INDEPENDENT AUDITORS' REPORT

[CA GOPALJI AGRAWAL]

Independent Auditor’s Report (IAR) – A dominoes impact on reporting

Background

Auditing and Assurance Standards Board (AASB) of ICAI has converged all Engagements and Quality Control Standards under the revised “Preface to Standards on Quality Control, Auditing, Review, Other Assurance and Related Services” with international standards as issued by International Auditing and Assurance Board (IAASB) and it is commendable that India is at par with international standards on auditing. These standards put forth the various auditing benchmarks which are used by the auditors and the performance of the auditors is also measured according to these standards. These standards bridge down the expectation gap of the stakeholders.

It is relevant that all the Standards collectively called Engagement Standards have been classified broadly under following four categories on the basis of two criteria as follows:

AUDIT -                       37 Standards on Auditing (Series 100-999) named as SAs

ASSURANCE               2 Standards on Assurance Engagements (Series 3000-3699) named as SAEs

REVIEW                      2 Standards on Review Engagements (Series 2000-2699) named as SRE

RELATED SERVICES   2 Standards on Related Services )Series 4000-4699) named as SRSs

The series has been assigned by IAASB of IFAC, followed by AASB of ICAI for the ease of familiarity and comparability.

Advantages of Audit

The audit process finally ensures the following quality characteristics in the financial statements (FSs) and enhances its credibility and reliability:

1. Overall presentation, structure and content of the FSs  in accordance with the Financial Reporting Framework
2. FSs including notes represent the underlying  transactions, circumstances and events in a true and fair manner
3. Adequate consistent application and disclosure of significant accounting policies
4. Use of reasonable accounting estimates
5. Relevant, reliable, comparable and understandable information
6. Usage of appropriate title and terminology  
7. Adequate disclosures even though not required by reporting framework to make these statements meaningful and faithful.

Importance of the Auditor’s report

The importance of the reports of the auditors has been getting attention of not only the expert governing bodies of the auditing profession but also the regulators, present and potential investors, lenders and creditors. Each user is keen to refer the auditor report to know whether the FSs of the reporting entity present a true and fair view of the financial position and performance of the entity. The importance of the auditor’s report is quiet evident from its placed position i.e., at the top of the Audited FSs irrespective of the nature, size and location of the entity throughout the world. 

It is the final outcome of the wholesome and intensive audit process involving a lot of time, efforts and auditing techniques, benchmarks, professional competence, skepticism and skills which provide a basis to form an opinion on the financial statements of the reporting entity. The Auditor’s report is the only users interface and end product of the lengthy and cumbersome process of audit which fix the liabilities of the auditors in case of any litigation once the true and fair view of the financial statements are challenged before any court of law or regulating authorities. The auditors must take utmost care while drafting this first and last deliverable which can free or fire him.

Auditors Report provides:

1. A reasonable assurance that FSs are free from material misstatements whether due to fraud or error & adding credibility to the FSs
2. Opinion as to compliance of applicable financial reporting framework
3. Educates the user about the responsibility of the management for the preparation of the FSs and auditors responsibility of expressing the opinion about its true and fair view
4. Addition of the word “Independent” distinguishes Auditors from management
5. Differentiate Independent Auditors Report, CA certificate, Review report, compliance report, compilation report, or agreed upon procedure reports.

It is very much pertinent to note that out of 43 Engagement Standards issued so far, 14 standards have been laid down just for the method, manner, form, content of the report  and responsibility of the auditors which directly govern the reports whether as:

• Independent Auditors under Fair Presentation Framework;
• Independent Auditor’s Report under Special Presentation Framework;
• Review report of historical financial information;
• Examination report of prospective financial information;
• Accountant Report on compiled financial information.

It is necessary to understand the nature of assignment beforehand and obtain the engagement letter from the clients as per SA 210 to avoid any expectation gap and mitigate the risk involved in the proper discharge of the professional responsibility.

The independent auditor always gives a reasonable assurance about the true and fair view of the historical financial information. Once an assignment other than audit of historical information is undertaken, normally a limited, moderate or negative assurance is provided to the users by Practitioner (professional accountant in public practice). The Practitioners should clarify the users through their report the kind of responsibility they have assumed. Due to ill conceived notions, the stakeholders ignorantly treat the opinion of independent auditors, certificate, review report or compilation report by a qualified chartered accountants at par which are instead poles apart so it is the onerous responsibility of the professional to make it clear in order to remove the misunderstanding.

