A
still applies.

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21(i) -Amount inadmissible under the proviso to section 36(1)(iii).

● Verify if the assessee expanded business or acquired new assets.


● Determine if the assessee borrowed capital for such expansion.
● Examine if the assessee debited interest on borrowed capital for new assets to the Profit and Loss account
before assets was put to use
● Such debited interest would be inadmissible under section 36(1)(iii) proviso.

Clause 22
a. Amount of interest inadmissible under section 23 of the Micro, Small and Medium Enterprises
Development Act, 2016

Auditor’s Consideration

Section 23 of the MSME Act lays down that an interest payable or paid by the buyer, under or in accordance
with the provisions of this Act, shall not for the purposes of the computation of income under the income-tax
Act 1961 be allowed as a deduction.

1. Determine if the enterprise falls under the MSME Development Act, 2006.
2. Report available or Unavailable information in Form No. 3CD;
3. Cross-check interest disclosures per Section 22 of the MSME Act, 2006.
4. Gather a complete list of "Supplier" classified suppliers under the MSME Act, 2006.
5. Conduct a review of the obtained supplier list.
6. Inspect accounts for any interest payable or paid under Section 16 of the MSME Act.
7. Perform a test check verification of interest paid or payable.
8. Confirm additional interest-related information in the auditee's financial statement.
9. If satisfied, report the debited amount under clause 22 after test check.
10. If the tax auditor verifies that the auditee hasn't provisioned or paid any interest due under the MSME
Act, no amount is inadmissible under Section 23, and this should be duly reported in the e-filing utility
format.

Clause 23
Particulars of payments made to persons specified under section 40A(2)(b).

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Audit Under Fiscal Laws

Payments to relatives and associates - Section 40A(2)


If the
● assessee incurs any expenditure in respect of which payment has been or is to be made to 'specified
persons'; and
● the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to-
○ the fair market value of goods, services or facilities for which the payment is made; or
○ the legitimate needs of the business or profession of the assessee; or the benefit derived by or
accruing to assessee there from;

then, so much of the expenditure as is so considered by the Assessing Officer to be excessive or unreasonable
shall not be allowed as deduction.

Thus, amount to be disallowed = Expenditure incurred - FMV of goods/services/facilities/benefit etc. received


by the assessee.

Clause 24
Amounts deemed to be profits and gains under section 32AC or 32AD or 33AB or 33ABA or 33AC.

Clause 25
Any amount of profit chargeable to tax under section 41 and computation thereof.
Audit Procedures
1. Obtain a list of all charges under Sec 41, with supporting documents.
2. Examine past records for information accuracy provided by the assessee.
3. Report profit taxable under this section, regardless of P&L account credit status.
4. Also state the calculation of profit chargeable under this clause.

The tax auditor should maintain the following in his working papers for the purpose of furnishing details
required in the format provided in the e-filing utility:

S.No. Name of the Amount of Section Description of Computation (if


person Income transaction Any)

1 2 3 4 5 6

Clause 26
In respect of any sum referred to in clause (a), (b), (c ), (d), (e), (f) or (g) of section 43B, the liability for which:-
a. Pre -existed on the first day of the previous year but was not allowed in the assessment of any preceding
previous year and was
I. Paid during the previous year;
II. Not paid during the previous year;
b. Was incurred in the previous year and was
I. Paid on or before the due date for furnishing the return of income of the previous year under
section 139(1);
II. Not paid on or before the aforesaid date.
(State whether the sales tax, customs duty, excise duty or any other indirect tax, levy, cess,
impost, etc, is passed through the profit and loss account.

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Audit Under Fiscal Laws

Clause 27
a. Amount of Central Value added Tax / GST Credits availed of or utilised during the previous year and its
treatment in the profit and loss account and treatment of outstanding Central Value Added Tax / GST
Credits in the accounts.

1. Disclose the amount of CENVAT/GST availed and used in this sub-clause.


2. Report the opening and closing balances of CENVAT/GST to avoid misunderstandings.
3. It's advisable to report both the availed and utilized credits of the previous year.
4. Report on how CENVAT/GST credit is treated in the profit and loss account and outstanding credits.
5. As a tax auditor, you should record and keep the following data in your working papers to report
using the e-filing utility format.

CENVAT / GST Amount Treatment in P&L Accounts

Opening balance

CENVAT / GST Availed

CENVAT / GST Utilised

Closing / outstanding Balance

b. Particulars of income or expenditure of prior period credited or debited to the profit and loss account.

1. This clause applies only to assessees following the mercantile accounting system.
2. In cash accounting, expenses/income debited/credited to P&L are for the current year.
3. Tax auditors should note previous years' expenditures or incomes if mercantile system is used.
4. Information may be obtained from annual accounts in audited businesses or professions.
5. In non-audited businesses, detailed ledger review may be necessary for expenditure or income period.

As a tax auditor, you should keep the following information in your working files for reporting in the e-filing
utility format:

S.No. Type Particulars Amount Prior Period to which it


relates

Clause 28 (Not Applicable as per current tax laws)


Whether during the previous year the assessee has received any property, being share of a company for not
being a company in which the public are substantially interested, without consideration or for inadequate
consideration as referred to in section 56(2)(viia), if yes, please furnish the details of the same.

Provisions of Section 56(2)(viia) are not applicable for transactions taken place on or after 01.04.2017

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Clause 29A
a. Whether any amount is to be included as income chargeable under the head ‘ income from other
sources as referred to in clause (ix) of sub-section (2) of section 56? (Yes/No)
b. If Yes, please furnish the following details:
I. Nature of income;
II. Amount thereof.

56(2)(ix)
Any sum of money received as an advance or otherwise in the course of negotiations for transfer of a capital
asset, if
a. such sum is forfeited; and
b. the negotiations do not result in transfer of such capital asset;

Audit Points
1. Acquire certificate from assessee for all such advances.
2. Review if any advances were written back this year and the basis of such action.
3. Examine contract terms to verify the conditions for forfeiting advances and actual forfeiture.

Clause 29B
a. Whether any amount is to be included as income chargeable under the head ‘income from other sources’
as referred to in clause (x) of sub-section(2) of section 56? (YES/NO)
b. If yes, please furnish the following details:
I. Nature of Income;
II. Amount (In Rs.) thereof.

