Chapter 1 Nature objective & scope

1. MEANING AND DEFINITION OF AUDITING

1. Audit is Independent examination of Financial information

2. of any entity – that entity may be profit oriented or not and irrespective of its
size or legal form.
{ For example – Profit oriented – Audit of Listed company engaged in business.
On the other hand, Audit of NGO – not profit oriented.}
3. The objective of the audit is to express an opinion on the financial statements.

The person conducting this task should take care to ensure that financial
statements would not mislead anybody.
This he can do honestly by satisfying himself that:
(i) the accounts have been drawn up with reference to entries in the books of account
(ii) the entries in the books of account are adequately supported by sufficient and
appropriate evidence;
(iii) none of the entries in the books of account has been omitted in the process of
compilation and nothing which is not in the books of account has found place in the
statements;
(iv) the information conveyed by the statements is clear and unambiguous;
(v) the financial statement amounts are properly classified, described and disclosed
in conformity with accounting standards; AND
(vi) the statement of accounts present a true and fair picture of the operational
results and of the assets and liabilities.

Example

While auditing the books of accounts of Talented and Efficient Limited for the
financial year 2020-21,the auditor of the above mentioned company observed that
Repair and Maintenance Expenses of Rs. 1,30,000 and Power and Fuel Expenses of
Rs. 2,92,000 were not recorded in books of accounts,however they were appearing
in financial statements of the above mentioned company. After such observation
the auditor of Talented and Efficient Limited came to the conclusion that the
financial statements are not presenting a true and fair picture of the operational
results of Talented and Efficient Limited for the financial year 2020-21.

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2. OBJECTIVES OF AUDIT

As per SA-200 “Overall Objectives of the Independent Auditor”,

in conducting an audit of financial statements, the overall objectives of the auditor
are:
(a) 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
(b) To report on the financial statements, and communicate as required by the SAs,
in accordance with the auditor’s findings.

Example

While auditing the books of accounts of Different and Capable Limited for the
financial year 2020-21, Mr. Z the auditor of the above mentioned company
explained to a new audit team members about the objectives for which Audit of a
company is conducted. While going through the financial statements of the
company, audit team observed that there were many errors in the heads of
expenses which were material and also requirements of Companies Act, 2013 were
not complied with. When audit team discussed the matters with Mr. Z with regard
to Different and Capable Limited , he came to the conclusion that the auditors did
not obtain reasonable assurance and were unable to express an opinion on the
financial statements of the company.

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3. SCOPE OF AUDIT

The following points merit consideration in regard to scope of audit:

1. The audit should be organized to cover adequately all aspects of the enterprise
relevant to the financial statements being audited.

2. To form an opinion on the financial statements, the auditor should be reasonably

satisfied as to whether the information contained in the underlying accounting
records and other source data is reliable and sufficient as the basis for the
preparation of the financial statements.

3. In forming his opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to statutory
requirements, where applicable.

4. The auditor assesses the reliability and sufficiency of the information contained
in the underlying accounting records and other source data by:
➢ making a study and evaluation of accounting systems and internal controls; and
➢ carrying out such other tests, enquiries and other verification procedures of
accounting transactions and account balances as he considers appropriate in the
particular circumstances.

5. The auditor determines whether the relevant information is properly disclosed in

the financial statements by:
➢ comparing the financial statements with the underlying accounting records and
other source data to see whether they properly summarize the transactions and
events recorded therein; and
➢ considering the judgments that management has made in preparing the financial
statements accordingly, the auditor assesses the selection and consistent
Application of accounting policies, the manner in which the information has been
classified, and the adequacy of disclosure.

6. The auditor is not expected to perform duties which fall outside the scope of his
competence.
{ For example, the professional skill required of an auditor does not include that
of a technical expert for determining physical condition of certain assets. }

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7. Constraints on the scope of the audit of financial statements that impair the
auditor’s ability to express an unqualified opinion on such financial statement should
be set out in his report, and a qualified opinion or disclaimer of opinion should be
expressed as appropriate.

3.2 ASPECTS TO BE COVERED IN AUDIT

The principal aspects to be covered in an audit of the financial statements are :

(i) An examination of the system of accounting and internal control to ascertain

whether it is appropriate for the business and helps in properly recording all
transactions.

Example

While conducting the audit of Extremely Careful Limited for the financial year
2020-21, the engagement partner of WY and Associates, auditor of the company
explained to the audit team members about the importance of verifying the
existence and proper working of system of internal control. He explained further
that if Internal Controls relating to financial transactions are adequate and working
properly, confidence of the auditor on the books of accounts and thereby the
financial statements increases and subsequently detailed audit procedures on
various transactions would be effective and efficient

(ii) Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses exist
to allow frauds and errors going unnoticed.

(iii) Checking of the arithmetical accuracy of the books of account by the verification
of postings, balances, etc.

(iv) Verification of the authenticity and validity of transactions entered into by making
an examination of the entries in the books of accounts with the relevant supporting
documents.

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(v) Ascertaining that a proper distinction has been made between items of capital and
of revenue nature and that the amounts of various items of income and
expenditure adjusted in the accounts corresponding to the accounting period.

(vi) Comparison of the balance sheet and profit and loss account or other statements
with the underlying record in order to see that they are in accordance therewith.

(vii) Verification of the title, existence and value of the assets appearing in the
balance sheet.

Assertions about account balances at the period end:

(a) Existence —assets, liabilities, and equity interests exist.
(b) Rights and obligations —the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
(c) Completeness —all assets, liabilities and equity interests that should have been
recorded have been recorded.
(d) 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.

Definition of Assertions
It refers to representations by management, explicit or otherwise, that are
embodied in the financial statements, as used by the auditor to consider the
different types of potential misstatements that may occur.

(viii) Verification of the liabilities stated in the balance sheet.

(ix) Checking the result shown by the profit and loss and to see whether the results
shown are true and fair.

(x) Where audit is of a corporate body, confirming that the statutory requirements
have been complied with.

(xi) Reporting to the appropriate person/body whether the statements of account

examined do reveal a true and fair view of the state of affairs and of the profit
and loss of the organisation.

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3. TYPES OF AUDIT

Audit is not legally obligatory for all types of business organisations or institutions.
On this basis audits may be of two broad categories-
i.e., audits required under law and voluntary audits.

(i) Audit required under law: The organisations which require audit under law are the
following:
✓ companies governed by the Companies Act;
✓ banking companies;
✓ Other statutory bodies required by their regulators or by specific Act.