The above referred 14 Engagement Standards directly govern the reports by Practitioners and are mandatory in nature. They deal in brief as under:

1. SA-700 Forming an opinion and reporting on Financial Statements

-Guiding principles to be followed in case of clean opinion on historical General Purpose Financial Statements (GPFSs)

“GPFSs are those financial statements intended to meet the needs of users who are not in a position to require any entity to prepare any reports tailored to their particular information needs.”

The FSs other than GPFSs are called Special Purpose Financial Statements (SPFSs) which are prepared in accordance with special purpose framework.

2. SA 705 Modifications to the opinion in Independent Auditors Reports

-Guiding principles to be followed in case auditor comes to the conclusion that clean opinion on historical GPFSs cannot be issued, hence opinion has to be modified (qualified, disclaimer or adverse opinion)

3. SA-706 Emphasis of Matter paragraphs (MP) and Other Matter Paragraphs (OMPs)  in Independent Auditors’ Report

-Guiding principles to be followed in case auditor want to bring into notice of certain matter though appropriately disclosed in the FSs but are so significant that he still wants to bring into notice of stakeholders or OMPs which are matters relating to audit, reports; responsibilities of auditor but do not have a bearing on the true and fair view of the FSs.

4. SA-710 Comparative Information-Corresponding figures and comparative FSs

-Guiding principle relating to responsibility of auditors in case of comparative versus corresponding previous period figures in case of historical GPFSs.

5. SA-720 Auditor’s responsibilities in relation to other information in documents containing audited financial statements

-Guiding principles in respect of the responsibilities of the auditors in respect of the information contained outside the audited FSs but in the other information of the same document containing FSs i.e. management reports and discussions.

6. SA 800- Special Considerations- Audit of Financial Statements prepared in accordance with special purpose framework

-Guiding principles for application of SA 100-700 and the form and content of the audit opinion if it is expressed other than GPFSs i.e. special purpose framework.

7. SA-805 Special Considerations- Audit of Single Financial Statements  and specific elements, accounts or items of a Financial Statements

-Guiding principles for the form and content of the audit opinion in case any single FS or specific elements of FSs i.e. assets, liabilities, income, expense or equity or any specific item or group of item.

8. SA-810 Engagement to report on Summary Financial Statements

-Guiding principles for the form, content and responsibility of the of the Practitioner  when they express their opinion on derived summary FSs from GPFSs. Exp. reporting under Prospectus etc.

9. SRE -2400 Engagement to Review Financial Statements

-Guiding principles for the form, content and responsibility of the auditors when they do not undertake audit giving reasonable assurance of the true and fair view but give a limited negative assurance while reviewing the FSs like reporting under clause 41 of the listing agreement

10. SRE-2410  Review of Interim Financial Information performed by the Independent Auditor of the entity

Same as per SRE 2400

11. SAE 3400- The examination of prospective financial information

-Guiding principles for the form, content and responsibility, disclosure of source of information, basis of forecast and major assumptions taken by the Practitioner  

12. SAE-3402 – Assurance Reports on controls at a service organization

-Guiding principles for the form, content and responsibility of reporting about the nature and design of control, its implementation and effectiveness by the Practitioner  

13. SRS-4400- Engagement to perform agreed upon procedures regarding Financial Information

-Guiding principles for the form, content and responsibility of factual reporting of agreed upon procedures relating to financial information instead of any assurance in the form of audit or review and meant for specific users.

14. SRS-4410- Engagement to compile Financial Information

-Guiding principles for the form, content and responsibility to collect. Classify, summarize the financial information as accountants not as an auditor or reviewer.

Moreover, ICAI has issued the following relevant Statements and Guidance Notes (GN) stating the principles with regard to Practitioner’s Reports:

1. Statement on Reporting u/s 227(1A) of the Companies Act, 1956
2. Statement on CARO 2003 u/s 227(4A)
3. GN on Independence of Auditors
4. GN on certificate issued under Acceptance of deposit Rules 1975
5. GN on Auditor report and certificates for special purpose
6. GN on Reports in Prospectus
7. GN on certificate on Corporate Governance
8. GN on section 227(3)(e) (f) of Companies Act, 1956
9. Guidance Note on Audit of Abridged Financial Statements

Parent Reporting Standards

The first three standards SA 700, 705 & 706 may be called as the Parent Standards of reporting as they lay down the principles and procedures to form, modify and present the opinion which governs all reporting whether under fair presentation framework or compliance framework. The other reporting standards are applied on the basis of compliance framework. So the focal auditing standards are discussed in detail as follows:

Governing Reporting Standards- SA 700

SA 700 - Forming an opinion and reporting on Financial Statements – applicable when clean or unmodified audit opinion is expressed under general purpose financial reporting framework.