Taxation of Gifts - 56(2)(x)


● Sum of Money.
○ If Aggregate Money › ₹ 50,000 then whole of money shall be taxable
● Immovable Property (Land, Building or Both)
○ Without Consideration
■ If per property, SDV > ₹ 50,000 then entire SDV shall be taxable
○ Inadequate Consideration
■ If per Property
● (SDV-Consideration) > ₹ 50,000 And
● SDV is more than 110% of Consideration
○ then difference between SDV & Consideration shall be taxable
○ SDV on Date of Agreement - Where
■ the date of agreement fixing the amount of consideration for the transfer of immovable
property and
■ the date of registration
■ are not the same,
● the stamp duty value on the date of agreement may be taken
● only in a case where the amount of consideration or a part thereof,
● has been paid by way of an account payee cheque or an account payee bank draft
or by use of electronic clearing system through a bank account, or such
prescribed electronic mode
● on or before the date of agreement for transfer of such immovable property

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● The prescribed electronic modes notified are credit card, debit card, net
banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface),
RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer),
and BHIM (Bharat Interface for Money) Aadhar Pay as other electronic modes of
payment
○ Valuation officer
■ If assessee is not satisfied with SDV then his case may be referred to Valuation Officer
(same as sec, 50C)
● Property other than IMP - any property, other than immovable property
○ Without consideration,
■ If Agg. FMV > ₹ 50,000 then entire FMV shall be taxable
○ Inadequate consideration
■ If Agg. (FMV- consideration) > ₹ 50,000, the difference between FMV & consideration
shall be taxable
Audit Procedures
● Obtain a certificate regarding any such receipts during the year.
● In case of asset valuation disputes, suggest the assessee get a registered valuer's report.
● If stamp duty value is disputed and unresolved by audit's end, the auditor should report this.

Clause 29
Whether during the previous year the assessee received any consideration for issue of shares which exceeds the
fair market value of the shares as referred to in section 56(2)(viib), if yes, please furnish the details of the same.
56(2)(viib)
● In case of a closely held company in case of issue of shares to a resident shareholder at premium Issue
Price - FMV will be taxable in the hands of the company.
● Fair market value of the shares shall be the higher of, the value as may be –
○ determined in accordance with the prescribed method; or
○ substantiated by the company to the satisfaction of the Assessing Officer, based on the value of
its assets on the date of issue of shares.
● For the purpose of computation of FMV, the value of assets would include the value of intangible assets
being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business
or commercial rights of similar nature.
AB Ltd. is a company in which public are not substantially interested. During the previous year 2022-23, the
company issued shares to residents of India and provides you the following data related to such issue:
No. of shares issued 1,00,000
Face Value Rs. 10 per share
Fair Market Value (FMV) Rs. 60 per share
Consideration received Rs. 80 per share
The management of the company contends that, it is a normal issue of shares, thus, needs not to be reported. As
the tax auditor of AB Ltd., how would you deal with the matter in your tax audit report?
(MTP2, Nov 2018, 5 marks)

Clause 30
Details of any amount borrowed on hundi or any amount due thereon (including interest on the amount
borrowed) repaid, otherwise than through an account payee cheque. [Section 69D].

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Clause 30A - Primary adjustment to transfer price


a. Whether primary adjustment to transfer price, as referred to in sub-section (1) of section 92CE, has been
made during the previous year? (Yes/No)
b. If yes, please furnish the following details:-
i) Under which clause of sub-section (1) of section 92CE primary adjustment is made?
ii) Amount (in Rs) of primary adjustment:
iii) Whether the excess money available with the associated enterprise is required to be repatriated to
India as per the provisions of sub-section (2) of section 92CE? (Yes/No)
iv) If yes, whether the excess money has been repatriated within the prescribed time (Yes/No)
v) If no, the amount (in Rs) of interest income on such excess money which has not been repatriated
within the prescribed time:

Clause 30B - Expenditure by way of interest or of similar nature exceeding Rs 1 crore


a. Whether the assessee has incurred expenditure during the previous year by way of interest or of similar
nature exceeding Rs 1 crore as referred to in subsection (1) of section 94B? (Yes/No)
b. If yes, please furnish the following details:-
i) Amount (in Rs) of expenditure by way of interest or of similar nature incurred
ii) Earnings before interest, tax, depreciation and amortization (EBITDA) during the previous year
(in Rs):
iii) Amount (in Rs) of expenditure by way of interest or of similar nature as per (i) above which
exceeds 30% of EBITDA as per (ii) above:
iv) Details of interest expenditure brought forward as per subsection (4) of section 94B:

Assessment Year Amount (in Rs)

v) Details of interest expenditure carried forward as per subsection (4) of section 94B

Assessment Year Amount (in Rs)

Clause 30C - Impermissible avoidance arrangement


a. Whether the assessee has entered into an impermissible avoidance arrangement, as referred to in section
96, during the previous year? (Yes/No.)
b. If yes, please specify:—
i) Nature of impermissible avoidance arrangement:
ii) Amount (in Rs) of tax benefit in the previous year arising, in aggregate, to all the parties to the
arrangement:
NOTES
● An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain
a tax benefit.

Clause 31
a. ​Particulars of each loan or deposit in an amount exceeding the limit specified in section 269SS taken or
accepted during the previous year:-

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Audit Under Fiscal Laws

i) name, address and permanent account number (if available with the assessee) of the lender or
depositor;
ii) amount of loan or deposit taken or accepted;
iii) whether the loan or deposit was squared up during the previous year;
iv) maximum amount outstanding in the account at any time during the previous year;
v) whether the loan or deposit was taken or accepted by cheque or bank draft or use of electronic
clearing system through a bank account;
vi) in case the loan or deposit was taken or accepted by cheque or bank draft, whether the same was
taken or accepted by an account payee cheque or an account payee bank draft.
These particulars need not be given in the case of a Government company, a banking company or a
corporation established by a Central, State or Provincial Act.

269SS
No person shall accept from any other person any loan or deposit, in any manner other than by an account payee
cheque or account payee bank draft or use of electronic clearing system through a bank account, if the amount is
Rs. 20,000 or more.

Also, no person shall accept any repayment of loan or deposit, in any other mode than an account payee cheque
or account payee bank draft or by use of electronic clearing system through a bank account, if the amount is Rs.
20,000 or more.