(ii) In the voluntary category are the audits of the accounts of proprietary entities,
partnership firms, HUF, etc. In respect of such accounts, there is no basic legal
requirement of audit. Many of such enterprises as a matter of internal rules
require audit. Some may be required to get their accounts audited on the
directives of Government for various purposes like sanction of grants, loans, etc.
But the important motive for getting accounts audited lies in the advantages that
follow from an independent professional audit. This is perhaps the reason why large
numbers of proprietary and partnership business firms get their accounts audited.
Government companies have some special features which will be discussed later.

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As already stated, the auditor should get the scope of his duties and
responsibilities defined by obtaining instructions in writing. Also, it is always a wise
precaution to state in the report, accompanying the financial statements of
proprietary or partnership firms or other similar organisations, the nature of the
work carried out and explain the important features of the financial statements on
which a report has been made. Furthermore, to ensure that the report will be
brought to the notice of all concerned stakeholders, the accounts should bear
reference to the report.

A special reference is necessary for non-profit making institutions like schools,

clubs, hospitals, etc. Most of these have some internal rules to govern their
affairs and generally a provision about the requirement of audit is inserted.
Activity in the nature of business is not altogether ruled out as a club may sell
drinks and eatables to the members and their guests or a school may have endowed
agricultural property to yield income. What makes them distinct, is the absence of
the question of division of profit. Any surplus which may arise can only be used for
achieving the objects of the institution. Educational institutions, hospitals,
associations, etc., irrespective of any internal rules, get their accounts audited
because most of them enjoy government or municipal grants and, generally, for this
purpose audited accounts are insisted upon.

Trusts, however, stand on a slightly different footing; these may be public trusts
or private trusts. Trusts can carry on business as well. In the majority of cases
trustees are private persons. Trusts generally have two classes of beneficiaries;
tenants for life and remainders; persons to whom the accounts are of the supreme
importance are often widows and minors, who cannot criticize the accounts in any
effective manner. Although audit of trusts, except for public trusts, is not
mandatory yet most of the trust deeds contain a clause for audit of accounts.
Private trustees also recognise the advantages of audit in their own interest, since
any erroneous treatment in the accounts for which they might be personally liable
will be pointed out by the auditor.

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5. ADVANTAGES OF AUDIT OF FINANCIAL STATEMENTS

The chief utility of audit lies in reliable financial statements on the basis of which
the state of affairs may be easy to understand. Apart from this obvious utility,
there are other advantages of audit. Some or all of these are of considerable
value even to those enterprises and organisations where audit is not compulsory,
these advantages are given below:

(a) It safeguards the financial interest of persons who are not associated with the
management of the entity, whether they are partners or shareholders ,bankers,
Financial Institutions, public at large etc.

(b) It acts as a moral check on the employees from committing defalcations or

embezzlement.

(c) Audited financial statements are helpful in settling liability for taxes, negotiating
loans and for determining the purchase consideration for a business.

(d) These are also useful for settling trade disputes for higher wages or bonus as well
as claims in respect of damage suffered by property, by fire or some other
calamity.

(e) An audit can also help in the detection of wastages and losses to show the
different ways by which these might be checked, especially those that occur due
to the absence or inadequacy of internal checks or internal control measures.

(f) Audit ascertains whether the necessary books of account and allied records have
been properly kept and helps the client in making good deficiencies or inadequacies
in this respect.

(g) As an appraisal function, audit reviews the existence and operations of various
controls in the organisations and reports weaknesses, inadequacies, etc., in them.

(h) Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.

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(i) Government may require audited and certified financial statements before it gives
assistance or issues a license for a particular trade.

ILLUSTRATION 1
The auditor of Very Different Limited explained to the audit team members as to
how the audited financial statements of the above mentioned company will help in
protecting the financial interests of shareholders of the company. Explain whether
audited financial statements of a company would help in protecting financial
interests of shareholders of that company.
SOLUTION
Audited financial statements of a company help in protecting financial interests of
shareholders of a company. Shareholders of a company are not directly involved in
management of company, so audited financial statements are definitely helpful to
the shareholders in understanding the true financial position of a company because
audit is an independent examination of financial statements of an entity.

6. INHERENT LIMITATIONS OF AUDIT

As per SA-200 “Overall Objectives of the Independent Auditor and the Conduct
of an Audit in accordance with SA’s”,

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.

The inherent limitations of an audit arise from:

(i) The Nature of Financial Reporting
The preparation of financial statements involves judgment by management in
applying the requirements of the entity’s applicable financial reporting framework
to the facts and circumstances of the entity. In addition,many financial statement
items involve subjective decisions or assessments or a degree of uncertainty, and
there may be range of acceptable interpretations or judgments that may be made.

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(ii) The Nature of Audit Procedures
There are practical and legal limitations on the auditor’s ability to obtain audit
evidence.

For example:-
1. 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.
2. Fraud may involve sophisticated and carefully organised schemes designed to conceal it.
Therefore, audit procedures used to gather audit evidence may be ineffective for
detecting an intentional misstatement that involves, for example, collusion to falsify
documentation which may cause the auditor to believe that audit evidence is valid when
it is not. The auditor is neither trained as nor expected to be an expert in the
authentication of documents.
3. 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.

We have to clearly understand that audit is distinct from investigation.

Investigation is a critical examination of the accounts with a special purpose. For
example, if fraud is suspected and it is specifically called upon to check the
accounts whether fraud really exists, it takes character of investigation.

The objective of audit, on the other hand as we have already discussed, is 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.

Therefore, audit is never started with a pre-conceived notion about state of

affairs; about wrong-doing; about some wrong having been committed. The auditor
seeks to report what he finds in normal course of examination of accounts.
However, it is quite possible that sometimes investigation results from the prima
facie findings of the auditor. It may happen that auditor has given some findings
of serious concern. Such findings may prompt for calling an investigation.

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Example
A Partnership Firm of Chartered Accountants SW and Associates was appointed to
audit the books of accounts of Efficient and Vibrant Limited for the financial year
2020-21. While auditing the books of accounts of the above mentioned company,
Mr. S one of the partners of SW and Associates observed that the management
and other senior employees of the above mentioned company were not cooperating
in providing required information for the purpose of audit to him and his audit
team members. This not so cooperative behaviour of management and senior
employees of Efficient and Vibrant Limited will act as an Inherent Limitation for
SW and Associates, thereby preventing the auditor from expressing an opinion on
the financial statements of the above mentioned company.

