SA 700, SA 705, SA 706 & SA 720

 CA Sunil S Kothari 23 rd June 2012 1

AAS 28

Auditor’s reports on all FS

SA 700 (R)

Only general purpose FS (SA 800 – special purpose FS) All kinds of opinions – clean, modified, emphasis of matter Only clean opinion (SA 705 – modified, SA 706 – Emphasis & Other Matter) Deals with how to report on FS Deals with how to -form an opinion -report on FS (clean report)

General purpose FS General purpose framework Fair presentation framework Compliance with framework + true and fair opinion Compliance framework No true and fair opinion, only compliance with framework

    Conclude on whether sufficient appropriate audit evidence as per SA 330 was obtained Conclude on whether uncorrected misstatements, individually or in aggregate, are material as per SA 450 Evaluate whether FS are prepared, in all material respects, as per from judgment bias applicable financial reporting framework, including its qualitative aspects and freedom Evaluate whether accounting policies are appropriately disclosed, consistently applied and are appropriate

Forming an opinion - requisites

     Evaluate whether estimates are reasonable Evaluate whether information presented is relevant, reliable, comparable and understandable Evaluate whether terminology used is appropriate Evaluate whether disclosures are adequate to enable users to clearly understand material transactions and events If reporting under a fair presentation framework, also evaluate whether FS achieve a fair presentation based on overall presentation, structure and contents; and whether they represent underlying transactions/ events befittingly

Forming an opinion - requisites

 Ensure that the financial reporting framework is adequately referred to Based on all above conclusions/ evaluations, auditor finally concludes whether the FS, as a whole, are free from material misstatement due to fraud or error

AAS 28

Paragraphs do not have heading Responsibility statement is brief All reporting is mixed up

SA 700 (R)

Each paragraph has distinctive heading Management’s responsibility and auditor’s responsibility are two separate paragraphs Report under regulation follows true and fair/ compliance opinion report in separate section statute/

AAS 28

Reference to auditing standards made even if law/ regulation prescribes format that does not meet structural requirements of standard

SA 700 (R)

Reference to auditing standards cannot be made unless basic structure of report meets requirements of revised standard The reporting under Indian SAs and ISAs simultaneously was not envisaged in existing standard Reporting simultaneously under Indian SAs and ISAs is permitted in single report

AAS 28

Auditor’s responsibility when entity presents supplementary info along with FS is not addressed in this Title: Auditor’s report

SA 700 (R)

Standard lays down auditor’s responsibility when entity presents supplementary info along with FS Independent auditor’s report No separate management’s responsibility paragraph Separate and more elaborate management’s responsibility paragraph

AAS 28

No separate auditor’s responsibility paragraph Scope paragraph

SA 700 (R)

Separate and more elaborate auditor’s responsibility paragraph No separate scope paragraph; but contents are generally covered in separate auditor’s responsibility paragraph

    Firstly, talks about Financial Statements (FS)audit Then refers to CARO reporting (regulatory requirement, not part of true and fair opinion reporting) Then goes to specific matters required to be reported under Companies Act – e.g., books of account, qualifications of directors u/s 274(1)(g), etc.

(regulatory requirement, not part of true and fair opinion reporting) Then reverts back to true and fair opinion on FS audit Appears to users as if regulatory compliance is part of true and fair opinion on FS

 From start of report to opinion paragraph, the structure is strictly restricted to the audit of the FS as performed under either a fair presentation framework or a compliance framework  All other matters that law / regulation requires to be part of auditor’s report are put in a separate section of report below the opinion paragraph

What is the logic?

 The logic is that the true and fair part of the report is governed by procedures performed by the auditor as per auditing standards insofar as they pertain to audits of general purpose financial statements  For instance, those audit procedures are designed to evaluate whether the FS are prepared in accordance with the stated financial reporting framework and are not materially misstated due to fraud or error

What is the logic?

 When we report on CARO, for example, we are responding to specific queries under the said Order.

 CARO report is a report on specific financial information that may or may not be contained in the financial statements and should, therefore, not be intermingled with the Opinion on the financial statements because completely different audit procedures are applied to provide a CARO report as versus the procedures used to give a report on the financial statements

What is the logic?