If the total of all loans/deposits from a person exceed ₹ 20,000 but each individual item is less than ₹ 20,000, the
information will still be required to be given in respect of all such entries starting from the entry when the
balance reaches ₹ 20,000 or more and until the balance goes down below ₹ 20,000. As such the tax auditor
should verify all loans/deposits taken or accepted where balance has reached ₹ 20,000 or more during the year
for the purpose of reporting under this clause.

b. Particulars of each specified sum in an amount exceeding the limit specified in section 269SS taken or
accepted during the previous year:-
i) name, address and Permanent Account Number (if available with the assessee) of the person
from whom specified sum is received;
ii) amount of specified sum taken or accepted;
iii) whether the specified sum was taken or accepted by cheque or bank draft or use of electronic
clearing system through a bank account;
iv) in case the specified sum was taken or accepted by cheque or bank draft, whether the same was
taken or accepted by an account payee cheque or an account payee bank draft.
(Particulars at (a) and (b) need not be given in the case of a Government company, a banking company or
a corporation established by the Central, State or Provincial Act.)

ba. Particulars of each receipt in an amount exceeding the limit specified in section 269ST, in aggregate from
a person in a day or in respect of a single transaction or in respect of transactions relating to one event or
occasion from a person, during the previous year, where such receipt is otherwise than by a cheque or bank
draft or use of electronic clearing system through a bank account:-
i) Name, address and Permanent Account Number (if available with the assessee) of the payer;
ii) Nature of transaction;
iii) Amount of receipt (in Rs );
iv) Date of receipt;

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269ST
No person shall receive an amount of two lakh rupees or more in aggregate from a person in a day; or in respect
of a single transaction; or in respect of transactions relating to one event or occasion from a person, otherwise
than by an account payee cheque or an account payee bank draft or use of electronic clearing system through a
bank account.

bb. Particulars of each receipt in an amount exceeding the limit specified in section 269ST, in aggregate from
a person in a day or in respect of a single transaction or in respect of transactions relating to one event or
occasion from a person, received by a cheque or bank draft, not being an account payee cheque or an
account payee bank draft, during the previous year:—
i) Name, address and Permanent Account Number (if available with the assessee) of the payer;
ii) Amount of receipt (in Rs);

bc. Particulars of each payment made in an amount exceeding the limit specified in section 269ST, in
aggregate to a person in a day or in respect of a single transaction or in respect of transactions relating
to one event or occasion to a person, otherwise than by a cheque or bank draft or use of electronic clearing
system through a bank account during the previous year:-
i) Name, address and Permanent Account Number (if available with the assessee) of the payee;
ii) Nature of transaction;
iii) Amount of payment (in Rs);
iv) Date of payment;

bd. Particulars of each payment in an amount exceeding the limit specified in section 269ST, in aggregate to
a person in a day or in respect of a single transaction or in respect of transactions relating to one event
or occasion to a person, made by a cheque or bank draft, not being an account payee cheque or an account
payee bank draft, during the previous year:—
i) Name, address and Permanent Account Number (if available with the assessee) of the payee;
ii) Amount of payment (in Rs);

(Particulars at (ba), (bb), (bc) and (bd) need not be given in the case of receipt by or payment to a
Government company, a banking Company, a post office savings bank, a cooperative bank or in the
case of transactions referred to in section 269SS or in the case of persons as may notified.

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Audit Under Fiscal Laws

Mr. Nemi is a contractor dealing in food catering, flower decorating and light decorating activities. He has received
contract in respect of food catering and flower decorating from one NGO for holding Annual Talent evening event
to celebrate completion of 15 years of their establishment. For the said event Mr. Nemi has received in cash Rs
1,85,000 for food catering and Rs 1,25,000 for flower decoration. As a tax auditor how would you deal and report on
the above?
(MTP1, May 2022, 5 marks) (MTP2, May 2023, 5 marks)

Clause 32
a. Details of brought forward loss or depreciation allowance, in the following manner, to the extent
available
SNo. Assessment Nature of Amount as All losses/ Amount as Amount as assessed Remarks
year loss / returned(in allowances adjusted by (give reference to
allowance rupees) not allowed withdrawal of relevant order)
under section additional
115BAA depreciation on
/115BAC account of
/115BAD opting for
taxation under
section 115BAC/
115BAD (To be
filled in for
assessment year
2021-2022 only.)

1 2 3 4 5 6 7 8

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b. whether a change in shareholding of the company has taken place in the previous year due to which the
losses incurred prior to the previous year cannot be allowed to be carried forward in terms of section 79.
c. whether the assessee has incurred any speculation loss referred to in section 73 during the previous year,
if yes, please furnish the details of the same.
d. whether the assessee has incurred any loss referred to in section 73A in respect of any specified business
during the previous year, if yes, please furnish details of the same.
e. In case of a company, please state that whether the company is deemed to be carrying on a speculation
business as referred in explanation to section 73, if yes, please furnish the details of speculation loss if
any incurred during the previous year.

Explanation to Section 73 provides that where any part of business of company consists of purchase and sale of
shares of other companies, such company. shall, for purpose of this section, be deemed to be carrying on
speculation business to extent to which business consists of purchase and sale of such shares.

Clause 33
Section-wise details of deductions, if any, admissible under Chapter VIA or Chapter III (Section 10A, Section
10AA)
Section under which deduction is Amounts admissible as per the provision of the Income Tax Act, 1961 and fulfils the conditions, if
claimed any, specified under the relevant provisions of Income Tax Act, 1961 or Income Tax Rules,1962 or
any other guidelines, circular, etc., issued in this behalf.

Clause 34
a. Whether the assessee is required to deduct or collect tax as per the provisions of Chapter XVII-B or
Chapter XVII-BB, if yes please furnish:
Tax Section Nature of Total Total Total Amount of Total Amount of Amount of
deduction payment amount of amount on amount on tax amount on tax tax
and payment or which tax which tax deducted or which tax deducted or deducted or
collection receipt of was was collected was collected on collected
Account the nature required to deducted or out of (6) deducted or (8) not
Number specified in be deducted collected at collected at deposited
(TAN) column (3) or collected specified less than to the credit
out of (4) rate out of specified of the
(5) rate out of Central
(7) Governmen
t out of (6)
and (8)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

b. Whether the assessee is required to furnish the statement of tax deducted or tax collected. If yes, please
furnish the details:
Tax deduction and Type of Form Due date for Date of Whether the statement of tax If not, please furnish list of
collection Account furnishing furnishing, if deducted or collected contains details/
Number (TAN) furnished information about all transactions which are not
transactions which are reported
required to be reported

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Audit Under Fiscal Laws

c. Whether the assessee is liable to pay interest under section 201(1A) or section 206C(7). If yes, please
furnish:
Tax deduction and collection Account Amount of interest under section 201(1A)/206C(7) Amount paid out of column (2)
Number (TAN) is payable along with date of payment.