(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost
The matter of difficulty, time, or cost involved is not in itself a valid basis for
the auditor to omit an audit procedure for which there is no alternative.

Appropriate planning assists in making sufficient time and resources available for the
conduct of the audit. Notwithstanding this, the relevance of information, and thereby
its value, tends to diminish over time, and there is a balance to be struck between the
reliability of information and its cost.

(iv) Other Matters that Affect the Limitations of an Audit

In case of certain subject matters, 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.

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ILLUSTRATION 2
MNO Ltd requested the auditor CA P to provide for absolute assurance in respect
of its ten branches scattered in Delhi and confirm that the financial statements
are free from material misstatement due to fraud or error. Advise.
SOLUTION
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.
In view of the above, CA P cannot provide audit absolute assurance to MNO Ltd in
respect of its branches.

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ILLUSTRATION 3
DEF & Co. Chartered Accountants successfully carried out the audit of Shree
Garments for the F.Y. 2019-2020. After the completion of the audit, there were
found material misstatements due to fraud in the financial statements which were
not noticed and reported by the auditor. Management alleges that it is failure on
the part of auditor. Comment.
SOLUTION
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.
Accordingly, 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. However, the inherent limitations of an
audit are not a justification for the auditor to be satisfied with less-than-
persuasive audit evidence. Whether the auditor has performed an audit in
accordance with SAs 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.

7. RELATIONSHIP OF AUDITING WITH OTHER DISCIPLINES

The field of auditing as a discipline in simple words involves review of various

assertions; both in financial as well as in non-financial terms, with a view to prove
the veracity of such assertions and expression of opinion by auditor on the same.
Thus, it is quite logical and natural that the function of audit can be performed if
and only if the person also possesses a good knowledge about the fields in respect
of which he is conducting such a review.

Auditing and Accounting: Auditing reviews the financial

statements which are nothing but a result of the overall
accounting process.

Auditing and Law: An auditor should have a good

knowledge of business laws affecting the entity.

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Auditing and Economics: Auditor is expected to be familiar with the overall economic
environment of the client.

Auditing and Behavioural Science: Knowledge of human behaviour is essential for an

auditor to effectively discharge his duties.

Auditing and Statistics & Mathematics: Auditor is also expected to have the
knowledge of statistical sampling for meaningful conclusions and mathematics for
verification of inventories.

Auditing & Data Processing: EDP auditing in itself is developing as a discipline in itself.

Auditing and Financial Management: The auditor is expected to have knowledge about
various financial techniques such as working capital management, fund flow, ratio
analysis, capital budgeting etc. Auditing and Production: good auditor is one who
understands the client and his business functions such as production, cost system,
marketing etc.

7.1 AUDITING AND ACCOUNTING

It has been pointed out earlier that both accounting and auditing are closely
related with each other as auditing reviews the financial statements which are
nothing but a result of the overall accounting process. It naturally calls on the
part of the auditor to have a thorough and sound knowledge of generally accepted
principles of accounting before he can review the financial statements. In fact,
auditing as a discipline is also closely related with various other disciplines as
there is lot of linkages in the work which is done by an auditor in his day-to-day
activities. To begin with, it may be noted that the discipline of auditing itself is a
logical construct and everything done in auditing must be bound by the rules of
logic. Ethical precepts are the foundations on which the foundation of the entire
accounting profession rests. The knowledge of language is also considered essential
in the field of auditing as the auditor shall be required to communicate, both in
writing as well as orally, in day-to-day work.

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7.2 AUDITING AND LAW

The relationship between auditing and law is very close one. Auditing involves
examination of various transactions from the view point of whether or not these
have been properly entered into. It necessitates that an auditor should have a
good knowledge of business laws affecting the entity. He should be familiar with
the law of contracts, negotiable instruments, etc. The knowledge of taxation laws
is also inevitable as entity is required to prepare their financial statements taking
into account various provisions affected by various tax laws. In analysing the
impact of various transactions particularly from the accounting aspect, an auditor
ought to have a good knowledge about the direct as well as indirect Tax Laws.

7.3 AUDITING AND ECONOMICS

As, it is well known, accounting is concerned with the accumulation and

presentation of data relating to economic activity. Though the concept of income
as put forward by economists is different as compared to the accountants concept
of income, still, there are lot of similar grounds on which the accounting has
flourished. From the auditing view point, the auditors are more concerned with
Micro economics rather than with the Macro economics. The knowledge of Macro
economics should include the nature of economic force that affects the firm,
relationship of price, productivity and the role of Government and Government
regulations. Auditor is expected to be familiar with the overall economic
environment in which his client is operating.

7.4 AUDITING AND BEHAVIOURAL SCIENCE

The field of auditing as a discipline involves review of various assertions; both in

financial as well as in non-financial terms, with a view to prove the veracity of
such assertions and expression of opinion by auditor on the same. Thus, it is quite
logical and natural that the function of audit can be performed if and only if the
person also possesses a good knowledge about the fields in respect of which he is
conducting such a review. The discipline of behavioural science is closely linked
with the subject of auditing. While it may be said that an auditor, particularly the
financial auditor, deals basically with the figures contained in the financial
statements but he shall be required to interact with a lot of people in the

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organisation. As against the financial auditor, the internal auditor or management
auditor is expected to deal with human beings rather than financial figures. One of
the basic elements in designing the internal control system is personnel. Howsoever,
if a sound internal control structure is designed, it cannot work until and unless
the people who are working in the organisation are competent and honest. The
knowledge of human behaviour is indeed very essential for an auditor so as to
effectively discharge his duties.

7.5 AUDITING AND STATISTICS & MATHEMATICS

With the passage of time, test check procedures in auditing have become part of
generally accepted auditing procedures. With the emergence of test check
procedure, discipline of statistics has come quite close to auditing as the auditor is
also expected to have the knowledge of statistical sampling so as to arrive at
meaningful conclusions. The knowledge of mathematics is also required on the part
of auditor particularly at the time of verification of inventories. The use of data
analytics is advancing rapidly in auditing where many organizations are using
continuous auditing and continuous monitoring of data to identify risks as part of
their system of internal control.

