adcanced auditing and professional ethics vol. 1

FINAL COURSE STUDY MATERIAL

PAPER

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Advanced Auditing and Professional EthicsVolume 1

BOARD OF STUDIES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

This study material has been prepared by the faculty of the Board of Studies. The objective of the study material is to provide teaching material to the students to enable them to obtain knowledge and skills in the subject. Students should also supplement their study by reference to the recommended text book(s). In case students need any clarifications or have any suggestions to make for further improvement of the material contained herein they may write to the Director of Studies. All care has been taken to provide interpretations and discussions in a manner useful for the students. However, the study material has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees. Permission of the Institute is essential for reproduction of any portion of this material.

The Institute of Chartered Accountants of India

All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior permission, in writing, from the publisher.

Website : www.icai.org

E-mail : [email protected]

Published by Dr. T.P. Ghosh, Director of Studies, ICAI, C-1, Sector-1, NOIDA-201301Typeset and designed at Board of Studies, The Institute of Chartered Accountants of India.

PREFACEAuditing is an important area of core competency of the Chartered Accountancy profession. Millions of investors, potential investors and other stakeholders of an organization repose faith and confidence on the auditors report and the Indian Chartered Accountancy Profession has aptly served the society and contributed for the national growth and development. This became possible simply because of adherence to the strict norms of professional selfdiscipline and pursuance of the global class auditing and assurance practices. On the wake of many corporate failures in the USA, SarbanesOxley Act was enacted which encompasses newer ideas of internal control and Peer review apart from reinforcing old best practices of auditing and assurance. Enhanced role of the auditors has also been perceived at home in the context of implementing code of corporate governance and various fiscal legislations. Students of the Final level must appreciate these developments, understand and apply the same even in their day to day work. Students should in the first instance focus on learning of auditing concepts, procedures and techniques from the study material. The knowledge being so derived may be related by the students to the practical work in the field of auditing which they do as part of their training. Auditing is largely a practical and application oriented discipline. Students should learn the auditing concepts and techniques as also their intricacies purely for the purposes of applying them in their audit work. The auditing knowledge inputs provided to the students by the Institute through the study material and other publications and the practical training inputs provided by the audit firms during the articleship training stage compliment one another. Students should, as part of their articleship training, involve themselves deeply in the professional audit work done by their principals, for the purpose of getting an intense practical knowledge and learning skills in Auditing. Here are few tips for examination preparation. Students must familiarise themselves with the syllabus in detail. Since they are expected to exhibit advanced knowledge, it is absolutely essential that they should be able to apply theoretical knowledge to diverse practical situations. Therefore, students must study intensively AASs, Accounting Standards, relevant provisions of the Companies Act, 1956, case laws, etc. A good knowledge of these would help you to tackle practical-oriented questions in the examination. The Institutes professional pronouncements like Accounting Standards, Statements on Standard Auditing Practices and Guidance Notes on various matters relating to Accountancy, Auditing and Taxation etc. are of critical importance to CA Final students as they form the base of their knowledge and its application to practical problems in the relevant subject areas. Students are expected to have a good insight of the contents of the above publications for their immediate purpose of examinations and also otherwise in their day to day work they are expected to make use of them. Some of these publications have been incorporated at the appropriate places in the study material. While reading through the chapters, you must take special note of various pronouncements issued by the Institute. As a matter of practical convenience, all important guidance notes and AASs have been covered at appropriate places. Some important guidance

