gaap and audit

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Developments in GAAPs and

Audit reporting requirements SA 700,705,706

Presented by

S. Sundaresan

IND-AS – Budget speech by Finance Minister

IND AS implementation around the corner

Consolidation Mandatory in Companies Act.

Mandatory for unlisted companies also

Schedule II – Depreciation

New Developments in GAAP

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It is not to be treated as GAAP but a regulatory requirement.

Important Points

1.Rates to useful life ( same as accounting standard)

2 One can follow different (i.e. more or less) useful lives than prescribed but need to justify ( i.e if you follow the useful lives prescribed you need not justify - but as per standard you still need to review if the actual useful lives are lower than prescribed)

Depreciation under the Companies Act

ED of the GN on Accounting for Service Concession Arrangements by Concessionaires

Guidance Notes issued in the past 3 years

GN on Accounting of Rate Regulated Activities

GN on Accounting for Self-generated Certified Emission Reductions (CERs)

GN on Accounting and auditing of Political Parties

GN on Accounting for Oil and Gas Producing Activities

Exposure Drafts and GN

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The Auditor’s Report on Financial Statements

Overview of Standards on Auditing (SA)

-SA 700, SA 705 & SA706

SA 700 Forming an Opinion and Reporting on Financial Statements - to be used only in case of unmodified opinion.

Standards pertaining to Audit Reports

SA 705 Modifications to the Opinion in the Independent Auditor’s Report

- to be used only in case of modified opinion.

SA 706 Emphasis of Matter Paragraphs and Other Matter paragraphs in the Independent Auditor’s Report

- to be used if there is an emphasis of matter and it also deals with Other Matters

Replaces AAS 28 – Auditor’s Report on Financials Statements.

Applicability to accounting periods beginning on or after April 1, 2012 vide ICAI’s announcement dated April 17, 2012

Not applicable in cases where reports formats are prescribed under various laws or regulations - ICAI’s Announcement – July 29, 2013

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In practice, one has to exercise a lot of judgement and the standards only provide a framework.

The reporting is required to be appropriate and precise considering the nature based on judgement----

Not qualify when an Emphasis of matter is appropriate

Not disclaim when qualification is appropriate

Not issue adverse opinion when disclaimer is appropriate

Need appropriate reporting

Forming an Opinion and Reporting on

Financial Statements

Standard on Auditing(SA)700

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This standard deals with the Auditor’s responsibility to form an opinion on the financial statements and the form and content of the Auditor’s Report.

The Standard deals with ‘Clean’ and ‘unmodified’ opinion in Audit Report to make it consistent.

Reporting on the financial statements per auditing standards clearly

demarcated from additional regulatory reporting under the law.

Applicable in case of General Purpose Financial Statements – prepared in accordance with a general purpose financial reporting framework (FRF). • Fair presentation framework • Compliance framework

Objective and Scope

The financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework including qualitative aspects of entity’s accounting policies and possible bias in management’s judgments.

Has obtained reasonable assurance about whether the financial statements are free of material misstatements due to Fraud or Error based on : Sufficient and appropriate audit evidence;

Whether uncorrected misstatements are material, Individually or in aggregate in accordance with SA 450.

Requirements of the reporting framework (eg., the Accounting Standards) have been materially complied with

Disclose the accounting policies selected and applied and Consistency and appropriateness of those policies

Reasonable estimates are used by the management Information presented in relevant, reliable, comparable and understandable Disclosures are adequate to enable users to understand the effect of material

transactions Terminology used is appropriate.

Forming a Clean (Unmodified) Opinion

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• When the auditors concludes that the financial statements are prepared, in all material respects, in accordance the applicable financial reporting framework, he shall express an Unmodified Opinion

• If the auditor concludes:- That based on audit evidence, the financial statements are NOT free of material

misstatements; That he is unable to obtain sufficient appropriate audit evidence to conclude

that the financial statements are free of material misstatements;

then he shall issue a modified opinion in accordance with SA705.