Clause 35
a. In the case of a trading concern, give quantitative details of the principal items of goods traded:
i) Opening stock;
ii) Purchases during the previous year;
iii) Sales during the previous year;
iv) Closing stock;
v) Shortage / excess, if any.

The tax auditor should obtain certificates from assessee in respect or principal items of goods traded,
balance of opening stock, purchases, sales and closing stock and extent of shortsoe/ excess/damage and
reasons thereof.

b. In the case of a manufacturing concern, give quantitative details of the principal items of raw materials,
finished products and by-products:
A. Raw materials:
i) opening stock;
ii) purchases during the previous year;
iii) consumption during the previous year;
iv) sales during the previous year;
v) closing stock;
vi) yield of finished products;
vii) percentage of yield;
viii) shortage / excess, if any

B. Finished products / By-products:


i) opening stock;
ii) purchases during the previous year;
iii) quantity manufactured during the previous year;
iv) sales during the previous year;
v) closing stock;
vi) shortage / excess, if any.
Clause 36
Omitted

Clause 36A
a. Whether the assessee has received any amount in the nature of dividend as referred to in subclause (e) of
clause (22) of Section 2. (Yes/No)
b. If yes, please furnish the following details:
● Amount Received (in Rs)
● Date of Receipt

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Audit Under Fiscal Laws

2(22)(e)
Any advance / loan by PRIVATE company to the extent of accumulated profits (Excluding capitalized profit) to
● Equity shareholders holding not less than 10% voting power or
● Any concern in which such shareholder (holding 10% voting power in the company) is having
not less than 20% profit sharing.
● Any person, on behalf, or for the individual benefit of such shareholder.

Following things must be checked on the date on which loan/advance is given


(a) Beneficial owner of shares
(b) Holding 10% or more voting power
(c) Member/partner in a concern.

● Substantial interest will be there if the person is having 20% or more profit sharing at any time during
the previous year.
● 2(22)(e) is applicable only in case of the companies in which the public is not substantially interested.
○ In other words it is applicable only in case of closely held companies.
● If any loan or advance was given to any shareholder and subsequently the loan amount was repaid by
him, even in such cases the loan or advance shall be considered to be dividend.
Audit Points
● Tax auditor should obtain from the assessee a certificate containing a list of closely held companies in
which he is the beneficial owner of shares carrying not less than 10% of the voting power and list of
concerns in which he has a substantial interest.
● Tax auditor should also obtain a certificate from the assessee giving particulars of any loan or advance
received from any concern in which he has substantial interest or from any closely held company in which
he is a beneficial owner of shares carrying not less than 10% voting power.

Clause 37
Whether any cost audit was carried out, if yes, give the details, if any, of disqualification or disagreement on any
matter/item/value/quantity as may be reported/identified by the cost auditor.

Clause 38
Whether any audit was conducted under the Central Excise Act, 1944, if yes, give the details, if any, of
disqualification or disagreement on any matter/item/value/quantity as may be reported/identified by the auditor.

Clause 39
Whether any audit was conducted under section 72A of the Finance Act, 1994 in relation to valuation of taxable
services, Finance Act, 1994 in relation to valuation of taxable services, if yes, give the details, if any, of
disqualification or disagreement on any matter/item/value/quantity as may be reported/identified by the auditor.

Clause 40
Details regarding turnover, gross profit, etc., for the previous year and preceding previous year

Serial No. Particulars Previous Year Preceding Previous Year


1. Total turnover of the assessee
2. Gross profit /turnover
3. Net profit/turnover

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Audit Under Fiscal Laws

4. Stock-in-trade/turnover
5. Material consumed/finished goods produced
(The details required to be furnished for principal items of goods traded or manufactured or services rendered)
● These ratios have to be calculated only for assesses who are engaged in manufacturing or trading
activities.
● Moreover, the ratios have to be given for the business as a whole and need not be given product wise.

Clause 41
Please furnish the details of demand raised or refund issued during the previous year under any tax laws other
than Income-tax Act, 1961 and Wealth-tax Act, 1957 along with details of relevant proceedings.

● The tax auditor should obtain a copy of all the demand/ refund orders issued by the governmental
authorities during the previous year under any tax laws other than Income Tax Act and Wealth Tax Act.
● The auditor should exercise his professional judgment in determining the applicability to relevant tax
laws for reporting under this clause.
● It may be noted that even though the demand/refund order is issued during the previous year, it may
pertain to a period other than the relevant previous year. In such cases also, reporting has to be done
under this clause.
● If there is any adiustment of refund against any demand. the auditor shall also report the same under this
clause.

Clause 42
a. Whether the assessee is required to furnish statement in Form No. 61 or Form No. 61A or Form No.
61B? (Yes/No)
b. If yes, please furnish:

Income-tax Type of Due date for Date of furnishing, Whether the Form contains information about all
Department Reporting Form furnishing if furnished details/ transactions which are required to be
Entity Identification reported. If not, please furnish list of the
Number details/transactions which are not reported.

NOTES
● Entities must obtain the transacting party's PAN. If no PAN, transacting party fills Form 60. Details of
these Forms are to be reported in Form 61 for the period 1st October to 31st March by 30th of April and
for the period 1st April to 30th of September by 31st of October.
○ 1. Auditors should verify transactions where the other party should quote PAN.
○ 2. Verify if Form 60 declarations were obtained when PAN wasn't provided.
○ 3. Check if taxpayer filed Form 61, including necessary details.
● Reporting Entities must file Form 61A for financial transactions specified in the relevant rules.They
must report by May 31st following the financial year.
○ The auditor should check if taxpayer needs to report under Section 285BA and Rule 114E.
○ Special focus needed during bond issuance, share issuance, and buyback years.
● Form 61B is required for FATCA (Foreign Account Tax Compliance Act) and CRS (Common Reporting
Standard) implementation. Rules detail due diligence for identifying reportable accounts. Identified
accounts are reported in Form 61B by May 31st annually.

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Audit Under Fiscal Laws

○ Auditor reviews due diligence procedures and results of such procedures w.r.t Form 61B.
○ Review list of Reportable Accounts and reported information.
○ Report any omissions or errors in Form 61B in Form 3CD.
○ Verify if revised Form 61B is filed to correct original errors.
○ If any errors in the original Form 61B are rectified in the revised Form 61B, there's no need to
report them in Form 3CD.
○ Ensure Form 61B is signed by the designated director and filed.