notes have been covered in the Advanced Accounting study material as well. Students must read monthly Journal The Chartered Accountant and the students newsletter The Chartered Accountant Student regularly. The Institutes monthly Journal The Chartered Accountant is a valuable source of articles on topical interest, relevant notifications and clarifications by Government of India, RBI, SEBI, etc., information on contemporary developments in Accounting, Finance, Auditing and Corporate and Tax Laws, etc. Students, especially Final students, should regularly keep in touch with the Journal to enrich their knowledge base, relevant for examination and other purpose. The Chartered Accountant Student, the students monthly newsletter, published by the Board is another regular channel of communication with students which contributes to the fund of knowledge required of CA students, through articles, case studies, reports, academic updates, announcements, etc. Students may also refer to compilation of suggested answers of Final (Old) Course to the extent these are relevant for the Final (New) Course. In addition, video CDs of various topics will also be made available which students may listen. These CDs contain lectures of eminent experts in the field of auditing. This study material is divided into twenty three chapters covering in details principles of Auditing, Audit and Assurance Standards issued by the ICAI , specific audit issues classified by organizations like Company Audit , audit of Banks , Audit of General Insurance Business , Audit of Co-Operative Societies and Audit of Public Sector Undertakings, special audit issues like audit under Fiscal Laws , role of auditor under clause 49 of the Listing Agreement , Audit of Consolidated Financial Statements, Investigation and Due Diligence. In Chapter 21, the latest concept of Peer Review has been explained in details, which are considered as an important step towards maintenance and improvement of audit quality. In Chapter 22, relevant aspects of the Sarbanes Oxley requirements are elaborated which will help the students to appreciate the global trend in auditing and build up international perspective. Lastly, in Chapter 23 Professional Ethics are dealt with which is regarded as a foundation to the audit function, which is essentially developed on the foundation of ethical norms, which has so far brought name and fame to the profession. All students of Final course should read this chapter with sincerity and imbibe the norms explained. These norms should be the guiding force while they will work as a chartered accountant. This study material is developed by a team of experts comprising of CA. T.P.Ghosh, Director of Studies, CA.Vikas Kumar, Executive Officer, Ms.Srishti Gupta and Ms.Ginni Aggarwal, Management Trainees in the Board of Studies. Contributions are also made by CA.K.S.Chauhan, Kanpur and CA.D.R.Sengupta, Kolkata. While preparing this material, various publications of the ICAI are adopted appropriately. Moreover, a good portion of this study material is taken from the Advanced Auditing study materials of the Final (Old) Course prepared by Shri Vijay Kapoor, Director, ICAI. The Board of Studies acknowledges the contributions made by all these faculty members. We would welcome suggestions to make this study material more useful to the students. In case of any doubt, students are welcome to write to the Director of Studies, The Institute of Chartered Accountants of India, C-1, Sector-1, Noida-201 301.

SYLLABUSPAPER 3 : ADVANCED AUDITING AND PROFESSIONAL ETHICS(One Paper- Three hours - 100 marks) Level of Knowledge: Advanced knowledge Objectives: (a) To gain expert knowledge of current auditing practices and procedures and apply them in auditing engagements, (b) To develop ability to solve cases relating to audit engagements. Contents: 1. Auditing Standards, Statements and Guidance Notes Auditing and Assurance Standards (AASs); Statements and Guidance Notes on Auditing issued by the ICAI; Significant differences between Auditing and Assurance Standards and International Standards on Auditing. 2. Audit strategy, planning and programming Planning the flow of audit work; audit strategy, planning programme and importance of supervision: review of audit notes and working papers; drafting of reports; principals ultimate responsibility; extent of delegation; control over quality of audit work; reliance on the work of other auditor, internal auditor or an expert. 3. Risk Assessment and Internal Control Evaluation of internal control procedures; techniques including questionnaire, flowchart; internal audit and external audit, coordination between the two. 4. Audit under computerized information system (CIS) environment Special aspects of CIS Audit Environment, need for review of internal control especially procedure controls and facility controls. Approach to audit in CIS Environment, use of computers for internal and management audit purposes: audit tools, test packs, computerized audit programmes; Special Aspects in Audit of E-Commerce Transaction. 5. Special audit techniques (a) Selective verification; statistical sampling: Special audit procedures; physical verification of assets, direct confirmation of debtors and creditors (b) Analytical review procedures (c) Risk-based auditing.

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Audit of limited companies Statutory requirements under the Companies Act 1956; Audit of branches: joint audits; Dividends and divisible profits % financial, legal, and policy considerations.