Form of Opinion

Where the layout of the report is prescribed by a law or regulation, the auditor shall refer to Standards of Auditing only if, at a minimum, each of the following elements are included: 1) Title 2) Addressee 3) Introductory paragraph 4) Management Responsibility Paragraph 5) Auditor’s Responsibility Paragraph 6) Opinion Paragraph 7) Other Reporting Responsibilities 8) Auditor’s Signature 9) Date 10) Place

Structure of the Auditor’s Report

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1. Title: Should have a clear title “Independent Auditor’s Report” 2. Addressee: Should be addressed as per the terms of Engagement ( Eg:- Shareholders, Board

of Directors, President of India, Specific Regulators) 3. Introductory Paragraph: The following information to be mentioned Identify whose financial statements have been audited State the financial statements have been audited Identify the title of each statement in the financial statements Balance Sheet Statement of Profit and Loss Account Cash Flow Statement Significant Accounting Policies and Other explanatory Notes Refer to the summary of significant accounting policies and explanatory information Specify the date or period covered

Specimen of Introductory para:- “We have audited the accompanying financial statements of _____ Limited (the Company) which comprise the Balance Sheet as at March 31, 20XX, and the Statement of Profit and Loss and Cash Flow Statement for the year then ended, and a summary of significant accounting policies and other explanatory information.”

Structure of the Auditor’s Report (Contd..)

4. Management Responsibility Statement:- Auditor shall describe the management responsibility for the preparation of financial statements which includes design, implementation and maintenance of internal control that the financial statements are free of material misstatements due to fraud or error.

Specimen of Management Responsibility para:-

“Management is responsible for the preparation of these financial statements that give a true and fair view of the financial position, financial performance and cash flows of the Company in accordance with the accounting standards referred to in sub-section (3C) of section 211 of the Companies Act, 1956 (“the Act”) read with the General Circular 15/2013 dated September 13, 2013 of the Ministry of Corporate Affairs in respect of section 133 of the Companies Act, 2013. This responsibility includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or error”.

Structure of the Auditor’s Report (contd..)

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5. Auditor’s Responsibility: State that the auditor’s responsibility is to express an opinion on the financial statements based on the audit. That the audit has been conducted in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India (ICAI). He should also explain that he has to comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.

Specimen of Auditor’s Responsibility para:- “Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement”. “An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of the accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.”. “We believe that the audit evidence we have obtained is sufficient and appropriate to provide a reasonable basis for our qualified opinion”.


6. Auditor’s Opinion: The Auditor’s opinion shall state that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting frame work.

• The financial statements present fairly, in all material respects, in accordance with [the applicable financial reporting framework]

• The financial statements give a true and fair view of in accordance with [the applicable financial reporting framework].

Necessary to identify the financial reporting framework so that users are aware of the context in which the report is issued. Framework:

• Reporting standards i.e. IFRS / IGAAP • Legal / Regulatory requirements i.e. Companies Act, IRDA, RBI.


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7. Other reporting responsibilities: If other reporting responsibilities are addressed, they should be reported separately in a separate section titled “Report on Other Legal & Regulatory requirements” Example

Section 227 and 274(1)(g) of the Companies Act, 1956 CARO / Physical verification certificates required by IRDA May contain similar sub-headings as the main part of the report

8. Signature: The report shall be signed in the name of the partner and the membership number and firm registration number should be mentioned.

9. Date: Report should be dated no earlier that the date when he obtains sufficient appropriate audit evidence

10. Place: The place of signature should also be mentioned


Modifications to the Opinion in

the Independent Auditor’s Report

Standard on Auditing (SA) 705

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Deals with circumstances when the auditor concludes modification to the report is necessary.

Types of modified opinions Qualified Opinion Adverse Opinion Disclaimer of Opinion

The decision on the type of opinion depends upon: The nature of the matter giving rise to the modification i.e. whether the financial statements

are materially misstated Inability to obtain sufficient and appropriate audit evidence Auditor’s judgment about the pervasiveness of the effects or possible effects of the matter

The auditor shall modify the opinion when: He concludes that, based on audit evidence, the financial statements as a whole are

NOT free of material misstatements; or The auditor is UNABLE to obtain sufficient appropriate audit evidence to conclude that

the financial statements are free of material misstatements

Introduction and Scope

QUALIFIED OPINION The auditor shall express qualified opinion when : He concludes that the misstatements, individually or in aggregate , are MATERIAL , BUT NOT

PERVASIVE to the financial statements He is unable to obtain sufficient appropriate audit evidence but also concludes that the

possible effects of undetected misstatements could be MATERIAL, BUT NOT PERVASIVE

ADVERSE OPINION When the auditor concludes that having obtained sufficient appropriate audit evidence, the misstatements, individually or in aggregate, are BOTH MATERIAL AND PERVASIVE, he issues an adverse opinion.