7.6 AUDITING AND DATA PROCESSING

Today, organisations are witnessing revolution in the field of data processing of

accounts. Many organisations are carrying out their financial accounting activities
with the help of computers which can document, record, collate, allocate and value
accounting data and information in very large quantity at very high speed. The
dependence on the accuracy of the programmed instructions given today, the
computer is able to carry out each of these activities with complete accuracy.
With such a phenomenal growth in the field of computer sciences, the auditor
should have good knowledge of the components, general capability of the system
and the related terms. In fact, Computerised Information System auditing is
developing as a discipline in itself.

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`
ILLUSTRATION 4
Mr. G, one of the team members of audit team of Different and Capable Limited
was of the view that role of computers and data processing in auditing is increasing
with each passing day.
Explain how computers and data processing helps in conducting audit of a company.
SOLUTION
The role of computers and data processing is important while conducting the audit
of a particular company. Computers are able to save and process large volumes of
data and at the same time provide that data whenever required. This way
computers and data processing would be of huge help to the auditor in terms of
saving time and efforts while conducting the audit of a company.

7.7 AUDITING AND FINANCIAL MANAGEMENT

Auditing is also closely related with other functional fields of business such as
finance, production, marketing, personnel and other general areas of business
management. With the overgrowing field of auditing, the financial services sector
occupies a dominant place in our system. While in general terms, the auditor is
expected to have knowledge about various financial techniques such as working
capital management, funds flow, ratio analysis, capital budgeting etc. The auditor
is also expected to have a fair knowledge of the institutions that comprise the
market place. The knowledge of various institutions and Government activities that
influence the operations of the financial market are also required to be understood
by an auditor.

7.8 AUDITING AND PRODUCTION

Regarding production function, it may be stated that a good auditor is one who
understands the client and his business. While carrying out the audit activity, the
auditor is required to evaluate transactions from the accounting aspect in relation
to the process through which it has passed through as accounting for by-products;
joint- products may also require to be done. The knowledge of production process
shall become more essential in case of an internal auditor. The auditor shall also
require understanding the cost system in operation in the factory and assessing
whether the same is adequate for the particular company. The understanding of

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the terminology of the production shall enable an auditor to communicate with
production employees in connection with his work. On the similar pattern the
auditor is also expected to have good understanding about the marketing,
personnel and other general business management areas.

8. STANDARD SETTING PROCESS

8.1 ROLE OF INTERNATIONAL AUDITING AND ASSURANCE

STANDARDS BOARD

In 1977, the International Federation of Accountants (IFAC) was set up with a

view to bringing harmony in the profession of accountancy on an international scale.
In pursuing this mission, the IFAC Board has established the International Auditing
and Assurance Standards Board (IAASB) to develop and issue, in the public
interest and under its own authority, high quality auditing standards for use around
the world. The IFAC Board has determined that designation of the IAASB as the
responsible body, under its own authority and within its stated terms of reference,
best serves the public interest in achieving this aspect of its mission.

The IAASB functions as an independent standard-setting body under the auspices

of IFAC. The objective of the IAASB is to serve the public interest by setting
high quality auditing standards and by facilitating the convergence of international
and national standards, thereby enhancing the quality and uniformity of practice
throughout the world and strengthening public confidence in the global auditing and
assurance profession. The IAASB achieves this objective by:

♦ Establishing high quality auditing standards and guidance for financial statement
audits that are generally accepted and recognized by investors, auditors,
governments, banking regulators, securities regulators and other key stakeholders
across the world;

♦ Establishing high quality standards and guidance for other types of assurance
services on both financial and non-financial matters;

♦ Establishing high quality standards and guidance for other related services;

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♦ Establishing high quality standards for quality control covering the scope of
services addressed by the IAASB; and ♦ Publishing other pronouncements on
auditing and assurance matters, thereby advancing public understanding of the
roles and responsibility of professional auditors and assurance service providers.

International Auditing and Assurance Standards Board (IAASB)

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

Auditing and Assurance Standards Board

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

8.2 ROLE OF AUDITING AND ASSURANCE STANDARDS BOARD

The Institute of Chartered Accountants of India is a member of the IFAC and is

committed to work towards the implementation of the guidelines issued by the
IFAC. The Institute of Chartered Accountants of India constituted the Auditing
Practices Committee (APC) in 1982. The main function of the APC is to review the
existing auditing practices in India and to develop Statements on Standard
Auditing Practices (SAPs) so that these may be issued by the Council of the
Institute. While formulating the SAPs in India, the APC gives due consideration to
the international auditing guidelines issued by the IAPC and then tries to integrate
them to the extent possible in the light of the conditions and practices prevailing
in India. While formulating the SAPs, the APC takes into consideration the
applicable laws, customs, usages and business environment in India. In July, 2002,
the Auditing Practices Committee has been converted into an Auditing and
Assurance Standards Board (AASB) by the Council of the Institute, to be in line
with the international trend. A significant step has been taken aimed at bringing in
the desired transparency in the working of the Auditing and Assurance Standards
Board, through participation of representatives of various segments of the society

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and interest groups, such as, regulators, industry and academics. The
nomenclature of SAPs had also been changed to Auditing and Assurance Standards
(AASs).

A major development in the field of auditing has been the issuance of revised and
/or redrafted International Standards on Auditing pursuant to the Clarity Project
of IAASB. The objective of this project is to improve the clarity of International
Standards on Auditing (ISAs). The IAASB aims to set high quality international
auditing and assurance standards that are understandable, clear and capable of
consistent application, thereby serving to enhance the quality and uniformity of
practice worldwide. The Auditing and Assurance Standards Board has also laid out
a strategy to match step with the IAASB Clarity Project. In the year 2007, the
Board issued several revised/new Standards pursuant to the IAASB Clarity Project.

Renaming, Re-numbering and Categorisation of Auditing and Assurance Standards

In terms of the Revised Preface, the Auditing and Assurance Standards are now
renamed based on the type of assurance provided by the engagement undertaken
by a member, viz.,

SAs APPLY IN THE AUDIT OF HISTORICAL FINANCIAL STATEMENTS.

SREs APPLY IN THE REVIEW OF HISTORICAL FINANCIAL STATEMENTS.

SAEs APPLY IN ASSURANCE ENGAGEMENTS, DEALING WITH SUBJECT

MATTERS OTHER THAN HISTORICAL FINANCIAL STATEMENTS.
SRSs APPLY TO ENGAGEMENTS TO APPLY AGREED UPON PROCEDURES TO
INFORMATION AND OTHER RELATED SERVICES ENGAGEMENTS SUCH
AS COMPILATION ENGAGEMENTS.

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.