Clause 43
a. Whether the assessee or its parent entity or alternate reporting entity is liable to furnish the report as
referred to in sub-section (2) of section 286 (Yes/No)
b. if yes, please furnish the following details
i. Whether report has been furnished by the assessee or its parent entity or an alternate reporting
entity
ii. Name of parent entity
iii. Name of alternate reporting entity (if applicable)
iv. Date of furnishing of report

● The Finance Act, 2016 by introducing Section 286 in the Act, has introduced provisions relating to the
Country by Country Report (CbCR) in India.
● Under Section 286, an international group has to furnish CbCR containing information about the whole
group comprising of various constituent entities.
● Sec. 286(2) of Income-tax Act, 1961 requires that every parent entity or the alternate reporting entity,
resident in India, shall, for every reporting accounting year, in respect of the international group of
which it is a constituent, furnish a report, to the prescribed authority within a period of 12 months from
the end of the said reporting accounting year, in the form and manner as may be prescribed.
● Report is to be filed in the Form 3CEAC.
● Tax auditor should verify whether the taxpayer is required to file the Form 3CEAC based on the
satisfaction of the conditions prescribed and whether the form has been filed within the prescribed
period.

Clause 44
Break-up of total expenditure of entities registered or not registered under the GST:
Serial Total amount of Expenditure in respect of entities registered under GST Expenditure relating
No. Expenditure incurred to entities not
during the year registered under GST

Relating to goods or Relating to Relating Total


services exempt from entities falling to other payment to
GST under composition registere registered
scheme d entities entities

Place (Signature and stamp/Seal of the signatory)


Date Name of the signatory
Full address

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Audit in Automated Environment

Chapter-15 Special Aspects of Auditing in an Automated


Environment

Meaning of Automated Environment

Can also be called Computer Environment or Computer based environment.

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Audit in Automated Environment

Layers in Automated Environment

FOR KNOWLEDGE PURPOSE ONLY - When a business operates in a more automated environment it is
likely that we will see several business functions and activities happening within the systems. Following are
some of the points to be considered.
● Computation and Calculations are automatically carried out (for example, bank interest computation
and inventory valuation)
● Accounting entries are posted automatically (for example, sub-ledger to GL postings are automatic)
● Business policies and procedures, including internal controls, are applied automatically (for example,
delegation of authority for journal approvals, customer credit limit checks are performed
automatically)
● Reports used in business are produced from systems. Management and other stakeholders rely on
these reports and information produced (for example, debtors ageing report)
● User access and security are controlled by assigning system roles to users (for example, segregation of
duties can be enforced effectively)

Relationship with SA 300, 315 and 330


● SA 300 - While planning auditor has to consider the availability of data and use of Computer assisted
audit techniques
● SA 315 - While assessing the ROMM, the auditor will now have to consider the automated controls
embedded in the information and accounting system.
● SA 330 - While testing (Compliance and substantive) auditor will use Computer assisted audit
techniques
● The key objective of audit do not change in an automated environment
● The auditor still needs to obtain an understanding of the system in order to assess control risk and plan
audit work to minimise detection risk. The level of audit testing will depend on the assessment of key

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Audit in Automated Environment

controls. If these are programmed controls, the auditor will need to ‘audit through the computer’ and
use CAATs to ensure controls are operating effectively.

Real Time Environment


Meaning

A real-time environment is a type of automated environment in which business operations and transactions are
initiated, processed and recorded immediately as they occur without any delay.

Example Core Banking

Components
● Applications - Core banking application
● Middleware - Switches, Web Servers
● Network - WAN etc
● Hardware - Storage devices, data centers

Other Points
● For a real time environment it is essential to have the systems, networks and applications available
during all times.
● Most real-time systems and environments are accessible through the public domain and internet and
hence, they are more likely to be vulnerable to network and cyber-attacks.
● It is critical for a company that operates in a real-time environment to constantly monitor all the IT
components to identify and resolve issues and failures.

CA Final RTP November 2018, MTP October 2018 - (www.icai.org)

COMPONENTS OF REAL TIME ENVIRONMENT.

A real-time environment is a type of automated environment in which business operations and transactions are initiated,
processed and recorded immediately as they happen without delay. It has several critical IT components that enable
anytime, anywhere transactions to take place. You are required to name the components and its example of real-time
environment.

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Audit in Automated Environment

Understanding and Documenting automated environment

SA 315 deals with identifying and assessing the risk of material misstatements, through understanding the
entity and its environment. It also requires obtaining an understanding of the internal control of the entity.
When an entity is operating in an automated environment the auditor should obtain an understanding of the
following in order to achieve the objective as stated in SA 315.

● Applications which are used by the entity


● IT Infrastructure components deployed in the entity
● Organisation structure and governance
● Policies, procedures and processes followed
● Risks and control

As per SA 315 read with SA 230 auditor should document his understanding of the entity and its environment
including internal control. If an entity is operating in an automated environment the understanding of the
automated environment must also be documented.

Types of Control in IT Environment


What is Control?
● Control in general means checking the
○ work is being performed as planned and
○ results are being achieved as expected.
● In every organisation there are some risks and in order to mitigate those risks we apply or use controls.
● Controls are also used to ensure compliance with regulatory or legal requirements or policies and
procedures of an organisation.

Control refers to the


● policies,
● procedures,
● practices and
● organization structures
that are designed to provide
● reasonable assurance
○ that business objectives are achieved and
○ undesired events are prevented or detected and corrected. (Management of Risk)

Who is responsible for DIM of Control?


● TCWG - Board
● Management
● Other Personnel

Types
● General IT Controls
● Application Controls
● IT Dependent Controls

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Audit in Automated Environment

General IT Controls
General Controls are
● pervasive controls and
● apply to all systems components, processes, and data for a given enterprise or systems environment.
● Includes but not limited to
○ Information security policy.
○ Administration, Access, and Authentication - IT should be administered with appropriate
policies and procedures clearly defining the levels of access to information and authentication
of users.
○ Management of Systems Acquisition and Implementation - Software solutions for CBS are most
developed, acquired and implemented. Hence, the process of acquisition and implementation of
systems should be properly controlled.
○ Change Management - IT solutions deployed and its various components must be changed in
tune with changing needs as per changes in technology environment, business processes,
regulatory and compliance requirements. All changes must be properly approved by the
management, before implementation.
○ Backup, Recovery and Business Continuity - Heavy dependence on IT and criticality makes it
imperative that resilience of operations should be ensured by having appropriate business
continuity including backup, recovery and off-site data centre.
○ Physical security.

