REVISED REPORTING REQUIREMENTS FOR AUDIT OF FINANCIAL STATEMENTS

An audit report is an opinion of an auditor regarding entity’s financial statements. It is the conclusion of an audit of financial statements is the audit report. It is only through the audit report that the statutory auditor communicates about the audit procedures followed, the auditing framework followed and whether the financial statements on which the report is given depicts a ‘True and Fair’ view.

The Institute of Chartered Accountants of India (ICAI) has promulgated several standards for the conduct of audit and reporting. The SAs are divided into 2 groups:

a) Standards on Quality Control (SQC) (which apply at the firm level) and

b) Standards on Audit (SA) which apply to audits of historical financial information. SAs are further categorised as standards dealing with:

i) G eneral principles and responsibilities (issued under 200 series);

ii) Risk assessment and response to assessed risks (issued under 300 and 400 series);

iii) Audit evidence (issued under 500 series);

iv) Using work of others (issued under 600 series);

v) Audit conclusions and reporting (issued under 700 series) and

vi) Specialised areas (issued under 800 series).

ICAI had issued a new set of SAs (under 700 series) which were to be applied for audits for financial statements for the period on or after 1st April 2011. However, in view of inadequate dissemination of information about the applicability of the series 700 SAs and consequent unawareness of the same, the applicability was postponed by ICAI for audits for financial statements for the period on or after 1st April 2012. Thus, audit reports for audits conducted for the financial year 2012-13 would be the first year of applicability of the series 700 SAs. ICAI has also issued “Implementation guide on Reporting Standards” to address the concerns, apprehensions and difficulties in relation to implementation of the new reporting standards.

This article discusses the Standards on Audit Conclusions and Reporting issued under 700 series.

The new SAs are listed as under:

SAs apply to audits of general purpose financial statements (GPFS). They do not apply to engagements other than audits, where the procedures performed are ‘reviews’ or ‘compilations’ or ‘agreedupon- procedures’. GPFS generally consist of balance sheet, statement of profit and loss (or income statement), cash flow statement, significant accounting policies and notes and where applicable, statement of changes in equity.

GPFS are Financial Statements are FS prepared in accordance with a Financial Reporting Framework (FRF) and is designed to meet common financial information needs of a wide range of users. The FRF may be a ‘fair presentation framework’ or a ‘compliance framework’. Broad differences between these two frameworks are given in the Table 1.

A question which arises is that apart from audit reports of companies, whether these SAs would also apply to reports issued under the Income Tax Act, 1961 (e.g. tax audit report issued in Form 3CB)? As mentioned in 6 above, SAs apply to audits of GPFS – hence if the financial statements for which the report is issued in Form 3CB, are GPFS, then these SAs would also apply for such reporting. Para 3.4 of the Preface to the Statements of Accounting Standards issued by ICAI in 2004 states that “the term ‘General Purpose Financial Statements’ includes balance sheet, statement of profit and loss, cash flow statement (wherever applicable) and statements and explanatory notes which form part thereof, issued for the use of various stakeholders, governments and their agencies and the public…”

Further, footnote 9 to SA 800 ‘Special Considerations – Audits of Financial Statements Prepared in accordance with Special Purpose Frameworks’ states that “In India, financial statements prepared for filing with income tax authorities are considered to be general purpose financial statements”.

In view of this specific assertion from ICAI, the audit report format prescribed by SA 700(R), SA 705, SA 706 and SA 710(R) would also apply to reports issued in Form 3CB under the Income Tax Act, 1961.

The ‘Financial Reporting Framework’ (FRF) is not defined in SA 700(R). However, para 22 of SA 700 (AAS 28) mentions: “Paragraph 3 of “Framework of Statements on Standard Auditing Practices and Guidance Notes on Related Services”, issued by the ICAI, discusses the financial reporting framework. It states: “ ….Thus, FS need to be prepared in accordance with one, or a combination of:

(a) Relevant statutory requirements, e.g., the Companies Act, 1956,

(b) Accounting Standards issued by ICAI; and

(c) Other recognised accounting principles and practices, e.g., those recommended in the Guidance Notes issued by the ICAI” (emphasis supplied)

The above Framework issued in 2001 has been withdrawn pursuant to the revised “Framework for Assurance Engagements” applicable from April 1, 2008. The revised framework does not define ‘Financial Reporting Framework’. Due to this, does it imply that the other recognised accounting principles and practices, e.g., those recommended in the Guidance Notes (GN) issued by the ICAI will not form part of FRF? ICAI needs to clarify this, since, if the GNs issued by ICAI do not form part of FRF, the very mandatory nature of these GN for members of ICAI comes in doubt.