DISCLAIMER OF OPINION When the auditor is unable to obtain sufficient appropriate audit evidence and concludes that

the possible effects of undetected misstatements are BOTH MATERIAL AND PERVASIVE, he issues an disclaimer of opinion .

In extremely rare circumstances , having obtained sufficient appropriate audit evidence, BUT due to multiple uncertainties , the auditor is not able to form an opinion , due to possible interaction of those uncertainties and their possible cumulative outcomes , he issues a disclaimer of opinion.

Modifications in the Report

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Sufficient appropriate audit evidence obtained

Sufficient appropriate audit evidence not obtained

Auditor concludes that FS as a whole are not

free from material misstatement

Auditor is unable to conclude whether FS as a whole are

free from material misstatement

Qualified opinion

Adverse opinion

Disclaimer of opinion

Depends on auditor’s judgement of

Whether FS are materially misstated

In absence of evidence whether FS may be materially misstated

Whether misstatement is or is likely to be

pervasive

What is PERVASIVE?

Misstatements Possible misstatements

That are not confined to specific components

accounts or items

If so confined, represent a

substantial portion

Where pertaining to disclosures, are

fundamental to users’ understanding of FS

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After obtaining sufficient

appropriate audit

evidence

Auditor concludes

that

Individual misstatements

Aggregate of misstatements

Are MATERIAL

but not PERVASIVE

OR

Auditor cannot obtain

sufficient appropriate

audit evidence

Auditor concludes

that

Possible effects of undetected

misstatements

Are MATERIAL

but not PERVASIVE

QUALIFIED OPINION

After obtaining sufficient

appropriate audit

evidence

Auditor concludes

that

Individual misstatements

OR

Aggregate of misstatements

Are MATERIAL

AND PERVASIVE

ADVERSE OPINION

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Auditor cannot obtain

sufficient appropriate

audit evidence

Auditor concludes

that

Possible effects of undetected

misstatements

Are MATERIAL

AND PERVASIVE

DISCLAIMER OF

OPINION

Multiple Uncertainties

Auditor concludes

that

Even after auditor has

obtained audit evidence

He cannot form an opinion on FS due to potential

interaction of the uncertainties and

their possible cumulative effect

After accepting engagement, management imposes a

scope limitation

Auditor assesses that this may

result in a qualified opinion

or disclaimer

Auditor requests management to remove the scope

limitation

Management does

not remove it

Auditor communicates this to Those charged with

governance (TCWG)

Considers alternative procedures

If he cannot obtain sufficient appropriate audit evidence, and

concludes that effect of undetected

misstatements is

Material but not pervasive

Material and pervasive

QUALIFY

RESIGN, if allowed to

GIVE DISCLAIMER

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Auditors ’ Report Modification Matrix:

Modifications in the Report( Contd..)

Nature of matter giving rise to the modification

Auditor’s Judgment about the Pervasiveness of the Effects or Possible Effects on the Financial

Statements

Material but not pervasive

Material and Pervasive

Financial statements are materially misstated

Qualified opinion Adverse opinion

Inability to obtain sufficient appropriate audit evidence

Qualified opinion

Disclaimer of opinion

A misstatement is the difference between the amount of classification, presentation, or disclosure reported in the financial statements and the classification, presentation, or disclosure required as per the applicable financial reporting framework.

This may arise in relation to :

1. Appropriateness of the selected accounting policies Selected accounting policies are not consistent with the applicable financial reporting

framework ; Financial statements , including notes thereon , do not represent underlying transactions

and events that achieves fair presentation 2. Application of selected accounting policies When accounting policies are not applied consistently , including consistency between

periods , similar transactions and events ; Method of application is erroneous

Material Misstatements

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3. Appropriateness or adequacy of disclosures in the financial statements : Financial statements do not include all disclosures required by the applicable financial

reporting framework Disclosures are not presented in accordance with the applicable financial reporting frame

work The financial statements do not provide the disclosures necessary to achieve fair

presentation

Material Misstatements (Contd..)

Auditor’s inability to obtain sufficient appropriate audit evidence may arise from :

Circumstances beyond the control of the entity; eg. Where records have been destroyed by fire, or seizure by government authority, etc.

Circumstances relating to nature or timing of the Auditor’s work eg. When auditor is appointed on such date that he cannot observe the physical count

Limitation imposed by the management Eg: Management prevents auditors from inventory counting / obtaining external confirmations.