Application Controls
● Operate at business process level
● Apply to the processing of transactions by individual applications.
● Ensure Completeness, accuracy and integrity of data.

Some examples of Application controls are as follows


● Edit checks and validation of input data,
● sequence number checks,
● user limit checks,
● reasonableness checks,
● mandatory data fields.

IT dependent controls
IT dependent controls are basically manual controls that make use of some form of data or information or
report produced from IT systems and applications.

Example - A system-generated report lists users that have not accessed a particular system within the past 60
days. The internal control may require an administrator to review such reports and disable certain users out of
it.

Due to the inherent dependency on IT, the effectiveness and reliability of Automated application controls and
IT dependent controls require the General IT Controls to be effective.

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Audit in Automated Environment

Classification of Controls on the basis of Level


(Entity Level and Process level)
Entity Level
● Part of Overall internal control
● Relates to 4 Components of IC Except Control activities
● IC has 5 components
○ Control Environment
○ Entity’s RAP
○ Information System and Communication
○ Control Activities
○ Monitoring.
● Operate across an organisation at all levels
○ From board and top management to department and transaction level.
● Hence we can say that they are pervasive.
● They are subjective in nature and hence require application of more professional judgement in their
○ Evaluation and
○ Testing
● In small and less complex companies, the entity level controls may not formally defined or documented.
● Direct ELCs
○ Business - Processes - Sub Processes - Activity and Transaction
○ Direct ELC operate at Business Level
○ They help in PDC MS in a timely manner
○ Example
■ Business performance reviews
■ Monitoring of effectiveness of control by Internal Audit Function
● Indirect ELCs
○ Not related to a specific business process, transaction or account balance
○ Not used to PDC MS
○ Contribute indirectly for effective operation of ELC and other control activities
○ Example
■ Organisation’s code of conduct
■ Having a proper whistle blower mechanism.
■ Human resource policies
■ Defining the roles and responsibilities of employees

What auditor will do w.r.t ELCs


● Out of the 4 relevant components of the IC Information system, communication is of utmost
importance in case of an automated environment.
● To understand information and communication system the auditor must understand
○ how business processes operate;
○ the relevant information systems used in the processing of business transactions and activities;
○ the risks and controls pertaining to the information systems and underlying infrastructure;
○ reliability of information generated from systems.
● Auditors are required to understand, evaluate and validate the entity level controls as a part of an audit
engagement.

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Audit in Automated Environment

● The results of testing entity level controls could have an impact on the nature, timing and extent of
other audit procedures including testing of controls.
● For example, when the entity level controls at a company are ___________________, the auditor may
consider ________________ the number of samples in the test of controls.

Process Level Controls


● Every Financial Statement Line Item is a result of a business process.
● For example, The value of sales in the FS is a line item and it is the result of business process - SALES
● Business Process - Sub Processes - Activity
● Auditors must understand the business process that makes up an account balance or financial statement
line item.
● Understanding the business process helps the auditor in identification of risks and controls within each
process, sub-process and activity. The auditor should document this understanding of the company’s
business process and flow of transactions in the audit file in accordance with SA 230.

CA Final May 2018(New)- (www.icai.org)

While evaluating the risks and controls at entity level, the Auditor should take cognizance of the prevalent direct and
indirect entity level controls operating in the entity. Explain what they pertain to, with few examples.

Answer

Data Analytics
● Generating and preparing meaningful information from raw system data using processes, tools, and
techniques is known as Data Analytics.
● The data analytics methods used in an audit are known as Computer Assisted Auditing Techniques or
CAATs.
● When auditing in an automated environment, auditors can apply the concepts of data analytics for
several aspects of an audit including the following:
● Preliminary Analytics
● Risk Assessment
● Control testing
● Non-Standard Journal Analysis
● Evaluation of deficiencies
● Fraud risk assessment

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Audit in Automated Environment

Steps / Approach to be followed while using CAATs

CA Final RTP May 2019- (www.icai.org)

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 the above
you are required to briefly discuss the meaning of data analytics and examples of circumstances when auditing in
an automated environment, auditors can apply the concepts of data analytics.

Consideration of automated environment in audit cycle


“The audit cycle consists of Planning, Execution and Completion. The automation in processing of business
transactions has considerations to be weighed by the Auditor at every phase of this cycle." Enumerate the focal
points of such considerations when auditing in an automated environment. [Nov. 2018]

In a controls-based audit, the audit approach can be classified into three broad phases comprising planning,
execution, and completion. In this approach, the considerations of an automated environment will be relevant
at every phase as given below.

● During risk assessment,


○ the auditor should consider risk arising from the use of IT systems at the company
● when obtaining an understanding of the business process and performing walkthroughs
○ the use of IT systems and applications should be considered.
● While assessing the entity level controls
○ the aspects related to IT governance need to be understood and reviewed;
● Pervasive controls including segregation of duties, general IT controls and applications
○ should be considered and reviewed
● During testing phase,

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Audit in Automated Environment

○ the results of general IT controls would impact the nature, timing and extent of testing
● When testing of reports and information produced by the entity (IPE) generated through IT systems and
applications
○ Consider the controls that ensure completeness, accuracy and integrity of the such IPE
● At the completion stage, evaluation of control deficiencies may require using data analytics and CAATs.

Enterprise Risk Management


What is Risk?
● Risk is the possibility that something could go wrong

Another definition
● Risk is uncertainty in achieving objectives.
● In simple terms, Risk can be defined as:
○ “the potential harm caused
○ if a threat exploits a particular vulnerability
○ For example: inadequate security is a vulnerability which could be exploited by a hacker.
● Risk can also be defined as “Exposure to potential losses.”

Some examples of Risk


● Market Risks
● Legal & Compliance Risks
● Technology and Security Risk
● Financial reporting risk
● Operational risk
● Credit risk
● Business Partner Risk
● Product Risk
● Project Risk
● Environmental risk

The business environment is becoming more and more dynamic and volatile. Some of the reasons for this
dynamic environment include globalisation, use of technology, new regulatory requirements, etc.

Because of this dynamic environment the associated risks to business have also increased and companies have a
need to continuously manage risks.

What is Risk Management?


Risk Management is a combination of process, people, tools and techniques through which companies identify,
assess, respond, mitigate and monitor risks.

Enterprise Risk Management


Enterprise Risk Management is a formal program or framework that is implemented across an enterprise or
company for enabling risk management.

One of the most critical components of Enterprise Risk Management is the Risk Assessment process.