SA 700(R) requires an auditor to form an opinion on whether the FS are prepared in all material respects in accordance with the applicable FRF. To form that opinion, the auditor has to conclude, whether reasonable assurance has been obtained that the FS as a whole are free from material misstatement, whether due to fraud or error. In order to come to such conclusion the auditor shall need to take into account the following:

i)    whether Sufficient Appropriate Audit Evidence (SAAE) has been obtained in accordance with SA 330 ‘Standard on the Auditor’s Responses to Assessed Risks’;

ii)    whether uncorrected misstatements are material, individually or in aggregate in accordance with SA 450 ‘Standard on Evaluation of mis-statements identified during the Audit’;

iii)    other required evaluations related to selection, consistent application and disclosure of the significant accounting policies and reasonability of accounting estimates by management; and

iv)    In case of fair presentation framework, evaluation to also include whether FS achieve fair presentation.

SA 700(R) requires that the auditor expresses an unmodified opinion if he concludes that the FS are prepared, in all material respects, in accordance with the applicable FRF. The auditor has to, however, give a modified opinion in two situations:

i)    When the auditor has obtained SAAE but he concludes that the FS taken as a whole are not free from material misstatement(s); or

ii)    When he is unable to obtain SAAE.

In either of the above situations the auditor must give a modified opinion as per SA 705.

In case of reporting under fair presentation frame-work, if the auditor concludes that the fair presentation is not achieved, he should discuss the matter with the management to resolve the issue and based on the outcome, decide whether he should give a modified opinion or not.

As per the SA 700(R), the auditor’s report has to be in writing and should include the following:

Title

The title of an auditor’s report should clearly indicate that it is the report of an independent auditor like “Independent Auditor’s Report”. Unlike the earlier title ‘Auditor’s Report’ this title makes it very implicit that independence is one of the important considerations while doing the audit.

Addressee

The report should be addressed to those for whom it is prepared in line with the existing requirement. Typically, it is addressed to ‘the shareholders’ or ‘the members’ in case of the statutory audit under the Companies Act, 1956 or to the Board of Directors in case of Consolidated Financial Statements (CFS).

Introductory Paragraph

In this paragraph apart from identifying the entity, the title of each statements comprised in the FS and the period covered by each of the statements, a specific reference has to be made to the summary of significant accounting policies and other explanatory information given in the FS. The following illustration is given in the Appendix of the Standard:
“We have audited the accompanying financial statements of ABC Ltd, which comprise the Balance Sheet as at March 31, 20XX, and the Statement of Profit and Loss for the year then ended, and a summary of significant accounting policies and other explanatory information”.

Management’s Responsibility Paragraph

The SA requires the Auditor to describe, under a separate paragraph with heading ‘Management’s Responsibility for the financial statements’ that the management (or those charged with governance) is responsible:

•    for the preparation of FS in accordance with the applicable FRF; and

•    for the design, implementation and maintenance of the internal controls relevant to the preparation of FS which are free from material misstatement, whether due to fraud or error.

In cases where FS are prepared in accordance with a fair presentation framework, the report should refer to “the preparation and fair presentation of these FS” or “the preparation of FS that give a true and fair view”.

Auditor’s Responsibility Paragraph

The SA requires the report to state the following:

i)    that the responsibility of the auditor is to express an opinion on the FS based on the audit;

ii)    that audit was conducted in accordance with Standards on Auditing issued by ICAI and that these SAs require the auditor to:

•    Comply with ethical requirements;

•    Plan and perform the audit to obtain reasonable assurance about whether the FS are free from material misstatement.

The report should also describe an audit by stating that:

•    An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the FS;

•    The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the FS, whether due to fraud or error.