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“Historical financial information means” 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.

Here, we have to broadly understand that “audit” and “review” are two different
terms. Audit is a reasonable assurance engagement and its objective is reduction in
assurance engagement risk to an acceptably low level in the circumstances of the
engagement. However, “review” is a limited assurance engagement and its objective
is a reduction in assurance engagement risk to a level that is acceptable in the
circumstances of the engagement.

Standards on Auditing have been issued on wide spectrum of issues in the field of
auditing including (but not limited to) overall objectives of independent auditor,
audit documentation, planning an audit of financial statements, identifying and
assessing risk of material misstatement, audit evidence, audit sampling, going
concern and forming an opinion and reporting on financial statements. You would be
studying about these standards and many others in subsequent chapters.

Some examples of Standards on Auditing are-

♦ SA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit
In Accordance with Standards on Auditing
♦ SA 230 Audit Documentation
♦ SA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment
♦ SA 500 Audit Evidence ♦ Revised SA 700 Forming an Opinion and Reporting on
Financial Statements

Examples of Standards on Review engagements are-

♦ SRE 2400 (Revised) Engagements to Review Historical Financial Statements
♦ SRE 2410 Review of Interim Financial Information Performed by the Independent
Auditor of the Entity

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.

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For example, an assurance engagement relating to examination of prospective
financial information. Prospective financial information means financial information
based on assumptions about events that may occur in the future and possible
actions by an entity. It can be in the form a forecast or projection or combination
of both.

It is to be noted that in such type of assurance engagements, examination is not

of historical financial information.

Here, it is important to note the difference between “Historical financial

information” and “Prospective financial information.” The former relates to
information expressed in financial terms of an entity about economic events,
conditions or circumstances occurring in past periods. The latter relates to
financial information based on assumptions about occurrence of future events and
possible actions by an entity. Therefore, historical financial information is rooted
in past events which have already occurred whereas prospective financial
information is related to future events.

Examples of Standards on Assurance Engagements are-

♦ SAE 3400 The Examination of Prospective Financial Information
♦ SAE 3420 Assurance Engagements to Report on the Compilation of Pro Forma
Financial Information Included in a Prospectus

Lastly, there are 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.

Examples of Standards on related services are-

♦ SRS 4400 Engagements to perform agreed-upon procedures regarding financial
Information
♦ SRS 4410 (Revised) Compilation engagements

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It is to be clearly understood that all the above standards i.e., Standards on
Auditing (SAs), Standards on Review Engagements (SREs), Standards on
Assurance Engagements (SAEs) and Standards on related services (SRSs) are
collectively known as the Engagement Standards.

Further, it is also to be remembered that Standards on Quality Control (SQCs)

are to be applied for all services covered by Engagement Standards.

Diagrammatic Representation
of the Structure of Standards Under the New Preface

These Standards will apply whenever an independent audit is carried out; that is,
in the independent examination of financial information of any entity, whether
profit oriented or not, and irrespective of its size, or legal form (unless specified
otherwise) when such an examination is conducted with a view to expressing an
opinion thereon.

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While discharging their attest function, it will be the duty of members of the
Institute to ensure that the Standards are followed in the audit of financial
information covered by their audit reports. If for any reason a member has not
been able to perform an audit in accordance with the Standards, his report should
draw attention to the material departures therefrom, auditors will be expected to
follow Standards in the audits commencing on or after the date specified in the
statement. Remember all Standards are mandatory from the date mentioned
therein and it is obligatory upon members of Institute to adhere to these whenever
an audit is carried out.

All relevant Standards which are important from students’ view point have been
covered as an integral part of the text.

Compliance with Documents Issued by the Institute:

The Institute has, from time to time, issued ‘Guidance Notes’ and ‘Statements’ on
a number of matters. The ‘Statements’ have been issued with a view to securing
compliance by members on matters which, in the opinion of the Council, are critical
for the proper discharge of their functions. ‘Statements’ therefore are mandatory.

Accordingly, while discharging their attest function, it will be the duty of the
members of the Institute:

(a) to examine whether ‘Statements’ relating to accounting matters are complied with
in the presentation of financial statements covered by their audit. In the event of
any deviation from the ‘Statements’, it will be their duty to make adequate
disclosures in their audit reports so that the users of financial statements may be
aware of such deviations; and
(b) to ensure that the ‘Statements’ relating to auditing matters are followed in the
audit of financial information covered by their audit reports. If, for any reason, a
member has not been able to perform an audit in accordance with such
‘Statements’, his report should draw attention to the material departures,
therefrom.

‘Guidance Notes’:
They are primarily designed to provide guidance to members on matters which may
arise in the course of their professional work and on which they may rely in the
course of their professional work and on which they may desire assistance in

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resolving issues which may pose difficulty. Guidance Notes are recommendatory in
nature. A member should ordinarily follow recommendations in a guidance note
relating to an auditing matter except where he is satisfied that in the
circumstances of the case, it may not be necessary to do so. Similarly, while
discharging his attest function, a member should examine whether the
recommendations in a guidance note relating to an accounting matter have been
followed or not. If the same have not been followed, the member should consider
whether keeping in view the circumstances of the case, a disclosure in his report is
necessary.

There are however a few guidance notes in case of which the Council has
specifically stated (discussed in Announcements part reproduced in Handbook on
Auditing Pronouncements) that they should be considered as mandatory on members
while discharging their attest function.

9. QUALITIES OF AN AUDITOR

It is not enough to realise what an auditor should be. He is concerned with the
reporting on financial matters of business and other institutions. Financial matters
inherently are to be set with the problems of human fallibility; errors and frauds
are frequent. The qualities required, according to Dicksee, are tact, caution,
firmness, good temper, integrity, discretion, industry, judgement, patience, clear
headedness and reliability. In short, all those personal qualities that go to make a
good businessman contribute to the making of a good auditor. In addition, he must
have the shine of culture for attaining a great height. He must have the highest
degree of integrity backed by adequate independence. In fact, Code of ethics
mentions integrity, objectivity and independence as one of the fundamental
principles of professional ethics.

He must have a thorough knowledge of the general principles of law which govern
matters with which he is likely to be in intimate contact. The Companies Act need
special mention but mercantile law, specially the law relating to contracts, is no
less important. Needless to say, where undertakings are governed by a special
statute, its knowledge will be imperative; in addition, a sound knowledge of the
law and practice of taxation is unavoidable.