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Audit in Automated Environment

The risk assessment process involves considerations for:


● qualitative and quantitative factors
● definition of key performance and risk indicators
● risk appetite;
● risk scores,
● scales and maps;
● use of data & metrics;
● benchmarking.

Steps in Risk Assessment Process


1. Define business objectives and goals
2. Identify events that affect achievement of business objectives
3. Assess the likelihood and impact
4. Respond and Mitigate Risk
5. Assess the residual risk.

Enterprise Risk Management & Internal Control


The internal control framework of a company is not separate, though it is an integral part of an Enterprise Risk
Management program.

The scope of an Enterprise Risk Management program is much broader than an internal control framework and
encompasses both internal and external factors that are relevant to business strategy, governance, business
process and transaction and activity level.

Internal control has specific objectives like safeguarding of assets, reliability of financial reporting etc. and
gives reasonable assurance about the same. Design implementation and maintenance of internal control cannot
compensate or provide assurance with respect to risk management for the entity.

Frameworks / Models for ERM


One of the most common frameworks that is suitable for implementing an effective enterprise risk
management is the COSO Enterprise Risk Management – Integrated Framework developed by the Committee
of Sponsoring Organisations (COSO) in 2004 and subsequently updated in 2016 to address the changes in
business environment.

Apart from the COSO framework, another relevant and widely available framework is the ISO 31000 Risk
Management standard published by the International Organization for Standardization.

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Liabilities of Auditor

Chapter-16 Liabilities of Auditor


Overview of Chapter

Nature of Auditor’s Liability


“Every person who enters into a learned profession undertakes to bring to the exercise of it a reasonable degree
of care and skill. He does not undertake, if he is an attorney, that at all events he shall gain his case, nor does a
surgeon undertake that he will perform a cure; nor does he undertake to use the highest degree of skill. There
may be persons who have a higher education and greater advantages than he has; but he undertakes to bring a
fair, reasonable and competent degree of skill.”

The work of an auditor being of a personal character, it must be performed either by him or by his persons
under his supervision since he himself remains finally responsible. - Also Refer to Clause 12 of Part I of First
Schedule.

No auditor can escape from personal liability by taking shelter under the misconduct of his own employees.

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Liabilities of Auditor

Professional Negligence
Failure to perform duties according to “accepted professional standards”, resulting in some loss or damage to a
party to whom the duty is owed.

Existence of Duty or Responsibility


A Chartered Accountant will be deemed to be guilty of negligence only when he owed a duty to a person(s) and
he had failed to perform or performed it with gross negligence.

Occurrence of Breach
To prove the occurrence of breach it is necessary to prove that there has been a deviation from the standard of
care and diligence which he was expected to exercise in the performance of his duties.

A professional man does not guarantee the success of his professional effort. Nevertheless he is expected to
possess a certain amount of knowledge and experience and he must exercise a reasonable degree of care and
skill for the performance of duties. If there is any default or failure in the conduct of an audit or in carrying out
any other engagement judged by professional standards the person responsible, therefore, would be guilty of
negligence.

Loss or Detriment
Loss or detriment, being suffered by the party to whom the duty was owed as a result of negligence.

Liability under companies act

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Liabilities of Auditor

Criminal Liability - Section 34 - Criminal liability for mis-statements in prospectus

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Liabilities of Auditor

Punishment For Fraud - 447

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Liabilities of Auditor

Civil Liabilities

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Liabilities of Auditor

Definition of an Expert 2(38)


"expert" includes an engineer, a valuer, a chartered accountant, a company secretary, a cost accountant and any
other person who has the power or authority to issue a certificate in pursuance of any law for the time being in
force;

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Liabilities of Auditor

Liability for Misfeasance

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Liabilities of Auditor

Liability under Income Tax Law

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Liabilities of Auditor

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CARO, 2020

Chapter-17 CARO - COMPANIES (AUDITOR'S REPORT) ORDER,


2020

Section 143(11)
The Central Government may,
● in consultation with the National Financial Reporting Authority,
● 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

Applicability
It shall apply to every company including a foreign company as defined in clause (42) of section 2 of the
Companies Act. 2013 except
● A banking company;
● An insurance company;
● A company licensed to operate u/s 8 of the Companies Act;
● A One person company as defined in sec. 2(62) of the Companies Act and a small Company as defined in
Sec. 2(85) of the Companies Act; and
● A private limited company, not being a subsidiary or holding of a public company,
○ Having a paid up capital & Reserves & surplus not more than Rs 1 Cr. as on the balance sheet
date, and
○ Which does not have total borrowings exceeding Rs 1 Cr. 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 Schedule III to the Companies Act, 2013
(Including revenue from discontinuing operations) exceeding Rs. 10 Crore during the financial
year as per the financial statements.

This Order shall NOT apply to the auditor's report on Consolidated FS except clause (xxi) of paragraph 3.

Paid up Share capital


● Paid up capital includes equity as well as preference.
● Amount originally paid up on forfeited shares should be added to the figure of paid up capital.
● Share Application money pending allotment - NO.
● Securities Premium - YES
● General Reserve - YES
● Reserves include Capital reserves, revenue reserves as well as Revaluation Reserves.
● Credit Balance of Profit and Loss Account will form part of the reserve.
● In case of debit balance of profit or loss, the same shall be netted for computing reserves & surplus.

Borrowings
● Loans from banks and financial institutions are to be considered in aggregate.

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CARO, 2020

● Financial Institutions include NBFC.


● Loans may be in any form like term loan, demand loans, cash credit overdraft, export credit, bill
purchased/discounted.
● Long term loans as well as short term loans, secured as well as unsecured will be considered .
● Outstanding dues, in respect of credit cards will also be considered.
● Interest accrued and also due will form part of loans and borrowings. If interest is only accrued it will
not form part of loan
● Fund based facilities are counted in borrowings whereas non fund based facilities are not counted.
● Security amount is not to be adjusted
● Loans from other than banking and financial institutions shall not be considered
● Limit or actual Amount? -

Total Revenue
● Revenue from operations and other Income.
● Here revenue will also include revenue from discontinuing operations as specified in the Order.
● Other income shall consist of the following;
❖ Interest Income (other than a finance company);
❖ Dividend Income;
❖ Net gain/loss on sale of investments;
❖ Other non-operating income (net of expenses directly attributable to such income).
● GST, Excise etc will not form part of revenue

Other Notes
Discussion on Small Company
A company is covered under the definition of small company; it will remain exempted from the applicability of
the Order even if it falls under any of the criteria specified for private company.