•    In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances,

An audit also includes evaluation of Appropriateness of accounting policies used and Reasonableness of management’s accounting estimates; and

Overall presentation of FS

i)    Where the FS are prepared in accordance with a fair presentation framework, the description of the audit in the auditor’s report shall refer to “the entity’s preparation of FS that give True & Fair view”

ii)    The auditor’s report should also state whether the auditor believes that he has obtained SAAE to provide a basis for his opinion.

Auditor’s Opinion Paragraph

The SA requires the expression of opinion as under:

Unmodified opinion expressed

In case of Fair Presentation framework:

FS present fairly, in all material respects, in accordance with {applicable FRF}

FS give a True & Fair view of in accordance with [applicable FRF]

The SA gives an illustration of an unmodified opinion in case of fair presentation framework under Companies Act, 1956 as under:

“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 Companies Act, 1956, in the manner so required and give a true & fair view of the financial position of ABC Ltd. As at March 31, 20xx and of its financial performance and its cash flows for the year then ended, in accordance with accounting standards referred to in section 211(3C) of the said Act”.

In case of Compliance framework:

FS are prepared, in all material respects, in accordance with [applicable FRF]

Other Reporting Responsibilities Paragraph

The SA mentions that sometimes the auditor is also required to report on other matters that are supplementary to the auditor’s responsibility to report on the financial statements. For example, report on additional specified procedures or to express an opinion on specific matters or under the relevant law or regulation. The SA provides that if the auditor addresses other reporting responsibilities in the auditor’s report on the FS that are in addition to the auditor’s responsibility under the SAs to report on the FS, they 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. For e.g. reporting under CARO or for NBFCs as required by RBI, etc.. Unlike the current practice where different practices were being followed with reference to such reporting, SA 700(R) requires the same to be reported under a specific heading.

Signature

The Audit Report has to be signed in the auditor’s personal name and where a firm is appointed as auditor, report shall be signed in personal name and in name of audit firm. The report has to also mention membership number issued by ICAI and wherever applicable, the registration number of the firm, allotted by the ICAI.

Though it apparently appears from the SA that the signatures need to be in individual as well as in the name of the firm, the implementation guide to SA 700(R) issued by ICAI in Question 21 mentions that “the intention of the SA is not to have 2 separate signatures, one in personal name and one in firm name, but that the partner signing should sign in his personal name for and on behalf of the firm which has been appointed as the auditor with the name and registration number of the firm also mentioned as signatory”.

Date of Auditor’s Report

The SA mentions that the audit report cannot be dated earlier than the date on which auditor has obtained SAAE on which the auditor’s opinion is based. This is to inform users of the FS that the auditor has considered effect of events and transactions that have occurred upto that date.

Place of Signature

The SA requires that the auditor’s report has to specify location, which is ordinarily the city where the audit report is signed. Thus, in a case where the report is signed in a city other that the one where the Board has adopted the FS, the name of the city where the directors sign would be different from that where the auditor signs the report.

The SA mentions that the wording of an auditor’s report may sometimes be prescribed by the law or regulation applicable to the client. If the prescribed terms are significantly different from the requirements of SAs, SA 210 ‘Agreeing the Terms of Audit Engagement’ requires the auditor to evaluate:

•    whether users might misunderstand the assurance obtained from the audit, and if so,

•    whether providing additional explanation in the auditor’s report can mitigate such misunderstanding.

SA 705 – Modifications to the opinion in the Independent Auditor’s Report

SA 705 deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700(R), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary.

SA 705 describes 3 types of modified opinions: (i) Qualified Opinion, (ii) Adverse Opinion and (iii) Disclaimer of Opinion

The decision on which type of modified opinion is appropriate depends on:

a)    Nature of matter giving rise to the modification i.e. whether the FS are materially misstated or in case of inability to obtain SAAE maybe materially misstated; and

b)    Auditor’s judgement about the pervasiveness of the effects or possible effects of the matter on the FS.

The SA mentions the circumstances when modification to opinion is required. It states that if the auditor concludes that based on the audit evidence obtained, the FS as a whole are not free from mate-rial misstatement, he can issued a modified report. This may be due to:

•    Inappropriateness of the selected accounting policies:

•     Accounting Policies not consistent with applicable FRF;

•     FS do not represent underlying transactions and events in a manner that achieves fair presentation;

•    Inappropriateness of adequacy of disclosures in FS

•     FS do not include all disclosures required by applicable FRF;

•     Disclosures not presented as per applicable FRF;

•     FS do not contain disclosures necessary to achieve fair presentation

•    Inability to obtain SAAE

•     Circumstances beyond control of entity; (e.g. records destroyed or seized by authorities)

•     Circumstances relating to nature of timing of auditor’s work; (e.g. timing such that physical inventory cannot be taken )

•     Limitations imposed by management (e.g. auditors prevented from obtaining external confirmations, etc.)