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Rights, duties, and liabilities of auditors; third party liability. Audit reports; Qualifications, notes on accounts, distinction between notes and qualifications, detailed observations by the statutory auditor to the management vis-a-vis obligations of reporting to the members. Audit Committee and Corporate Governance

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10. Audit of Consolidated Financial Statements, Audit Reports and Certificates for Special Purpose engagements; Certificates under the Payment of Bonus Act, import/export control authorities, etc.; Specific services to non-audit clients; Certificate on Corporate Governance. 11. Special features of audit of banks, insurance companies, co-operative societies and nonbanking financial companies. 12. Audit under Fiscal Laws, viz, Direct and Indirect Tax Laws. 13. Cost audit 14. Special audit assignments like audit of bank borrowers, audit of stock and commodity exchange intermediaries and depositories; inspection of special entities like banks, financial institutions, mutual funds, stock brokers. 15. Special features in audit of public sector companies. Directions of Comptroller and Auditor General of India under Section 619; Concepts of propriety and efficiency audit. 16. Internal audit, management and operational audit Nature and purpose, organisation, audit programme, behavioural problems; Internal Audit Standards issued by the ICAI; Specific areas of management and operational audit involving review of internal control, purchasing operations, manufacturing operations, selling and distribution, personnel policies, systems and procedures. Aspects relating to concurrent audit. 17. Investigation and Due Diligence. 18. Concept of peer review 19. Salient features of Sarbanes Oxley Act, 2002 with special reference to reporting on internal control. 20. Professional Ethics Code of Ethics with special reference to the relevant provisions of The Chartered Accountants Act, 1949 and the Regulations thereunder.

VOLUME-1ADVANCED AUDITING AND PROFESSIONAL ETHICS CONTENTSCHAPTER 1 : AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES - AN OVERVIEW 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Introduction ................................................................................................... 1.1 Historical Retrospect ..................................................................................... 1.2 Auditing and Assurance Standards Board Scope and Functions .................... 1.2 Framework of AASs and Guidance Notes on Related Services ........................ 1.4 Auditing Standards ........................................................................................ 1.6 Guidance Notes........................................................................................... 1.29 Guidance Note(S) on Related Services......................................................... 1.35 Authority Attached to the Documents issued by the Institute .......................... 1.35

CHAPTER 2: AUDIT STRATERGY, PLANNING AND PROGRAMMING 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 Commencing an Audit.................................................................................... 2.1 Formulating an Audit Programme ................................................................... 2.4 Designing Audit Strategy ............................................................................. 2.17 Using the work of an Expert ......................................................................... 2.20 Relying upon the work of Internal Auditor ..................................................... 2.23 Using the work of another Auditor ................................................................ 2.23 Principals ultimate Responsibility ................................................................ 2.23 Reliance on the Management or other Certificates by the Auditor .................. 2.24 Management Representations ...................................................................... 2.26 Drafting of Report ........................................................................................ 2.27 Control of Quality of Audit Work ................................................................... 2.28

CHAPTER 3: RISK ASSESSMENT AND INTERNAL CONTROL 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 Introduction ................................................................................................... 3.1 Internal Control System - Nature, Scope, Objective and Structure.................... 3.2 Components of Internal Control ...................................................................... 3.6 Review of the System of Internal Control ........................................................ 3.7 Methods of Recording .................................................................................... 3.9 Evaluation of Internal Control ....................................................................... 3.19 Internal Control and Risk Assessment .......................................................... 3.20 Internal control in Small Business Enterprises .............................................. 3.26 Reporting to clients on Internal Control Weaknesses ..................................... 3.26

CHAPTER 4: AUDIT UNDER COMPUTERISED INFORMATION SYSTEM (CIS) ENVIRONMENT 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13 4.14 Introduction ................................................................................................... 4.1 Scope of Audit in a CIS Environment .............................................................. 4.1 Impact of changes on Business Processes (for shifting from manual to electronic medium)........................................................................................................ 4.3 Audit Approach in a CIS environment ............................................................. 4.3 Types of Computer Systems .......................................................................... 4.7 Effect of Computers on Internal Controls ...................................................... 4.12 Effects of Computers on Auditing ................................................................. 4.14 Internal controls in a CIS environment .......................................................... 4.15 Consideration of Control Attributes by the Auditors ....................................... 4.17 Internal control requirement under CIS Environment ..................................... 4.17 Approach to Auditing in a CIS Environment................................................... 4.19 Review of Checks and Controls in a CIS Environment ................................... 4.21 Auditors Involvement in the Clients System Development and Documentation Control........................................................................................................ 4.28 Computer assisted audit techniques (CAATs) ............................................... 4.31