Definition of Small Company


Sec 2(85) of the Companies Act, 2013 defines a small company. As present, is a private company which satisfies
both the following conditions

- Paid Up Share Capital ≤ 4 crores AND


- Turnover ≤ 40 crores.

The following 3 categories of Companies shall NOT be regarded as SMALL Companies:


1. A HOLDING company or a SUBSIDIARY company.
2. A company registered under SECTION 8. or
3. A company or body corporate governed by any SPECIAL ACT.

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CARO, 2020

Para 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 on the accounts of every company
audited by him, to which this Order applies, contain the matters specified in paragraphs 3 and 4, as may be
applicable

Provided this Order shall not apply to the auditor's report on consolidated financial statements except clause
(xxi) of paragraph 3.

Para 4 - Reasons to be stated for unfavourable or qualified answers.


- 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

- Where the auditor is unable to express any opinion on any specific matter,
- his report shall
- indicate such fact
- with the reasons as to why it is not possible for him to give his opinion On the same.

Para 3- Matters to be included in the auditor’s report under CARO, 2020


The auditor's report on the accounts of a company to which this Order applies shall include a statement on the
following matters, namely:-

Para 3(i)- Property, Plant and Equipment -


Proper Records
Whether the company is maintaining proper records
- showing full particulars,
- including quantitative details and
- situation of Property, Plant and Equipment;

Proper records - Intangible assets


Whether the company is maintaining proper records showing full particulars of intangible assets;

Physical Verification
Whether these Property, Plant and Equipment have been physically verified by the management at reasonable
intervals;

Material discrepancies
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.

Title Deeds
Whether the title deeds of all the immovable properties

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CARO, 2020

- (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 statements are held in the name of the company, if not, provide the details thereof in
the format below

Revaluation of PPE / ITA


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;

Proceedings for benami property


● 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;

Para 3(ii) - Inventory


Physical Verification, Coverage and Procedure.
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;

Discrepancies of 10% or more


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;

Working capital limits


Whether
● during any point of time of the year,
● the company has been sanctioned working capital limits in excess of five crore rupees,

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CARO, 2020

● 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;

Para 3(iii) - Investment / Guarantee / Security / Loans and Advances


a. whether during the year the company has provided loans or provided advances in the nature of loans, or
[not applicable to companies whose principal business is to give loans]
furnished guarantee, or provided security to any other entity ,
if so, indicate-
○ 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;
○ 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;

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CARO, 2020

3(iv) - Sections 185 and 186


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;

3(v) - Deposit Accepted


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;

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CARO, 2020

3(vi) Cost Records


● 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.

3 (vii) Statutory Dues


Undisputed statutory dues
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;

Disputed statutory dues


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);

3(viii)
Whether any transactions

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CARO, 2020

● 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;

3(ix) Repayment of Loan Etc


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 lender Amount not Whether principal or No. of days delay or Remarks, if any
borrowing, paid on due interest unpaid
including date
debt
securities

lender wise details to be


provided in case of defaults
to banks, 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;

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CARO, 2020

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CARO, 2020

3(x) - IPO FPO etc


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 noncompliance;

3 (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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CARO, 2020

3(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.

3 (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

3 (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.

3 (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

3(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;

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CARO, 2020

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;

Core Investment Companies


● Core Investment Companies (CICs) are specialized Non-Banking Financial Companies (NBFCs).
● A Core Investment Company registered with the RBI has an asset size of above Rs 100 crore.
● Their main business is acquisition of shares and securities with certain conditions.

3(xvii) - Cash losses


- 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

3 (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.

3 (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 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.

3(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 subsection (5) of section 135 of the Companies Act,
pursuant to any ongoing project,

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CARO, 2020

○ has been transferred to special account in compliance with the provision of subsection (6) of
section 135 of the said Act.

3(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.

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Miscellaneous

Chapter- 18 Miscellaneous
AUDIT PROGRAMME
Meaning
An audit programme consists of
- a series of verification procedures
- to be applied to the financial statements and accounts of a given company
- for the purpose of obtaining sufficient evidence
- to enable the auditor to express an informed opinion on such statements.

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

Nature of Business in which the organisation is engaged.


On first appointment, the auditor should evaluate financial & accounting organization by visiting client's office,
observing transaction process & records. For industrial concerns, visit the factory to understand manufacturing
processes, quantitative records and loss statistics. The audit program should be developed based on the
technical, financial, and accounting structure of the company.

Overall Plan
Draw up an overall plan for the audit program to ensure systematic work. Any divergence from this plan
requires modification after due consideration before incorporating it into the audit program. Strict adherence
to the framework provided in the overall plan is essential.

System of internal control and accounting procedures:


Internal control system ensures constant check on financial and statistical records.
Auditors require proper transaction authorization for accurate financial statements.
Evaluation of internal controls aids in shaping substantive auditing procedures. Examination of internal control
should involve review, testing, and evaluation.

Size of the organisation and structure of its management


Larger organization size increases complexity in examining accounting records, especially with multiple
branches or products.

Information as regards organisation of the business.


Auditor needs client's history, business details, engagement purpose, and audit timeline to plan audit.

Accounting and management policies


Reviewing past financial statements reveals past accounting and management policies and their consistency.

Drawing up the audit programme


With collected information, the auditor can decide audit coverage, detail level, test checks, and specific audit
procedures. 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

1. Firstly a broad outline of the audit programme should be drawn up.


2. After reviewing internal procedures, fill details considering internal control deficiencies.

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Miscellaneous

3. Post-detailed checks, determine required special procedures like balance verification and asset
inspections.Nature of business might necessitate special procedures, like tax liability verification for
shipping companies.

Review and modification of audit program


At each subsequent engagement, the programme should be reviewed and, if necessary, modified on account of:
1. Experience gained during the previous audits;
2. 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
3. Evaluation of internal control made for the current year.

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

Internal control
Objectives of Internal Control System

The objectives of internal controls relating to the accounting system are:


1. Transactions are executed through general or specific management authorization.
2. All transactions are promptly recorded in an appropriate manner to permit the preparation of financial
information and to maintain accountability of assets
3. Assets and records are safeguarded from unauthorized access, use or disposition.
4. Assets are verified at reasonable intervals and appropriate action is taken with regard to the
discrepancies.

Ensure all transactions are


● Recorded
● Real
● Properly valued
● Classified and disclosed
● Properly Valued
● Timely Posted and
● Summarized.

Limitation of Internal Control


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.

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Miscellaneous

● 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 emplovees 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.

Neeraj Arora | www.edu91.org 18.3

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