SA 705 lays down as under the criteria for deter-mining the type of modification which are given in Table 2:

•    Are not confined to specific elements, accounts or items of the FS;

•    If so confined, represent or could represent a substantial proportion of the FS

•    In relation to disclosures, are fundamental to users’ understanding of the FS.

The SA requires the auditor to disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained SAAE regarding each of the individual uncertainties, it is not possible to form an opinion on the FS due to the potential interaction of the uncertainties and their possible cumulative effect on the FS.

SA 705 also gives the form and content of Auditor’s Report in case of Modified Opinion. It requires that

i)    In addition to other elements as per SA 700(R), the Auditor’s Responsibility statement is to be amended to provide description of matter giving rise to modification;

ii)    The placement of the same is immediately before the Opinion para with the heading “Basis for Modified Opinion”

iii)    The contents of the ‘Basis of Modification Para’ dependon the cause of modification.. The same are given in Table 3

“Except for the effects of the matter(s) described in the ‘Basis for qualified opinion para’’

•    In case of Fair Presentation framework:

The FS present fairly, in all material respects (or give a true and fair view) in accordance with the [applicable FRF]

•    In case of Compliance framework:

The FS have been prepared, in all material respects in accordance with the {applicable FRF}”.

SA 705 requires an Adverse Opinion to be given as:

“In the auditor’s opinion, because of the significance of the matter(s) described in the ‘Basis of Adverse Opinion para’,

•    In case of Fair Presentation framework: “The FS do not present fairly, in all material respects (or give a true and fair view) in accordance with the [applicable FRF]”.

•    In case of Compliance framework: “The FS have not been prepared, in all material respects in accordance with the [applicable FRF]”.

SA 705 requires a Disclaimer of Opinion to be given as:

“Because of the significance of the matter(s) described in the ‘Basis for Disclaimer of Opinion para’, the auditor has not been able to obtain SAAE to provide a basis for an audit opinion and accordingly, the auditor does not express an opinion on the FS.”

The SA also requires description of auditor’s responsibility to be amended when the auditor expresses a qualified or adverse opinion. In such cases, the description of the auditor’s responsibility has to be amended to state that the auditor believes that he has obtained SAAE to provide a basis for his modified audit opinion.

In case, the auditor has disclaimed an Opinion, he has to amend the introductory paragraph of the auditor’s report to state that he was engaged to audit the FS and amend the description of the auditor’s responsibility. The same should be as under:

“Because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion”

SA 706 – Emphasis of Matter (EOM) paragraph and Other Matter (OM) paragraph in the Independent Auditor’s Report

SA 706 deals with additional communication in the Auditor’s Report when auditor considers necessary to draw user’s attention to:

•    Matter(s) presented or disclosed in FS are of such importance that they are fundamental to user’s understanding of FS

Or

•    Matter(s) other than those presented or disclosed in FS that are relevant to user’s understanding of audit or auditor’s responsibilities or audit report

SA 706 has laid down the following requirements with respect to EOM para:

•    Auditor should obtain SAAE evidence that the matter is not materially misstated in the FS;

•    EOM para shall refer only to information presented or disclosed in the FS;

•    Widespread use of EOM para diminishes the effectiveness of the auditor’s communication of such matters, by implying that matter has not been appropriately presented or disclosed in FS;

•    It is to be placed immediately after Opinion para.

The SA requires that the EOM para must include a clear reference to the matter being emphasized, where the relevant disclosures that fully describe the matter can be found in FS and indicate that the audit opinion is not modified in respect of matter emphasized. An EOM para is to be included in the Auditor’s Report in the following circumstances:

•    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 FS 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.

As per the SA, if the auditor considers it necessary to communicate a matter other than those that are presented or disclosed in the FS that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report and this is not prohibited by law or regulation, he shall do so in a paragraph in the auditor’s report, with the heading “Other Matter”, or other appropriate heading. This paragraph is placed immediately after the Opinion paragraph and any EOM paragraph.