CHAPTER 5: SPECIAL AUDIT TECHNIQUES 5.1 5.2 5.3 5.4 5.5 5.6 Introduction ................................................................................................... 5.1 Statistical Sampling in Auditing .................................................................... 5.10 Audit of Fixed Assets ................................................................................... 5.18 Audit Risk ................................................................................................... 5.20 Risk-Based Audit ......................................................................................... 5.22 Materiality and Audit Risk ............................................................................ 5.24

CHAPTER 6: THE COMPANY AUDIT 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 6.14 Introduction ................................................................................................... 6.1 Appointment of Company Auditor ................................................................... 6.1 Remuneration.............................................................................................. 6.12 Functions, Duties and Rights of Auditors ...................................................... 6.19 Audit of Branches ........................................................................................ 6.26 Reliance on the Work and Report of the other Auditor ................................... 6.28 Joint Audit................................................................................................... 6.31 Gist of Important Circulars ........................................................................... 6.34 Compliance with Relevant Provisions of the Companies Act, 1956 ................. 6.39 Auditors Duty under Companies Act, 1956 ................................................... 6.45 Final Accounts Preparation and Presentation................................................ 6.51 Significance of True and Fair ....................................................................... 6.54 Divisible Profits, Dividends and Reserves ..................................................... 6.55 Depreciation................................................................................................ 6.77

CHAPTER 7: LIABILITIES OF AUDITORS 7.1 7.2 7.3 7.4 Nature of Auditors Liability ............................................................................ 7.1 Professional Negligence ................................................................................ 7.3 Cases Concerning the Civil Liability of Auditors for Negligence...................... 7.15 Civil Liabilities under the Companies Act ...................................................... 7.17

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Criminal Liability under the Companies Act ................................................... 7.22 Cases Concerning the Misconduct of Auditors under the Chartered Accountants Act .......................................................................... 7.25 Liabilities under Income Tax Act,1961 .......................................................... 7.27

CHAPTER 8: AUDIT REPORT 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 Auditors opinion ........................................................................................... 8.1 The Auditors Report on Financial Statements................................................. 8.4 Statement on Qualifications in the Auditors Report ....................................... 8.16 Distinction between Audit Report and Certificate ........................................... 8.32 Audit Reports and Certificates for Special Purposes ...................................... 8.35 Audit of Company Prospectuses................................................................... 8.38 Audit Reports/Certificates on Financial Information in Offer Documents ......... 8.41 Statement on the Companies (Auditors Report) Order, 2003 ......................... 8.54

CHAPTER 9: AUDIT COMMITTEE AND CORPORATE GOVERNANCE 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 9.11 9.12 Introduction ................................................................................................... 9.1 Definition of Corporate Governance................................................................ 9.2 Managements Responsibility ......................................................................... 9.3 Audit Committee under Clause 49 .................................................................. 9.3 Functions of the Audit Committee................................................................... 9.6 Review of Information by Audit Committee...................................................... 9.6 Audit Committee Under Section 292 A of The Companies Act, 1956 ................ 9.7 Audit Committee A Comparative .................................................................. 9.8 Role of Auditor in Audit Committee and Certification of Compliance of Conditions of Corporate Governance...................................... 9.10 Disclosures ................................................................................................. 9.22 Report on Corporate Governance ................................................................. 9.23 Auditors Certificate ..................................................................................... 9.24

CHAPTER 10: AUDIT OF CONSOLIDATED FINANCIAL STATEMENTS 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 Introduction ................................................................................................. 10.1 Definitions................................................................................................... 10.2 Responsibility of Parent ............................................................................... 10.2 Responsibility of the Auditor of the Consolidated Financial Statements .......... 10.2 Audit Considerations ................................................................................... 10.3 Auditing the Consolidation ........................................................................... 10.5 Special Considerations ................................................................................ 10.7 Management Representations .....................................................................10.10 Reporting ...................................................................................................10.11 When the Parents Auditor is also the Auditor of its Subsidiaries...................10.11 When the Parents Auditor is not the Auditor of its Subsidiary (ies) ...............10.11