This SA succeeds its earlier version issued in 2003 and lays down the principles for the format, content and manner that are more exhaustive, detailed, heading-wise, clear, unambiguous, comparable demarcating between the fair and compliance reporting framework instead of mixed summarized form of report used earlier.

A general purpose financial reporting framework is a framework designed to meet the needs of a wide range of users.

Special purpose financial reporting framework is a framework designed to meet the needs of a specific set of users.

The audited financial statements of the companies is the best example of the combination of the general purpose and special purpose FSs therefore report is divided into two parts with headings namely I. Report on the FSs and II. Report on other legal and regulatory requirements.

Conditions for clean audit opinion

(a)  The Financial Statements adequately disclose the governing financial reporting framework. 

(b)  The auditor obtains sufficient appropriate audit evidence in accordance with SA 330;

(c)  Uncorrected misstatements are, individually or in the aggregate, are not material in accordance with SA 450;

(d)  Requirements of the reporting framework like The Companies Act read with notified Accounting Standards have been materially complied with;

(e)  Management’s judgments in preparing the FSs are free from ‘bias’ as per SA 260 and SA 540;

(f)   The FSs adequately disclose the accounting policies selected and applied;

(g)  Those accounting policies are appropriate and consistent with the financial reporting framework;

(h)  The accounting estimates made by management are reasonable;

(i)   The information presented in the financial statements is relevant, reliable, comparable and understandable;

(j)   There are adequate disclosures for users to understand the FSs

(k)   Effect of material transactions, conditions and events on the information conveyed in the financial statements is fairly presented;

(l)    The terminology used in the financial statements is appropriate.

SA 705- Modifications to the opinion in Independent Auditors Reports (Applicable only when auditor concludes that clean or unmodified opinion cannot be expressed)

Conditions for modified Opinion

(i)     The Auditor is unable to obtain sufficient appropriate audit evidence in respect of any five elements of the financial statements viz. Assets, Liabilities, Income, Expense and Equity and  other reporting requirements as per governing financial reporting framework

Or

(ii) Obtains sufficient appropriate audit evidence which signifies that any of these elements or disclosures has materially been misstated in the financial statements.

The report is never modified but only the opinion part of the report is modified. The modifications in the audit opinion might of three characters in order of severity and seriousness: qualified opinion, disclaimer of opinion and adverse opinion. The decision can be drawn on the basis described below in the table

Nature of matter giving rise to modification	Auditor’s   judgment about the  materiality and pervasiveness of the Effects or Possible Effects on the financial statements
	Material but not Pervasive	Material andPervasive
FS are materially misstated	Qualified opinion	Adverse opinion
Inability to obtain sufficient appropriate audit evidence	Qualified opinion	Disclaimer of opinion

 

It is relevant to understand the meaning of the terms material, misstatement and pervasive.

Material: Information is material if its omission or misstatement (individually or collectively) could influence the economic decisions of the users taken on the basis of financial information. Materiality depends on the size or nature or a combination of both. It is entity specific.

Misstatement: Misstatement of the financial statements occurs when there is a difference between how each of these aspects is reported by the management in the financial statements and how it should be as per the applicable financial reporting framework.

Pervasive:

(A)Where it pertains to an amount(s) in the financial statements, it is not confined to specific components, accounts or items of the financial statements. If it is so confined, it represents or could represent a substantial portion of the financial statements; or

(B)Where it pertains to disclosures, such disclosures or the matter(s) therein are/ could be fundamental to the user’s understanding of the financial statements.

SA 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs In IARs

(It lays the principles for stating these matter or other than matter paragraphs in IAR which are neither part of audit opinion nor in the nature of qualifications)

Matter Paragraph is stated after opinion paragraph in following situations:

“A paragraph included in the auditor’s report that refers to a matter appropriately presented  or  disclosed  in  the  financial  statements  that,  in  the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.”

In earlier version of SA 700, the matter paragraphs were treated in the nature of qualifications but now these are not alternate of modifications.

Other Matter Paragraph (OMP)

“A paragraph included in the auditor’s report that refers to matters other than those presented or  disclosed  in  the  financial  statements  that,  in  the  auditor’s judgment, is relevant to users’ understanding of  the

(a) audit,

(b) the auditor’s responsibilities or

(c) auditor’s report.

Reporting format

Report is to be drafted with the headings namely (a) Title (b) Addressee (c) Reporting on Financial Statements – introductory paragraph (d) Management’s responsibility paragraph  (e)Auditor’s responsibility paragraph (f) Basis for qualified, disclaimer or adverse opinion  (f) Auditor’s opinion paragraph  (g) Other responsibilities paragraphs- Matter Paragraph and Other Matter Paragraph (h) Report on other legal and regulatory requirements  (i) Signature  (j)Date of the auditor’s report (always on or after approval date) (k) Place of signature  (l)FRN and Membership Number.