In case limitation is imposed by the management, the auditor shall request the management to remove the limitation

If the management still persists, Auditor shall communicate it to those charged with governance and determine if alternative audit procedures are possible.

If the auditor is unable to obtain sufficient appropriate audit evidence, he shall:

Resign from the engagement, where practicable and not prohibited by law

If resignation is not possible due to stage of the auditor legal or professional restriction, the auditor shall give a disclaimer of opinion

Where the auditor decides to resign, he shall inform to those charged with the governance any matters regarding misstatements identified during the audit that would have given rise to modification in the report

Inability to obtain Sufficient Appropriate Audit Evidence

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In addition to the elements of the auditor’s report referred in SA 700 , the following need to be added for modified reports :

Basis of modification paragraph Amendments in the opinion paragraph Amendments in the Auditor’s responsibility paragraph

Form and Content of Modified Report

Basis of modification paragraph This is placed immediately before the opinion paragraph and under the heading “Basis of

Qualified Opinion, Basis of Adverse Opinion, Basis of Disclaimer of Opinion ” Modification may relate to : Specific amounts in the financial statements–in this case, include the description and

quantification of the financial effects, if practicable . If not practicable , state the fact in the report

Narrative disclosures in the financial statements–in this case explain how the disclosures are misstated

Non-disclosure of information required to be disclosed–in this case Discuss the non disclosure with those charged with governance Describe the nature of omitted information If practicable, not prohibited by law and if sufficient appropriate audit evidence relating

to that item is obtained, include the omitted disclosure Even if the auditor has expressed an adverse opinion or disclaimer of opinion, he shall

describe other matters which he is aware that would have required a modification

Form and Content of Modified Report

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Amendments in the opinion paragraph Use the heading–“ Qualified Opinion ”, “ Adverse Opinion ” , or “ Disclaimer

of Opinion ” Must use the phrases-“ with the foregoing explanation ” or “ subject to ” or “

except that” Where a qualified opinion is issued due to material misstatement the auditor

shall state in the opinion paragraph that except for the matters described in the basis of qualified opinion, the financial statements have been prepared, in all material respects, in accordance with the applicable financial reporting framework

When modification arises from inability to obtain sufficient appropriate audit evidence, the auditor shall use the corresponding phrase “ except for the possible effects of the matter(s) … ” or the modified opinion

Form and Content of Modified Report (Contd..)

When issuing an adverse opinion, the auditor shall state That the financial statements DO NOT PRESENT a true and fair view; or The financial statements have NOT been prepared, in all material respects,

in accordance with the applicable financial reporting framework When the auditor disclaims an opinion due to inability to obtain sufficient

appropriate audit evidence, he shall state: Because of the significance of the matter (s) described in the Basis for

Disclaimer of opinion paragraph ,the auditor has NOT been able to obtain sufficient appropriate audit evidence therefore The auditor does NOT express an opinion on the financial statements


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Amendments in the Auditor’s responsibility paragraph In case of qualified opinion or adverse opinion, the auditor shall state that he

believes that the audit evidence is sufficient and appropriate to provide a basis for his MODIFIED audit opinion

In case of disclaimer of opinion due to inability to obtain sufficient appropriate audit evidence :

The auditor shall amend the introductory paragraph to state that he was engaged to audit the financial statements;

He shall amend the Auditor’s responsibility paragraph and scope to include the following“ because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph , we have not been able obtain sufficient appropriate audit evidence to provide a basis for our audit opinion.”


Basis of Qualified Opinion “ The Company’s inventories are carried in the Balance Sheet at Rs. XXX. Management has not stated the inventories at the lower of cost and net realisable value but has stated them solely at cost, which constitutes a departure from the Accounting Standards referred to in sub-section (3C) of section 211 of the Act. The Company’s records indicate that had management stated the inventories at the lower of cost and net realisable value, an amount of Rs. XXX would have been required to write the inventories down to their net realisable value. Accordingly, cost of sales would have been increased by Rs. XXX, and income tax, net profit and shareholders’ funds would have been reduced by Rs. XXX, Rs. XXX and Rs. XXX , respectively”.

Qualified Opinion “ In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India”

Examples of Qualified Opinion

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Basis of Adverse Opinion “ As explained in Note X, the Company has not consolidated the financial statements of subsidiary XYZ Company it acquired during 20XX because it has not yet been able to ascertain the fair values of certain of the subsidiary’s material assets and liabilities at the acquisition date. This acquisition is therefore accounted for as an investment. Under the accounting principles generally accepted in India, the subsidiary should have been consolidated because it is controlled by the Company. Had XYZ been consolidated, many elements in the accompanying financial statements would have been materially affected. The effects on the financial statements of the failure to consolidate have not been determined”.