 Likewise, when we report on books of account, or agreement of financial statements with books of account, or on qualification of directors, we are reporting on matters that are not really covered by our Opinion on the financial statements

 The existing standard says: ◦ “A statute governing the entity or a regulator may require the auditor to include certain matters in the audit report or prescribe the form in which the auditor should issue his report. In such a case, the auditor should incorporate in his audit report, the matters specified by the statute or regulator and/or report in the form prescribed by them in addition to the requirements of this AAS.”

 SA 700 says that unless auditor’s report contains, at a minimum, the basic elements of an auditor’s report as per the auditing standards, it would cease to be credible, lack consistency and could mislead the user into making inappropriate business decisions – thereby exposing the auditor to significant risk  SA 210 mandates that if the auditor does not have the ability to include relevant elements, such as the management’s responsibility paragraph, generally applicable in India the auditor’s responsibility paragraph, etc., he may not refer to the audit having been done in accordance with the SAs or auditing standards

Sufficient appropriate audit evidence obtained Auditor concludes that FS as a whole are not free from material misstatement Qualified opinion Adverse opinion Sufficient appropriate audit evidence not obtained Auditor is unable to conclude whether FS as a whole are free from material misstatement Disclaimer of opinion Whether FS

are

materially misstated Depends on auditor’s judgement of 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

After obtaining sufficient appropriate audit evidence Auditor concludes that Auditor cannot obtain sufficient appropriate audit evidence Auditor concludes that Individual misstatements OR Aggregate of misstatements Possible effects of undetected misstatements

Are MATERIAL but not PERVASIVE

QUALIFIED OPINION

Are MATERIAL but not PERVASIVE

After obtaining sufficient appropriate audit evidence Auditor concludes that Individual misstatements OR Aggregate of misstatements

Are MATERIAL AND PERVASIVE ADVERSE OPINION

Auditor cannot obtain sufficient appropriate audit evidence Auditor concludes that Possible effects of undetected misstatements

Are MATERIAL AND PERVASIVE

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

DISCLAIMER OF OPINION

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 Material but not pervasive Material and pervasive If he cannot obtain sufficient appropriate audit evidence, and concludes that effect of undetected misstatements is

QUALIFY RESIGN, if allowed to GIVE DISCLAIMER

Nature of matter giving rise to the modification Auditor’s judgment about the pervasiveness of the effects or possible effects on FS

Financial statements are materially misstated Material but not pervasive Qualified opinion Material and pervasive Adverse opinion Inability to obtain sufficient appropriate audit evidence Qualified opinion Disclaimer of opinion

 When expressing adverse opinion or disclaiming an opinion on the FS as a whole the auditor cannot also express an unmodified opinion on one or more specific elements, accounts or items in the FS with respect to the same financial reporting framework

Report to contain all elements per SA 700

+

Basis for modification paragraph Just above the Opinion paragraph Basis for Qualified Opinion Heading to be Basis for Adverse Opinion Basis for Disclaimer of Opinion Describing matter of modification

Describe and quantify effect of misstatement Say so if quantification Adverse or disclaimer of opinion expressed is impracticable But there are other matters that would have required modification Discuss with TCWG Explain how disclosures are misstated Explain reason why sufficient appropriate audit evidence was unavailable Reasons and effects of such other matters to be given in Basis of Modification paragraph Non-disclosure Describe omitted information If permitted provide the non-disclosed information, if practical and if sufficient appropriate audit evidence is obtained BASIS OF MODIFICATION PARAGRAPH

  

Heading

◦ “Qualified Opinion”, “Adverse Opinion” or “Disclaimer of Opinion”

Qualified opinion due to

material misstatement

◦ In our opinion, except for the effects of matters described in the Basis for Qualified Opinion paragraph  The FS give true and fair view in accordance…  The FS have been prepared, in all material respects, in accordance with…

If qualified for inability to obtain sufficient appropriate audit evidence

◦ ….except for the possible effects of the matters…

 Requirements when the auditor expresses a Qualified

Opinion

o the auditor should state in the opinion paragraph that, in the auditor’s opinion, except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view (or “present fairly, in all material respects”) in accordance with the applicable financial reporting framework o When the modification arises from an inability to obtain sufficient appropriate audit evidence, the auditor should use the corresponding phrase “except for the possible effects of the matter(s) ...” for the modified opinion

