Theoretical Gist on SA 700, 705, 706

CA Durgesh Kabra

AUDITORS’ REPORTING RESPONSIBILITY

As per the Companies Act, 2013 the auditor is required to comply with the requirements stated under section 143, the guidance notes issued by the ICAI and the Standards on Auditing notified by the Central Government in consultation with the ICAI.

SA 700 (Revised) FORMING AN OPINION AND REPORTING ON FINANCIAL STATEMENTS

SA 705 MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT

SA 706 EMPHASIS OF MATTER PARAGRAPHS AND OTHER MATTER PARAGRAPHS IN THE INDEPENDENT AUDITOR’S REPORT

INITIAL INTRODUCTION:

• Sections 143 (and certain other sections) of Companies Act, 2013
• Audit Report – 143 (3) (a) to (j)
• 143(2) Duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor
• Section 143(3) Powers and duties of auditors and auditing standards and The Companies (Audit and Auditors) Rules, 2014
• Other matters to be included in auditor’s report
• Reporting of frauds by auditor – GN on Reporting u/s 143 (12) and 143 (13)
• 143 (11) CARO Order 2015 – MCA and GN on CARO 2015 – ICAI
• SA 700, 705, 706
• New Auditor’s Report formats issued by ICAI (incl. CFS)
• GN on Reporting u/s 143 (3)(f) and (h) of Companies Act 2013

KEY POINTS IN REPORTING:

• Compliance with auditing standards is mandatory under section 143 (9) & (10) of Companies Act, 2013.
• Applies to audit of general purpose Financial Statements.
  • Not to reviews, compilation or agreed upon procedures.
• Consistency in format of audit report with clear heading promotes credibility in the global markets.
• Management and Auditors Responsibilities paragraph are elaborated.
  • Reduces the ‘expectation gap’ in regard to scope of auditor.
• It deals with how to form an audit opinion, reach audit conclusions and issue different types of audit reports.
  • Guidance given for scenarios in which opinions are to be given as ‘Emphasis of matter’ or ‘Qualification’ or ‘Adverse Opinion’.
• Implementation Guide on Reporting Standards issued by ICAI
  • Includes 55 FAQ’s and 26 illustrative formats of audit report.
• As per para A18 of SA 705, if financial statements are subject matter of qualification, the effect of the qualification on the financial Statements (unless impracticable) individually and in aggregate to be given.
  • Example: – If inventory is overstated- effects on income tax, PBT, PAT and reserves to be given.
• These Standards are based on the International Standard on Auditing.
  • [IAASB has revised the auditing reporting standards (ISA 701) in January 2015 and include new standard on “Communicating Key Audit Matters in the Independent Auditor’s Report”]

Impact of Going Concern [SA 570] in Audit Report

Component	Disclosure in Auditor’s Report
Existence of material uncertainity and disclosure made in financials	Emphasis of Matter [para 19]
Existence of material uncertainity and disclosure not made in financials	Qualified or Adverse Opinion [para 20]
Use of going concern assumption inappropriate	Adverse Opinion [para 21 and A25]
Management unwilling to make or extent its assessment	Qualified or Disclaimer of Opinion [para A27]

Reporting under section 143 (3) Auditor’s Report:

1. whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements;

2. whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;

3. whether the report on the accounts of any branch office of the company audited under sub-section (8) by a person other than the company’s auditor has been sent to him under the proviso to that sub-section and the manner in which he has dealt with it in preparing his report;

4. whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;

5. whether, in his opinion, the financial statements comply with the accounting standards;

6. the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company; GN issued by ICAI

7. whether any director is disqualified from being appointed as a director under sub-section (2) of section 164;

8. any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith; GN issued by ICAI

9. whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls; [IFC defined in 134(5)] Voluntary reporting for FY 14-15 and mandatory from 15-16 onwards

10. such other matters as may be prescribed – Rule 11 (Section 143(3) (j) )

• Whether company has disclosed impact, if any, of pending litigations on its financial position in its FS.
• Whether company has provided for material foreseeable losses, if any, on long term contracts including derivative contracts.
• Whether there has been any delay in transferring amounts to Investor Education and Protection Fund (IEPF).

General Points:

1. The report shall state the reasons for negative remarks or qualification made (Requirement of highlighting adverse observations/comments in audit report in thick type or italics omitted.) (Section 143 (4))

2. Reporting to C & AG for Government Companies ( Section 143 (5) to 143 (7))

3. Branch Audit to report to Main Auditor (Section 143 (8))

4. Standards on Auditing by ICAI shall be deemed Auditing Standards till NFRA did not notifies.

CARO Reporting under section 143 (11) including CARO Reporting for consolidated financial statements under section 143 (11)

1. Maintenance of fixed assets records & its physical verification

2. Maintenance of inventory records & its physical verification

3. Loans given by the company to related parties. Reporting is not required in respect of loans taken.

4. Internal control system for purchase of inventory & fixed assets and for sale of goods & services

5. Compliance with the provisions for deposits accepted by the company.

6. Maintenance of cost records (if applicable).

7. Regularity in depositing undisputed statutory dues and details in respect of disputed statutory dues. Further, new sub clause added for reporting on transfer of amount to IEPF.