Adverse Opinion

“In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion paragraph, the consolidated financial statements do not give a true and fair view in conformity with the accounting principles generally accepted in India”

Examples of Adverse Opinion

Basis of Disclaimer of Opinion “The Company’s investment in its joint venture XYZ Company is carried at Rs. XXX in the Company’s Balance Sheet, which represents over 90% of the Company’s net assets as at March 31, 20XX. We were not allowed access to the management and the auditors of XYZ Company. As a result, we were unable to determine whether any adjustments were necessary in respect of the Company’s proportional share of XYZ Company’s assets that it controls jointly, its proportional share of XYZ Company’s liabilities for which it is jointly responsible, its proportional share of XYZ Company’s income and expenses for the year, and the elements making up the Cash Flow Statement”.

Disclaimer of Opinion

“ Because of the significance of the matter described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the financial statements.”

Examples of Disclaimer of Opinion

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Emphasis of Matter Paragraphs and Other

Matter Paragraphs in the Independent Auditor’s

Report

Standard on Auditing (SA) 706

Types of paragraph Emphasis of Matter Paragraph in the Audit Report On a matter that is appropriately presented or disclosed in Financial Statements. Insertion of an emphasis of matter paragraph in the Auditor’s Report does not

make the opinion “modified” An Emphasis of Matter paragraph is not a substitute for either the auditor

expressing a qualified opinion or an adverse opinion, or disclaiming an opinion An emphasis of matter is not a part of the audit opinion at all. It is a separate,

independent paragraph designed to provide “additional communication” to the users

Other paragraphs Paragraph in the Audit Report that refers to a matter other than those presented or

disclosed in Financial Statements.

Form of Audit Report

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An emphasis of matter paragraph is useful when the auditor, having formed an opinion, intends to draw the attention of the users to :

A matter, though appropriately presented and disclosed, is of fundamental importance to the users to understand the financial statements;

Any other matter relevant to the users’ understanding of the audit, auditor’s

responsibility or Auditor’s Report. Where an emphasis of matter paragraph is required by any other auditing standard,

the disclosure shall be as per this SA. Such a paragraph shall refer to information presented and disclosed in financial

statements.

The auditor should have obtained sufficient appropriate audit evidence that the matter is not materially misstated.

Emphasis of Matter Paragraph

The emphasis of matter paragraph shall be placed immediately after the Opinion paragraph in the Auditor’s Report under the heading “Emphasis of Matter Paragraph”

Include a clear reference to the matter being emphasized and to the

relevant disclosures

Indicate that the Auditor’s opinion is NOT modified by using words like “ Without qualifying our opinion” or “Our report is not qualified on this account”

Emphasis of Matter Paragraph (Contd..)

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Examples when an emphasis of matter paragraph is to be included:

An uncertainty relating to the future outcome of an exceptional litigation or regulatory action

Early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date

A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position


Emphasis of Matter”

“We draw attention to Note XX of Schedule XX to the financial statements stating that the Company has paid Rs. xx Crores under protest against claims of Rs. xx Crores for expenses which the Company has disputed in matters that are in various stages of litigation. Pending resolution of these disputes by the relevant courts, these expenses have been accounted for in the May 11, 2013 financial statements based on the management’s expectation of the amounts due. Our opinion is not qualified in respect of this matter.”


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An Other Matter paragraph may be required to enhance users’ understanding of an audit

Examples:- Relevant to Users’ Understanding of the Auditor’s Responsibilities or the

Auditor’s Report Reporting on more than one set of financial statements Restriction on distribution or use of the Auditor’s Report

Specimen:- “We did not audit the financial statements of certain subsidiaries, whose financial statements reflect total assets (net) of Rs. XXXX as at March 31, 20XX, total revenues of Rs. XXXX and net cash outflows amounting to Rs. XXXX for the year then ended. These financial statements have been audited by other auditors whose reports have been furnished to us by the Management, and our opinion is based solely on the reports of the other auditors. Our opinion is not qualified in respect of this matter”

Other Matter

Place of Other Matter:-

Depends on the nature of the information to be communicated

Other Matter (Contd..)

If the other matter pertains to the audit, the auditor’s responsibility or the auditor’s

report insofar as

Where placed in auditor’s report?