A big question poses in the minds of all concerned while seeing the title of report “Independent Auditor’s Report”

Why Independent?

The new report has added the word “Independent” in the tile “Auditor’s Report” to make it clear to the users of the FSs that the auditors are independent of the management.

Independence carries two important notions viz. independence of mind and independence in appearance

(a)Independence of mind

The state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism.

(b) Independence in appearance

The avoidance of facts and circumstances that are so significant a reasonable and informed third party, having knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity or professional skepticism had been compromised.

Threats to Independence

1. I.             Statutory safeguards for independence

Section 226 of the Companies Act, 1956

The following persons cannot be appointed as the auditor:

       i)       Officer or employee of the company;

       ii)       Partner of a person in the employment of an officer or of an employee of the Company;

       iii)      Person who is indebted to the company for an amount exceeding Rs. 1000;

       iv)      Person who has given any guarantee or provided any security in connection with the indebtedness of any third person to the company for an amount exceeding Rs. 1000;

(v)      Person holding any security of that company.

The CA Act 1949 as amended:

Clause (8) of Part I of First Schedule to the Chartered Accountants Act, 1949 emphasized the requirement of mandatory communication with the previous auditor in all types of audit viz., statutory audit, tax audit, internal audit, concurrent audit or any kind of audit and it is equally applicable to audits of both government and non-government entities.

Clause (10) of Part I of the First Schedule to the CA Act, 1949 prohibits acceptance of audit based on contingent fees, i.e., fees, which are either based on percentage of profits or otherwise dependent on the finding or the results of employment.

Clause (4) of Part I of the Second Schedule to the CA Act, 1949 provides that a CA in practice shall be deemed to be guilty of professional misconduct if he expresses his opinion on financial statements of any business or any enterprise in which he, his firm or a partner or relative  of partner has a substantial interest.

The Council has decided that a chartered accountant should not by himself or in his firm name:

(i)     Accept the auditor-ship of a college, if he is working as a part-time lecturer in the college.

(ii)    Accept the auditor-ship of a trust where his partner is either an employee or a trustee of the trust.

(iii)   The appointment as statutory auditor of Public Sector Undertaking(s)/ Government Company(ies)/Listed Company(ies) and other Public Company(ies) having turnover of Rs. 50 crores or more in a year and accepts any other work(s) or assignment(s) or service(s) in regard to the same Undertaking(s)/ Company(ies) on a remuneration which in total exceeds the fee payable for carrying out the statutory audit of the same Undertaking/company.

(iv)   Professional fees for audit and other services received by the firm in which he is a partner, by him and his partners individually and by firm or firms in which he or his partner are partners from one or more clients or companies under the same management does not exceed 40 percent of the gross annual fees of the firm, firms and partners referred to above unless it is upto rupees two lac only.

(v)    An overdue fee from the client is also treated as self interest threat.

(vi)   Accepting the assignment at lower fees as charged by predecessor

SEBI regulation

As per clause 49 of the listing agreement, a partner or an executive of CA firm having done statutory or internal audit cannot be appointed as Independent Director of the company for the three years subsequent to ceasing such position.

2. These risks to independence can also be mitigated by following personal principles:

1. Integrity – Honest and straightforward approach
2. Objectivity – Not to compromise professional duty
3. Professional Competence and due care – maintain professional knowledge and skill as per requirements & act diligently as per applicable technical and professional standards
4. Confidentiality- Not to disclose the information to outsiders unless required by law or with specific authority and using information for the advantage/disadvantage for themselves/others

Professional Behavior – not indulge in such activities which may bring disrepute to the profession

Service before self is the underlying principle of all aforesaid mitigating factors.

3. Other safeguards

1. Safeguards in work environment like adherence of independence policy to be laid down by firms

          (i)            Documented policy for identification and evaluation of threats, safeguards to be implemented to mitigate the threats at an acceptable level.

          (ii)           Placement /rotation of partners/team members

          (iii)          Communication of Independence Policy to all partners/staff and declaration by them

          (iv)          Partner to be designated as compliance in charge

2. Disciplinary mechanism at firm level for compliance of Independence Policy.

In view of the all around developments in Engagement Standards, it is an  urgent need for the practitioner to deeply go through all these standards, statements and Guidance notes governing the reports before putting themselves in the hands of stakeholders at large.