8. Accumulated losses and cash loss of the company during the current and immediately preceding year.

9. Default in repayment of dues to financial institution or bank or debenture holders.

10. Guarantee given by the company for loans taken by others from banks and financial institutions, the terms whereof are prejudicial to the interest of the company

11. Application of term loans for the purpose for which they were obtained.

12. Nature and amount involved in fraud on or by the company reported during the year.

• If CARO is not applicable it has to be stated in the audit report.
• There was mixed practice – some auditors mentioned non-applicability for each clause separately, and others clubbed all non-applicable clauses in an opening paragraph. ICAI permits both practices .
• CARO 2015 is now also applicable to consolidated financial statements.
• Auditors comments to be based on the reports of the Auditors of the components which are Indian companies, since other component auditors’ would not be required to make any report under CARO 2015

SA 700 – This standard deals with the auditors’ responsibility to form an opinion on the financial statements and the form and content of the Auditors’ Report.

REQUIREMENTS OF FORMING AN OPINION

• The auditor shall form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework including qualitative aspects of entity’s accounting policies and possible bias in management’s judgments.
• He shall conclude as to whether he 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
• Auditors’ evaluation to include particularly the following:
  • Significant accounting policies applied
  • Consistency 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

FORM OF OPINION

• 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:

(a) that based on audit evidence, the financial statements are NOT free of material misstatements;

(b) 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 SA 705.

Contents of Standard Auditor’s Report

1. Title – “Independent Auditors’ Report”

2. Addressee – Should be addressed as per the terms of engagement

3. Report on the Consolidated or Standalone Financial Statements

4. Introductory Paragraph – The following information to be mentioned

a. Identify whose financial statements have been audited

b. State the financial statements audited

c. Identify the title of each statement in the financial statements

d. Refer to the summary of significant accounting policies and explanatory information

e. Specify the date or period covered

5. Management’s Responsibility for the Standalone Financial 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

6. Auditor’s Responsibility– State that the auditors’ 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. The auditor should describe :

• That he has performed procedures to obtain audit evidence
• These procedures are based on auditors’ professional judgement
• That the audit also includes assessment of appropriateness of accounting policies used and reasonableness of accounting estimates made
• The auditor shall state whether he believes that the audit evidence obtained is sufficient and appropriate to provide basis for his opinion

7 Auditor’s Opinion – The auditors’ opinion shall state that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. If the applicable financial reporting framework is not the accounting standards issued by the ICAI, NACAS, ASB, etc, then the auditor shall identify the jurisdiction.

8. Emphasis of Matter

9. Other Matter

10. Report on Other Legal and Regulatory Requirements – If other reporting responsibilities are addressed, they should be indicated

11. Signature of the Auditor – The report shall be signed in the name of the partner and the membership number and firm registration number should be mentioned

12. Date of the Auditor’s Report – report should be dated no earlier that the date when he obtains sufficient appropriate audit evidence

13. Place of Signature

SA 705 and 706 deal with form and content of modified opinion and emphasis of matter paragraph or other matter paragraph

SA 705

♠ 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
  • Auditors’ 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

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, is 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.

Auditors’ Report Modification Matrix

◊ A misstatement is the difference between the amounts 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 :

• Appropriateness of the selected accounting policies
• Application of the selected accounting policies
• Appropriateness or adequacy of disclosures in the financial statements

Appropriateness of the selected accounting policies

Material misstatements relating to appropriateness may arise when:

• 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
  

Application of selected accounting policies

Material misstatements relating to application may arise when:

• When accounting policies are not applied consistently, including consistency between periods, similar transactions and events;
• Method of application is erroneous
  

Appropriateness or adequacy of disclosures in the financial statements

Material misstatements relating to appropriateness or adequacy of disclosures may arise when:

• 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 framework
• The financial statements do not provide the disclosures necessary to achieve fair presentation

INABILITY TO OBTAIN SUFFICIENT APPROPRIATE AUDIT EVIDENCE

♠ Auditors’ 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 auditors’ work eg. when auditor is appointed on such date that he cannot observe the physical count
• Limitation imposed by the management
• In case limitation is imposed by the management, the auditor shall request the management to remove the limitation
• If the management still persists, he 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 audit or 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

FORM AND CONTENT OF MODIFIED REPORT

In addition to the elements of the auditors’ 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 Auditors’ responsibility paragraph

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
  • If modification results from inability to obtain sufficient appropriate audit evidence, include the reason for inability
  • 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

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)…” for the modified opinion
• 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
  • The auditor does NOT express an opinion on the financial statements
    

Amendments in the Auditors’ 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 auditors’ 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.”

SA 706

♠ 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 auditors’ 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
• The auditor should have obtained sufficient appropriate audit evidence that the matter is not materially misstated
• The emphasis of matter paragraph shall be placed immediately after the Opinion paragraph in the Auditors’ 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 auditors’ opinion is NOT modified by using words like “Without qualifying our opinion”

♠ If auditor wants to communicate any other matter not prohibited by law, he may do so using an “Other Matter” paragraph immediately after the Emphasis of matter paragraph.

The process of reaching a conclusion involves Meticulous collection of evidence, Detailed documentation of work done and Analyzing with professional skill, competence and reasoned judgment

• Sufficient and appropriate evidence obtained – SA 330
• Materiality of uncorrected misstatements – SA 450
• Requirements of reporting framework materially complied with (Accounting Standards)
• Management judgment are not biased – SA 260 and 540
• Adequate disclosure of accounting policies
• Accounting policies are appropriate and consistent
• Accounting estimates are reasonable
• Information is relevant, reliable, comparable and understandable
• Adequate disclosure for users to understand
• Terminology used is appropriate
• Achieve true and fair presentation considering
• Overall structure and content
• Represent underlying transactions in a manner that’s true and fair