Expressing an opinion on the financial statements

Placed immediately below the Emphasis of Matter paragraph

Other reporting responsibilities of the auditor (eg. Reporting under CARO)

Included in the section titled: “Report on Other Legal and Regulatory

Requirements:

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Judgement of appropriate reporting depends on the facts and circumstances of each case.

e.g There is a pending tax litigation amounting a significant amount say 200 crores and the amount is disclosed under contingent liabilities.

Case 1

The company won the case in high court and department is in appeal

There is no other judgement or amendment to the law contrary to the High Court decision

How do you exercise judgement…

Case 2

The company lost the case in Tribunal/ High Court and is in appeal in High court/ Supreme Court

The amount is quite significant to the entity

The company and the legal opinion still contends that there is a strong case

You may not conclude that provision is necessary


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Case 3

The company lost the case in High Court and is in appeal

There are many such cases from other High Courts also

There is no favourable case to support

The company and the legal opinion still contends that the case is different and not comparable to other such cases

Case 4

There is a Supreme Court decision which is clearly against the matter in appeal and it is more likely than not that the appear will be decided against the company.


Q-: Is it possible for the financial statements to be prepared in accordance with two financial reporting frameworks and if so, how is auditor’s opinion expressed

A: Each framework is considered separately in forming an auditor’s opinion. If the financial statements are found to be in compliance with each of the frameworks, the auditor may issue two separate opinions, one for compliance with each framework.

If they are in compliance with one framework but not the other, an unmodified opinion may be given on the former under this SA and a modified opinion on the latter under SA 705

FAQ’s

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Q: How does an auditor deal with a situation where the audited entity voluntarily provides supplementary information or where a law or regulation requires additional information that is outside the scope of the applicable financial reporting framework?

If such information is embedded in the financial statements, the auditor discusses with the client if such information could be displayed separately outside the financial statements.

Where such supplementary information (eg., a GAAP reconciliation between Indian GAAP and IFRSs included in the Notes to the Financial Statements) cannot be clearly differentiated from the rest of the financial statements, the auditor’s opinion shall have to cover that too. This means that the auditor would need to audit this information and report on it in the ordinary course

If the management (or law/ regulation) requires such information not to be subjected to audit, the auditor must ensure that such information is presented in a way that clearly shows that it is “unaudited”. However under SA 720 the auditor still has the responsibility to read that information to identify if it contains any material inconsistency with the audited financial statements

FAQ’s

Q : How does one decide the nature of modification that should be made?

An auditor has to evaluate the situation carefully before making his judgment as to the nature of modification. It is very important that he, in terms of the principles laid down in SA 230, Audit Documentation, also documents in his work papers how and why he reached this professional judgment.

Judgement Judgement Judgement

Document Document Document…..

FAQ’s

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There can be two situations:

(a) There is a matter for which the auditor has sufficient appropriate audit evidence to determine that due to such matter the financial statements are materially misstated, and

(b) There is a matter for which the auditor is unable to obtain sufficient appropriate audit evidence to determine whether due to it the financial statements may be materially misstated.

In either case the report will be modified, but the nature of modification can be different.

FAQ’s (Contd..)

Ex: There are certain ongoing income tax matters. There can be two instances:

- There are similar income tax matters for other assesses and it was decided against the assess at the High Court, however the Company is not making provision. – Qualified opinion

- There are similar income tax matters for other assesses (e.g. denial of benefit of Sec 80IC deduction), however the matter is yet to be concluded.- a) Qualified opinion if the impact is material but not pervasive b) If the impact is pervasive then Disclaimer of opinion.

FAQ’s (Contd..)

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Q : What is an auditor obligated to do if he expects to modify his report

If the auditor expects to issue anything other than a clean opinion, he has an obligation to communicate this to those charged with governance (eg, an audit committee or board of directors or partners/ trustees in case of a firm/ trust) that he intends to do so, as well as provide them the proposed wording.

FAQ’s

Some Observations out of Reports

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Following qualification is given in the basis of qualified opinion paragraph in Audit Report of a Company: “Attention is drawn to Note No. X1 of Notes on Financial Statements which is reproduced : The liabilities to ABC Bank for the various credit facilities granted as shown in Note No. X2 of Notes on Financial Statements have been taken over by XYZ Pvt. Ltd. as per the agreement entered into by and between ABC Bank and XYZ Pvt. Ltd.. XYZ Pvt. Ltd. has served notice to company for recovery of dues of Rs.XXX Lacs. The Company has disputed the agreement and has obtained a stay of recovery from DRT. XYZ Pvt. Ltd. has taken the symbolic possession of mortgaged premises i.e. 2nd charge on factory and 1st charge on 1000 sq. ft. of office premise. The matter is pending with DRT for final hearing and disposal. In view of the above, the impact on the financial statements cannot be quantified.”