 Requirements when the auditor expresses an Adverse

Opinion

o the auditor should state in the opinion paragraph that, in the auditor’s opinion, because of the significance of the matter(s) described in the Basis for Adverse Opinion paragraph, the financial statements do not give a true and fair view (or “do not present fairly”) in accordance with the applicable financial reporting framework

 Requirements when the auditor disclaims an opinion o When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor should state in the opinion paragraph that, 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 to provide a basis for an audit opinion and, accordingly, the auditor does not express an opinion on the financial statements

 When the auditor expresses a qualified or adverse

opinion

o Requires to state that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s modified audit opinion  When the auditor disclaims an opinion o Need to state that they were unable to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion

 The auditors need to communicate to those charged with governance, the reasons and circumstances that led to the expected modifications as well as the proposed wording of the modification

◦ ◦ ◦ ◦ The Modified Opinion section of AAS 28 refers to matters that affect the auditor's opinion and matters that don't

Matters that don't

, are reported in an Emphasis of Matter paragraph (EMP) EMP

amounts to a modification

report, but does not affect the opinion EMP is placed in the report paragraph of the auditor's

preceding

the opinion

◦ ◦ ◦ EMP is to be given where a going concern question is not resolved and adequate disclosure is made EMP is to be given where there is a significant uncertainty (other than going concern), whose resolution depends on future events and which may affect the FS – e.g. a lawsuit EMP is considered adequate in dealing with the above except in extreme cases (e.g. situations involving multiple uncertainties) where a disclaimer should be given

Draw users’ attention to matters presented/ disclosed in FS fundamental that are to users’ understanding of FS Emphasis of Matter paragraph (EMP) Draw users’ attention to matters not presented/ disclosed in FS relevant auditor’s report that are to users’ understanding of the audit, auditor’s responsibilities or

EMP

Matters presented/ disclosed in FS Fundamental to users’ understanding Understanding of FS Other Matter Paragraph (OMP)

OMP

Matters NOT presented/ disclosed in FS Relevant to users’ understanding Understanding of the audit, auditor’s

responsibilities or auditor’s report

Has to be fundamental to users’ understanding Auditor has obtained sufficient appropriate audit evidence that matter is not materially misstated in the FS Matter referred to must be presented/ disclosed in FS

EMP is included immediately AFTER opinion paragraph Heading “Emphasis of Matter” is given Reference to where matter emphasised can be found in FS is given Indicate that auditor’s opinion is NOT MODIFIED in respect of matter emphasised

EMP: examples

◦ Uncertainty relating to future outcome of exceptional litigation or regulatory action ◦ Early adoption and application of an accounting standard that has pervasive effect on the FS ◦ Major catastrophe that has/ had/ continues to have significant effect on the FS

EMP: other considerations

◦ Use of EMP should not be widespread and should not include more information than what is presented/ disclosed elsewhere in FS ◦ EMP is not a substitute for  A modified opinion (qualified/ adverse/ disclaimer)  Disclosures that management should make

Matter has to be relevant to users’ understanding Heading “Other Matter(s)” is given Given only for users’ understanding of matters related to the audit, auditor’s responsibilities and auditor’s report Such reporting is not prohibited by law or regulation Is placed after opinion para and any EMP in report on FS, but may be placed in Other Reporting Responsibilities section if its contents relate to such responsibilities

• • Users' understanding of audit Auditor appointed by law is unable to resign when management imposes a pervasive scope limitation • • Users' understanding of auditor's responsibility or

auditor's report

Law requires auditor to elaborate on matters that provide further explanation of his responsibilities in the audit or the auditor's report

Examples of circumstances necessitating OMP

◦ • • Reporting on > 1 set of FS • If auditor is engaged to issue a report under Indian GAAP as well as under IFRS, he may use OMP in each report to inform users that he has also reported under another framework Restriction on distribution or use of report If special purpose FS are prepared in accordance with a general purpose framework because such a framework meets users' needs, auditor may use OMP to say that his report is intended solely for the intended users and should not be distributed/ used by others

What is the type of opinion in the following cases?

Case - 1  Inventories are misstated. Say it is 15 % of the profits for the year.

The misstatement is deemed to be material but not pervasive to the financial statements.

Case – 2  The auditor was unable to obtain sufficient appropriate audit evidence about multiple elements of the financial statements. That is, say, the auditor was unable to obtain audit evidence about the entity’s inventories and accounts receivable. The possible effects of this inability to obtain sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements.