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He must pursue an intensive programme of theoretical education in subjects like
financial and management accounting, general management, business and corporate
laws, computers and information systems, taxation, economics, etc. Both practical
training and theoretical education are equally necessary for the development of
professional competence of an auditor for undertaking any kind of audit assignment.

The auditor should be equipped not only with a sufficient knowledge of the way in
which business generally is conducted but also with an understanding of the special
features peculiar to a particular business whose accounts are under audit. The
auditor, who holds a position of trust, must have the basic human qualities apart
from the technical requirement of professional training and education.

He is called upon constantly to critically review financial statements and it is

obviously useless for him to attempt that task unless his own knowledge is that of
an expert. An exhaustive knowledge of accounting in all its branches is the sine
qua non of the practice of auditing. He must know thoroughly all accounting
principles and techniques.

Lord Justice Lindley in the course of the judgment in the famous London & General
Bank case had succinctly summed up the overall view of what an auditor should be
as regards the personal qualities. He said, “an auditor must be honest that is, he
must not certify what he does not believe to be true and must take reasonable
care and skill before he believes that what he certifies is true”.

10. ELEMEMTS 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.

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10.1 LEADERSHIP RESPONSIBILITY FOR QUALITY ON AUDITIS

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 appropriate messages to the other
members of the engagement team, in taking responsibility for the overall quality
on each audit engagement, emphasise:

(a) The importance to audit quality of:

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

Defination of Engagement Partner

Engagement partner refers to the partner or other person in the firm who is
responsible for the audit engagement and its performance, and for the auditor’s
report that is issued on behalf of the firm, and who, where required, has the
appropriate authority from a professional, legal or regulatory body.

10.2 ETHICAL REQUIREMENTS RELATING TO AN AUDITI OF

FINANCIAL STATEMENTS

The auditor shall comply with relevant ethical requirements, including those
pertaining to independence, relating to financial statement audit engagements.
Relevant ethical requirements ordinarily comprise the Code of Ethics for
Professional Accountants (IESBA Code) related to an audit of financial statements.

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First, broadly understand what are ethics? ”Ethics” are the principles of conduct
governing an individual or group. Professions like law, medicine have their code of
ethics. Auditing profession is no exception. Rather, in profession of auditing,
importance of ethics is manifold.

The IESBA Code establishes the following as the fundamental principles of

professional ethics relevant to the auditor when conducting an audit of financial
statements. We shall understand broad meaning and intent of these fundamental
principles as under:-

(a) Integrity
Integrity requires auditor to be straight forward and honest in all professional and
business relationships. It implies fair dealing and truthfulness. It effectively means
that he shall not be associated with reports, returns, communications or other
information which he believes contains a materially false or misleading statement;
contains statements or information provided recklessly or omits required information
where such omission could be misleading.

(b) Objectivity
The principle of objectivity requires an auditor not to compromise professional
judgment because of bias, conflict of interest or undue influence of others.

(c) Professional competence and due care

It requires that auditor attains and maintains professional knowledge and skill at the
level required to render competent professional service based on current technical and
professional standards and legislation and also to act diligently and in accordance with
technical and professional standards. Diligence includes responsibility to act carefully,
thoroughly and on a timely basis in accordance with requirements of an assignment.

(d) Confidentiality
Confidentiality principle requires an auditor to respect the confidentiality of information
acquired as a result of professional or business relationships.

(e) Professional behaviour

It requires an auditor to comply with relevant laws and regulations and avoid any
conduct that he knows or should know might discredit the profession.

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The auditor should be independent of the entity subject to the audit. The Code
describes independence as comprising both
INDEPENDENCE OF MIND
AND
INDEPENDENCE IN APPEARANCE

The auditor’s independence safeguards the auditor’s ability to form an audit opinion
without being affected by any influences. Independence enhances the auditor’s
ability to act with integrity, to be objective and to maintain an attitude of
professional skepticism.

Standard on Quality Control (SQC) 1 sets out the responsibilities of the firm for
establishing policies and procedures regarding compliance with relevant ethical
requirements.

SA 220 sets out the engagement partner’s responsibilities with respect to relevant
ethical requirements. These include evaluating whether members of the engagement
team have complied with relevant ethical requirements. SA 220 recognises that the
engagement team is entitled to rely on a firm’s systems in meeting its
responsibilities with respect to quality control procedures.

10.2.1 INDEPENDENCE OF AUDITORS

Professional integrity and independence are considered essential characteristics of
all the professions but are more so in the case of accountancy profession.
Independence implies that the judgement of a person is not subordinate to the
wishes or direction of another person who might have engaged him.

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.

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There are two interlinked perspectives of independence of auditors,
One, independence of mind;
And
Two, independence in appearance.
The Code of Ethics for Professional Accountants issued by International Federation
of Accountants (IFAC) defines the term ‘Independence’ as follows:

“Independence is:
(a) Independence of mind – the state of mind that permits the provision of an opinion
without being affected by influences allowing an individual to act with integrity,
and exercise objectivity and professional skepticism;
and
(b) Independence in appearance – the avoidance of facts and circumstances that are so
significant that a third party would reasonably conclude an auditor’s integrity,
objectivity or professional skepticism had been compromised.”

Independence of the auditor has not only to exist in fact, but also appear to so
exist to all reasonable persons.

The objective of an audit of financial statements is to enable an auditor to express

an opinion on such financial statements. The auditor’s opinion helps determination
of the true and fair view of the financial position and operating results of an
enterprise. The user should not assume that the auditor’s opinion is an assurance
as to the future viability of the enterprise or the efficiency or effectiveness with
which management has conducted the affairs of the enterprise.

The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override
his objectivity. He should maintain an impartial attitude and both be and appear to
be free of any interest which might be regarded as being incompatible with
integrity and objectivity.

Many different circumstances, or combination of circumstances, may be relevant

and accordingly it is impossible to define every situation that creates threats to
independence and specify the appropriate mitigating action that should be taken.
In addition, the nature of assurance engagements may differ and consequently
different threats may exist requiring the application of different safeguards.

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10.2.2 THREATS TO INDEPENDENCE
The Code of Ethics for Professional Accountants, prepared by the International
Federation of Accountants (IFAC) identifies five types of threats.
These are:

1. Self-interest threats, which occur when an auditing firm, its partner or associate
could benefit from a financial interest in an audit client.
Examples include-
❑ direct financial interest or materially significant indirect financial interest in a
client,
❑ loan or guarantee to or from the concerned client,
❑ undue dependence on a client’s fees and, hence, concerns about losing the
engagement,
❑ close business relationship with an audit client,
❑ potential employment with the client,
❑ contingent fees for the audit engagement.
Like, in case an audit firm unduly relies on fees from a client, it may result in
threat to self interest of auditor and he may not work objectively for the fear of
losing client.