Issue 1

It was noted that the manner of the reporting suggests that the auditor merely wanted to invite attention to the subject matter of a particular note without giving any reason for qualification. If is felt that if the Auditor had obtained sufficient appropriate audit evidence that the matter is not materially misstated in the financial statements, he could have, under Para 6 of SA 706 included an Emphasis of Matter Paragraph instead of a qualified opinion.

Observation

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It was noted from the Auditor’s Report that the basis for qualified opinion states as follows: “In our opinion and to the best of our information and according to the explanations given to us, attention is drawn to the following, in respect of these financial statements: A. In respect of non compliances:

1. Note No. 29 relating to AS 5 “Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies” and AS 10 “Accounting for Fixed Assets

2. Note No. 39 relating to AS 29 “Provisions, Contingent Liabilities and Contingent Assets" in respect of non-provision of interest and penalties on delays in deposit of statutory dues with Government, Semi-Government and Local Authorities.”

Issue 2

It was viewed that the qualifications included in the audit report is not clear and have not been drafted as per SA 705, which requires a clear description of all the substantive reasons to be included in the qualified opinion including mentioning the basis for the qualified opinion. Further the impacts on the financials are also not disclosed in the Audit report.

Observation

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Following qualification has been given in the Auditor’s Report of a company: “Opinion Attention is required to following notes forming parts of accounts-

1. Note no. X1 relating to non provision of interest amounting to Rs. XXXXXX lacs on secured/unsecured debt.

2. Note no. X2 relating to preparation of accounts on a going concern basis.

Subject to the foregoing, in our opinion and to the best of our information and according to the explanations given to us, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:…”

Issue 3

It is noted that the Auditor has stated his qualification under the heading “Opinion” without stating whether it is qualified or not, though he has indicated that his opinion is “subject to” but has also not given a proper description of the matter giving rise to the modification which is not in accordance with paragraph 16 of SA-705 which states that: “When the auditor modifies the opinion on the financial statements, the auditor shall, in addition to the specific elements required by the SA 700 (Revised), include a paragraph in the auditor’s report that provides a description of the matter giving rise to the modification. The auditor shall place this paragraph immediately before the opinion paragraph in the auditor’s report and use the heading “Basis for Qualified Opinion”, “Basis for Adverse Opinion”, or “Basis for Disclaimer of Opinion”, as appropriate. “ Hence, the manner of modification of the report is not in accordance with SA-705.

Observations

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Following qualification has been given in the Auditor’s Report of a Company:

“Opinion

In our opinion and to the best of our information and according to the explanations given to us, the financial statements subject to the observations in Para 2 (b) and 2 (e) below, give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:..”

Report on Other Legal and Regulatory Requirements

As required by section 227(3) of the Act, we report that:

b) i. In absence of detailed working papers on physical verification of inventories, discrepancies, if any, between book and physical inventories could not be ascertained including effect of the same in the financial statements of the company.

ii. Interest on delayed payment of statutory dues has not been provided for, which has neither been quantified nor the effect of the same on the financial statements has been ascertained.

iii. No provision has been made against performance Bank Guarantees invoked amounting to Rs. 59.40 Crores against the company and disputed by it.

iv. No provision has been made against sundry debtors amounting to Rs. 442.16 Crores disputed by the parties and referred for arbitration.

……

e) in our opinion, the Balance Sheet, Statement of Profit and Loss, and Cash Flow Statement comply with the Accounting Standards referred to in subsection (3C) of section 211 of the Companies Act, 1956 except Accounting Standard 2 ( Valuation of Inventories) issued by The Institute of Chartered Accountants of India as stated in Para .2 (b) (i) above.”