◦ Qualified 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: 48

  Disclaimer of opinion We were appointed as auditors of the Company after March 31, 20XX and thus could not observe the counting of physical inventories at the beginning and end of the year. Accordingly, we were unable to satisfy ourselves by alternative means concerning the inventory quantities held at December 31, 20X0 and March 31, 20X1 which are stated in the Balance Sheet at Rs. XXX and Rs. XXX, respectively. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable. As of the date of our audit report, management was still in the process of rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts receivable included in the Balance Sheet at a total amount of Rs. XXX as at March 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the Statement of Profit and Loss and Cash Flow Statement.

Disclaimer of Opinion

Because of the significance of the matters 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.

49

 Case 3   The auditor of ABC Ltd.

was unable to obtain sufficient appropriate audit evidence regarding existence of investments in XYZ Ltd in a foreign branch. The possible effects of the inability to obtain sufficient appropriate audit evidence are deemed to be material but not pervasive to the financial statement.

Case 4  You are the auditor of XYZ Ltd. There is uncertainty relating to a pending exceptional litigation Matter – say there is a law suit filed against the company for tax or some other matter. You cannot conclude that it should be provided for.

◦ Qualified ABC Company Limited’s investment in XYZ Company, a foreign company acquired during the year and accounted as Held to maturity investment in Balance sheet of ABC company’ Ltd. We were unable to obtain sufficient appropriate audit evidence about the existence of ABC Company Limited’s investment in XYZ Company as at March 31, 20XX because we were denied access to the financial information relating to the same, management, Consequently, we were unable to determine whether any adjustments to these amounts were necessary.

Qualified Opinion

In our opinion and to the best of our information and according to the explanations given to us, except for the possible 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: 51

◦ Emphasis of Matter paragraph after opinion paragraph following shall be added: “We draw attention to Note X to the financial statements which describes the uncertainty related to the outcome of the lawsuit filed against the Company by XYZ Company. Our opinion is not qualified in respect of this matter 52

 Case 5  In case of auditor of Consolidated Financial Statement, there are certain subsidiaries which were not audited by him but which form part of the consolidated financial statements under report. Also the amounts involved are not insignificant.

◦ Other Matter paragraph Other Matter “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.” 54

This SA deals with Auditor’s responsibility in relation to

Other Information*

presented in documents (annual reports or similar document) containing audited Financial Statements and the auditor’s report thereon.

*Other information may comprise for example:  A report by Management or those charged with governance on operations.

 Financial Summaries or highlights.

 Planned Capital expenditures.

 Financial ratios.

The objective of the auditor is to respond appropriately when documents containing audited financial statements and the auditor’s report thereon include other information that could undermine the credibility of those financial statements and the auditor’s report.

Reading Other Information

The Auditor shall make an appropriate arrangements with Management or Those Charged with Governance, to provide such other information, prior to the date of auditor’s report to the auditor.

Read such other information to identify Material Inconsistencies or Material Misstatement of facts , if any with audited financial statements.

MI observed in Other Information Prior to Auditor’s Report Date MI observed in Other Information Subsequent to Auditor’s Report Date - When revision of audited Financial Statements is necessary & management refuses, modify opinion in accordance with SA-705.

-When revision of such Other Information is necessary and management refuses, communicate to TCWG and: a) Include such matter in Emphasis of Matter Para as per SA-706; OR b) If possible, withdraw from engagement.

- When revision of audited Financial Statements is necessary, follow requirements of SA-560 Subsequent Events.

-When revision of such Other Information is necessary and management makes such changes, ensure steps taken by the management.

-When management refuses to make changes to other information, notify to TCWG & seek legal opinion.

On observing the Material Misstatement, following actions can be taken by an auditor: a) Discuss the matter with management to evaluate the validity of the management’s disclosures and after discussion with management, auditor may conclude that valid differences of judgment or opinion exists; b) Request Management to consult qualified third party, such as legal entity’s counsel and auditor shall consider such advice received; c) If auditor feels that such misstatement needs correction and management refuses for the same then auditor shall notify such facts to TCWG and seek legal opinion from his own legal counsel.

Effective Date:

This standard is effective from 1 st April 2010