2. Self-review threats, which occur when during a review of any judgement or

conclusion reached in a previous audit or non-audit engagement (Non audit services
include any professional services provided to an entity by an auditor, other than
audit or review of the financial statements. These include management services,
internal audit, investment advisory service, design and implementation of
information technology systems etc.), or when a member of the audit team was
previously a director or senior employee of the client. Instances where such
threats come into play are-
❑ when an auditor having recently been a director or senior officer of the company
❑ when auditors perform services that are themselves subject matters of audit.

3. Advocacy threats, which occur when the auditor promotes, or is perceived to

promote, a client’s opinion to a point where people may believe that objectivity is
getting compromised, e.g. when an auditor deals with shares or securities of the
audited company, or becomes the client’s advocate in litigation and third party
disputes. In such situations, auditor can be perceived as backing and championing
causes of auditee client and it may lead to belief that auditor is not acting and

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working objectively. Remember that auditor has not only to be independent but also
appear to be acting so.

4. Familiarity threats are self-evident, and occur when auditors form relationships with
the client where they end up being too sympathetic to the client’s interests.
This can occur in many ways:
❑ close relative of the audit team working in a senior position in the client company
❑ former partner of the audit firm being a director or senior employee of the
client,
❑ long association between specific auditors and their specific client counterparts,
❑ acceptance of significant gifts or hospitality from the client company, its
directors or employees.
Provisions in Companies Act, 2013 regarding rotation of auditors mainly address
these very familiarity threats. Such provisions prescribe that auditor is rotated
after a certain number of years so that auditors do not become too familiar with
their clients. {You would study about these provisions in detail in Chapter 10 on
Company audit.}

5. Intimidation threats, which occur when auditors are deterred from acting
objectively with an adequate degree of professional skepticism. Basically, these
could happen because of threat of replacement over disagreements with the
application of accounting principles, or pressure to disproportionately reduce work
in response to reduced audit fees or being threatened with litigation. Such threats
attempt to intimidate auditors to deter them from acting objectively.

10.2.3 SAFEGARDS TO INDEPENDENCE

The Chartered Accountant has a responsibility to remain independent by taking into

account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
The following are the guiding principles in this regard:-

1. For the public to have confidence in the quality of audit, it is essential that
auditors should always be and appears to be independent of the entities that they
are auditing.

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2. In the case of audit, the key fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be independent.

3. Before taking on any work, an auditor must conscientiously consider whether it

involves threats to his independence.

4. When such threats exist, the auditor should either desist from the task or put in
place safeguards that eliminate them.

5. If the auditor is unable to fully implement credible and adequate safeguards, then
he must not accept the work.

EXAMPLE
Mr. S and Mr. W are partners in SW and Associates, a Partnership Firm of
Chartered Accountants. During the financial year 2020-21, SW and Associates
were appointed as auditors of Capable and Composed Limited. The brother of
Mr. W was involved in the management of Capable and Composed Limited. Mr. S
being aware of the whole situation, on behalf of SW and Associates did not accept
the appointment as auditors of Capable and Composed Limited as it would act as a
threat (familiarity threat) and affect independence of auditors.

10.2.4 PROFESSIONAL SKEPTICISM

Defination of PROFESSIONAL SKEPTCISM

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.

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.

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♦ Maintaining professional skepticism throughout the audit is necessary if the
auditor is to reduce the risks of.
♦ Overlooking unusual circumstances.
♦ Over generalising when drawing conclusions from audit observations.
♦ Using inappropriate assumptions in determining the nature, timing, and extent of
the audit procedures and evaluating the results thereof.

Professional skepticism is necessary to the critical assessment of audit evidence.

It also includes consideration of the sufficiency and appropriateness of audit
evidence obtained in the light of the circumstances, for example in the case where
fraud risk factors exist and a single document, of a nature that is susceptible to
fraud, is the sole supporting evidence for a material financial statement amount.

The auditor may accept records and documents as genuine unless the auditor has
reason to believe the contrary. Nevertheless, the auditor is required to consider
the reliability of information to be used as audit evidence. In cases of doubt about
the reliability of information or indications of possible fraud, the SAs require that
the auditor investigate further and determine what modifications or additions to
audit procedures are necessary to resolve the matter.

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.

ILLUSTRATION 5
Mr. H is an audit team member of a Partnership Firm of Chartered Accountants
WY and Associates. Mr. H was of the opinion that Professional Skepticism is
required only at planning stage of an audit because situations and circumstances
which are unusual in nature exist at the beginning of an audit only. Explain whether
Professional Skepticism is only required at planning stage of an audit.
SOLUTION
Professional Skepticism is not only required at planning stage of an audit, rather
Professional Skepticism is required during the entire process of an audit because
situations and circumstances that are not usual in nature exist during the entire
process of an audit.

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10.3 ACCEPTANCE AND CONTINUANCE OF CLIENT

RELATIONSHIPS AND AUDITI ENGAGEMENTS

The engagement partner shall be satisfied that appropriate procedures regarding

the acceptance and continuance of client relationships and audit engagements have
been followed:

SQC 1 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:

♦ The integrity of the principal owners, key management and those charged with
governance of the entity;
♦ Whether the engagement team is competent to perform the audit engagement
and has the necessary capabilities, including time and resources;
♦ Whether the firm and the engagement team can comply with relevant ethical
requirements;
♦ 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.

10.4 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.

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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;
(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.

10.5 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 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.

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10.6 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. Such policies and procedures should include an ongoing consideration and
evaluation of the firm’s system of quality control, including a periodic inspection of
a selection of completed engagements.

The purpose of monitoring compliance with quality control policies and procedures is
to provide an evaluation of:

(a) Adherence to professional standards and regulatory and legal requirements;

(b) Whether the quality control system has been appropriately designed and
effectively implemented;
(c) 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.

11. PRECONDITIONS FOR AN AUDIT

As per SA 210 “Agreeing the Terms of Audit Engagements”,

preconditions for an audit may be defined as the use by management of an
acceptable financial reporting framework in the preparation of the financial
statements and the agreement of management and, where appropriate, those
charged with governance to the premise on which an audit is conducted.