Issue 4

It may be noted that paragraph 38 of SA 700 states as follows: “Other Reporting Responsibilities 38. If the auditor addresses other reporting responsibilities in the auditor’s report on the financial statements that are in addition to the auditor’s responsibility under the SAs to report on the financial statements, these other reporting responsibilities shall be addressed in a separate section in the auditor’s report that shall be sub-titled “Report on Other Legal and Regulatory Requirements,” or otherwise as appropriate to the content of the section.” It was viewed that reporting qualification under Report on Other Legal and Regulatory Requirements is not in accordance with paragraph 22 of SA 705 which states that, “When the auditor modifies the audit opinion, the auditor shall use, the heading “Qualified Opinion”, “Adverse Opinion”, or “Disclaimer of Opinion” as appropriate, for the opinion paragraph”.

Observation

33

Following qualification has been given in the Auditor’s Report of a Company: “Opinion a. Attention is invited to the following The accounts of the Company are drawn up on “Going Concern” basis even though

the accumulated losses of the Company exceed its paid up capital and reserve. The Company is “Sick Industrial Company” under the provisions of Sick Industrial Companies Act, 1985.

Issue of Takeover Notice by ABC LIMITED due to nonpayment of its dues under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The”Going Concern” status of the Company is not affected as physical possession of the assets have not been taken. (Refer Note No 23).

Balances of Secured Loans as at 31.03.2013 are subject to their confirmation and reconciliation.

Balances of sundry debtors and advances as at 31.03.2013 are subject to their confirmation and reconciliation.

Subject to the forgoing, in our opinion and to the best of our information and according to the explanations given to us, the said accounts read with Significant Accounting Policies and notes thereon give the information required by the Companies Act, 1956, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:…”

Issue 5

It may be noted that SA 705 requires that when the Auditor modifies the opinion, he shall, in addition to the SA 700 (Revised) requirement, include a paragraph that provides a description of the matter giving rise to the modification. The auditor shall place this paragraph immediately before the opinion paragraph and use the heading “Basis for Qualified Opinion”; “Basis for Adverse Opinion”; Basis for Disclaimer of Opinion”. SA 706 requires that vide paragraph 6 “if the auditor considers it necessary to draw users attention to a matter presented or disclosed in the financial statement that, in the auditors judgment, is of such importance that it is fundamental to users understanding of the financial statements, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report. Such a paragraph shall refer only to information presented or disclosed in the financial statement. It was viewed that the opinion of the auditor is not a qualified opinion, it is more of a Matter of Emphasis where auditor is trying to draw attention to certain facts. Accordingly, the same should have been paragraphed his under “Emphasis of Matter.”

Observation

34

It may be noted that SA 705 requires that when the Auditor modifies the opinion, he shall, in addition to the SA 700 (Revised) requirement, include a paragraph that provides a description of the matter giving rise to the modification. The auditor shall place this paragraph immediately before the opinion paragraph and use the heading “Basis for Qualified Opinion”; “Basis for Adverse Opinion”; Basis for Disclaimer of Opinion”. SA 706 requires that vide paragraph 6 “if the auditor considers it necessary to draw users attention to a matter presented or disclosed in the financial statement that, in the auditors judgment, is of such importance that it is fundamental to users understanding of the financial statements, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report. Such a paragraph shall refer only to information presented or disclosed in the financial statement. It was viewed that the opinion of the auditor is not a qualified opinion, it is more of a Matter of Emphasis where auditor is trying to draw attention to certain facts. Accordingly, the same should have been paragraphed his under “Emphasis of Matter.”

Observation

……….

Regulator is overseeing whether reporting is appropriate and not excessive

Regulator is following up on auditors qualification

Regulatory Focus

35

SEBI has now decided to put in place a system to monitor the audit qualifications contained in the audit report accompanying the audited annual financial statements submitted by listed companies.

SEBI has constituted the ‘Qualified Audit Review Committee’ (QARC) with representatives from Institute of Chartered Accountants of India (ICAI), stock exchanges, etc. The QARC shall review the cases received from the stock exchanges and guide SEBI in processing the qualified annual audit reports referred to by the stock exchanges.

Regulatory focus

After analyzing the qualifications in audit reports, QARC may make following recommendations:

If, prima facie, QARC is of the view that an audit qualification is not significant, it may suggest steps for rectification of such qualification;

If, prima facie, QARC is of the view that an audit qualification is significant and the explanation given by the listed company concerned / its Audit Committee is unsatisfactory, the case may be referred to the Financial Reporting Review Board of ICAI (ICAI-FRRB) for their opinion on whether the qualification is justified or requires restatement of the books of accounts of the listed company;

If an audit qualification is not quantifiable, QARC may suggest rectification of the same within a stipulated period.

Regulatory focus (Contd..)

gaap and audit

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