SA 710(R) – Comparative Information – Corresponding Figures and Comparative Financial Statements

SA 710(R) deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements. The nature of the comparative information that is presented in an entity’s FS depends on the requirements of the applicable FRF.

SA 710(R) mentions that there are two broad approaches to the auditor’s reporting responsibilities in respect of comparative information: (a) Corresponding Figures; and (b) Comparative Financial Statements.

The approach to be adopted is often specified by law or regulation or in the terms of engagement. SA710 (R) addresses separately the auditor’s reporting requirements for each approach.

SA 710(R) requires the auditor to determine whether FS include the comparative information required by the applicable FRF and whether such information is appropriately classified. For this purpose, the auditor has to evaluate whether:

a)    The comparative information agrees with the amounts and other disclosures presented in the prior period; and
b)    The accounting policies reflected in the comparative information are consistent with those applied in the current period or, if there have been changes in accounting policies, whether those changes have been properly accounted for and adequately presented and disclosed.

If the auditor becomes aware of a possible material misstatement in the comparative information while performing the current period audit, the auditor has to perform such additional audit procedures as are necessary in the circumstances to obtain SAAE evidence to determine whether a material misstatement exists.

The SA requires that when corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures except in the circumstances described as under:

i)    If the auditor’s report on the prior period, as previously issued, included a qualified opinion, a disclaimer of opinion, or an adverse opinion and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s financial statements. In such cases, in the ‘Basis for Modification’ paragraph in the auditor’s report, the auditor shall either:

•    Refer to both the current period’s figures and the corresponding figures in the description of the matter giving rise to the modification when the effects or possible effects of the matter on the current period’s figures are material;

Or

•    In other cases, explain that the audit opinion has been modified because of the effects or possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures

ii)    If the auditor obtains audit evidence that a material misstatement exists in the prior period FS on which an unmodified opinion has been previously issued, the auditor has to verify whether the misstatement has been dealt with as required under the applicable FRF and, if that is not the case, the auditor shall express a qualified opinion or an adverse opinion in the auditor’s report on the current period FS, modified with respect to the corresponding figures included therein.

iii)    If FS of prior period were audited by a predecessor auditor, and the auditor is allowed and decides to refer to the predecessor auditor’s report for the corresponding figures, then the auditor shall state in an OM para that the FS of the prior period were audited by the predecessor auditor, the type of opinion expressed by him along with the reasons for the same and the date of that report.

iv)    If the FS of prior period were not audited, the auditor has to state in an OM para that the corresponding figures are unaudited. However, it will not relieve the auditor from obtaining SAAE that the opening balances do not contain material misstatements that materially affect current period’s FS.

The SA also requires that when comparative financial statements are presented, the auditor’s opinion shall refer to each period for which financial statements are presented and on which an audit opinion is expressed.

As per the SA, when reporting on prior period FS in connection with the current period’s audit, if the auditor’s opinion on such prior period FS differs from the opinion the auditor previously expressed, the auditor will have to disclose the substantive reasons for the different opinion in an OM paragraph in accordance with SA 706. In case, however, the FS of prior period were audited by a predecessor auditor, the requirements as prescribed above in point 39 (iii) will apply, whereas if the FS of prior period were not audited, the requirements as prescribed above in point 40(iv) will apply.

What’s new in the revised audit report formats? The revised formats of audit reports given in the SAsare very specific formats for issuing unmodified reports [SA 700(R)], modified reports (SA 705) and giving Emphasis of Matter paragraphs in the audit reports (SA 706). Unlike current audit reports, where diverse practices were being followed in giving modified reports or giving emphasis of matter, the positioning of the various paras are also specifically mentioned in these SAs. This would make audit reports uniform across different audit firms and also achieve better comparability.

Conclusion

As can be seen from the above, the audit report will undergo a substantial change for audits for periods beginning on or after April 1, 2012. The new format of the report is very different from the old format and will require auditors to spend more time in redrafting their reports to be in line with SA 700(R), SA 705, SA 706 and SA 710(R). The specific elements as required by the revised report, should also, hope-fully, make reading and understanding reports easier for shareholders and analysts and have a better appreciate the role of auditors.