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In order to establish whether the preconditions for an audit are present, the
auditor shall:
(a) Determine whether the financial reporting framework is acceptable;
(b) Obtain the agreement of management that it acknowledges and understands its
responsibility:
(i) For the preparation of the financial statements in accordance with the applicable
financial reporting framework;
(ii) For the internal control as management considers necessary;
(iii) 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;
➢ Unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence.

ILLUSTRATION 6
TH and Associates, a Partnership Firm of Chartered Accountants are appointed as
auditors of Grateful and Cheerful Limited for the financial year 2020-21. Mr. Y
is one of the audit team members of TH and Associates. Mr. Y required from the
company, its financial statements and other relevant information for which the
audit is to be conducted. State who is responsible for providing such an
information to the auditor.
SOLUTION
Management of a company is responsible for providing 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 unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence.

12. AGREEMENT ON AUDIT ENGAGEMENT TERMS

Legal requirement to get the accounts audited so far extends only to companies,
registered societies etc. In these cases the respective law governs the appointment
of auditors and their duties. In all other cases, it is a matter of contract. It is,
therefore, important, both for the auditor and client, that each party should be
clear about the nature of the engagement. It must be reduced to writing and

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should exactly specify the scope of the work. The audit engagement letter is sent
by the auditor to his client.
The ICAI has issued SA 210 “Agreeing the Terms of Audit Engagements” on the
subject. It is in the interest of both the auditor and the client to issue an
engagement letter so that the possibility of misunderstanding is reduced to a great
extent.

In the case of partnerships, a few more precautions are needed. The appointment
of the auditor is normally governed by the partnership deed. The accountant, when
he is approached for undertaking a professional assignment by a firm or a partner
of a firm, should first get a clear idea of the nature of the service required and
then ensure, with reference to the terms of partnership agreement that his
appointment is valid.

According to SA 210 “Agreeing the Terms of Audit Engagements”, the auditor shall
agree the terms of the audit engagement with management or those charged with
governance, as appropriate.

The agreed terms of the audit engagement shall be recorded in an audit

engagement letter or other suitable form of written agreement and shall include:
(a) The objective and scope of the audit of the financial statements;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;
(d) Identification of the applicable financial reporting framework for the preparation
of the financial statements;
(e) 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 , 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.

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13. 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, 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.

ILLUSTRATION 7
R & Co, a firm of Chartered Accountants have not revised the terms of engagements
and obtained confirmation from the clients for last 5 years despite changes in business
and professional environment.
Required
Elucidate the circumstances that may warrant the revision in terms of engagement.
SOLUTION
As per SA 210 on “Agreeing the Terms of Audit Engagements”, the auditor may
decide not to send a new audit engagement letter or other written agreement each
period. However, the factors that may make it appropriate to revise the terms of
the audit engagement or to remind the entity of existing terms are discussed above

14. 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.

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Analysis
— If management or TCWG
— impose limitation on the scope
— such that auditor believes
— limitation would result in
— auditor disclaiming an opinion
— the auditor shall not accept such a limited engagement

15. ACCEPTANCEOF A CHANGE IN ENGAGEMENT

An auditor who, before the completion of the engagement, is requested to change

the engagement to one which provides a lower level of assurance, should consider
the appropriateness of doing so.
A request from the client for the auditor to change the engagement may result
from-
1. a change in circumstances affecting the need for the service,
2. a misunderstanding as to the nature of an audit or related service originally
requested.
3. a restriction on the scope of the engagement, whether imposed by management or
caused by circumstances.

The auditor would consider carefully the reason given for the request, particularly
the implications of a restriction on the scope of the engagement, especially any
legal or contractual implications.

If the auditor concludes that there is reasonable justification to change the

engagement and if the audit work performed complied with the SAs applicable to the

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changed engagement, the report issued would be appropriate for the revised terms
of engagement. In order to avoid confusion, the report would not include reference
to:

(a) the original engagement;

Or
(b) any procedures that may have been performed in the original engagement.

The auditor should not agree to a change of engagement where there is no

reasonable justification for doing so.

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.

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:
(a) Withdraw from the audit engagement where possible under applicable law or
regulation;
And
(b) 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.

ILLUSTRATION 8
M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for the
financial year 2014-15. CA. Suresh, one of the partners of M/s Sureshchandra &
Co., completed entire routine audit work by 29th May, 2015. Unfortunately, on
the very next morning, while going towards office of SC Ltd. to sign final audit
report, he met with a road accident and died. CA. Chandra, another partner of
M/s Sureshchandra & Co., therefore, signed the accounts of SC Ltd., without
reviewing the work performed by CA. Suresh.
Required
State with reasons whether CA. Chandra is right in expressing an opinion on
financial statements the audit of which is performed by another auditor.

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SOLUTION
Relying on Work Performed by Another Auditor:
As per SA 220 “Quality Control for an Audit of Financial Statements”,
an engagement partner taking over an audit during the engagement may apply the
review procedures such as the work has been performed in accordance with
professional standards and regulatory and legal requirements; significant matters
have been raised for further consideration; appropriate consultations have taken
place and the resulting conclusions have been documented and implemented; there
is a need to revise the nature, timing and extent of work performed; the work
performed supports the conclusions reached and is appropriately documented; the
evidence obtained is sufficient and appropriate to support the auditor’s report; and
the objectives of the engagement procedures have been achieved.

Further, one of the basic principles, which govern the auditor’s professional
responsibilities and which should be complied with wherever an audit is carried, is
that when the auditor delegates work to assistants or uses work performed by
other auditor and experts, he will continue to be responsible for forming and
expressing his opinion on the financial information. However, he will be entitled to
rely on work performed by others, provided he exercises adequate skill and care
and is not aware of any reason to believe that he should not have so relied. This is
the fundamental principle which is ethically required as per Code of Ethics.

However, the auditor should carefully direct, supervise and review work delegated.
He should obtain reasonable assurance that work performed by other
auditors/experts and assistants is adequate for his purpose.

In the given case, all the auditing procedures before the moment of signing of
final report have been performed by CA. Suresh. However, the report could not
be signed by him due to his unfortunate death. Later on, CA. Chandra signed the
report relying on the work performed by CA. Suresh. Here, CA. Chandra is
allowed to sign the audit report, though, will be responsible for expressing the
opinion. He may rely on the work performed by CA. Suresh provided he further
exercises adequate skill and due care and review the work performed by him.

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