CHAPTER 11: AUDIT OF BANKS 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 Introduction ................................................................................................. 11.1 Special Features ......................................................................................... 11.2 Legal Framework......................................................................................... 11.3 Form and Content of Financial Statements ................................................... 11.3 Audit of Accounts ........................................................................................ 11.6 Internal Control in Certain Selected Areas ...................................................11.16 Verification of Assets and Balances.............................................................11.20 Capital Adequacy .......................................................................................11.70 Concurrent Audit ........................................................................................11.70

CHAPTER 12: AUDIT OF GENERAL INSURANCE COMPANIES 12.1 12.2 12.3 Introduction ................................................................................................. 12.1 Legal Framework......................................................................................... 12.2 Insurance Regulatory and Development Authority (IRDA) Act, 1999 and Regulations Framed there under............................................................ 12.5

12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.11

Features of Accounting System of Insurance Companies............................... 12.5 Audit of Accounts .......................................................................................12.16 Specific Control Procedures related to General Insurance Business..............12.19 Audit Procedures ........................................................................................12.20 Items Relating to Balance Sheet .................................................................12.28 Reinsurance ...............................................................................................12.35 Co-Insurance .............................................................................................12.41 Solvency Margin .........................................................................................12.41

CHAPTER 13: AUDIT OF CO-OPERATIVE SOCIETIES 13.1 13.2 13.3 13.4 13.5 13.6 Introduction ................................................................................................. 13.1 Auditor and Management ............................................................................. 13.2 Special features of Co-operative Audit.......................................................... 13.7 Right and Duties of Co-operative Auditors .................................................... 13.9 Form of Audit Report ..................................................................................13.10 Audit, Inquiry and Inspection of Multi-State Co-operative Societies ...............13.11

CHAPTER 14: AUDIT OF NON-BANKING FINANCIAL COMPANIES 14.1 14.2 14.3 14.4 Introduction ................................................................................................. 14.1 Audit Procedure .......................................................................................... 14.2 Audit Check-List .......................................................................................... 14.6 Auditors duty .............................................................................................. 14.9

CHAPTER 15: AUDIT UNDER FISCAL LAWS 15.1 15.2 15.3 15.4 Introduction ................................................................................................. 15.1 Audit(s) Under the Income-Tax Act, 1961 ..................................................... 15.1 Tax Audit under section 44AB ...................................................................... 15.4 Audit Provisions under Vat Law ...................................................................15.53

CHAPTER 16: COST AUDIT 16.1 16.2 16.3 16.4 16.5 16.6 16.7 16.8 16.9 Concept of Cost Audit .................................................................................. 16.1 Types of Cost Audit ..................................................................................... 16.2 Advantages of Cost Audit............................................................................. 16.3 Functions of Cost Auditor............................................................................. 16.4 Programme of Cost Audit ............................................................................. 16.7 General Features of Cost Records ............................................................... 16.8 Cost Audit under the Companies Act ...........................................................16.15 Steps in Cost Audit .....................................................................................16.17 Right and Duties of Cost Auditor .................................................................16.22

CHAPTER 17: SPECIAL AUDIT ASSIGNMENTS 17.1 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.9 17.10 17.11 17.12 17.13 17.14 17.15 Audit of Members of Stock Exchanges ......................................................... 17.1 Functioning of Stock Exchanges................................................................... 17.2 Rolling Settlement ......................................................................................17.11 Derivatives .................................................................................................17.12 Circuit Filters of Circuit Breakers.................................................................17.13 Accounting for Stock Exchange Transactions...............................................17.14 Conduct of Audit.........................................................................................17.16 Auditors Report .........................................................................................17.23 Audit of Mutual Funds .................................................................................17.24 Audit of Depositories ..................................................................................17.27 Certification Pursuant to Companies (Acceptance of Deposit) Rules, 1975 ....17.28 Environmental Auditing ...............................................................................17.31 Energy Audit ..............................................................................................17.35 Audit of Accounts of Non-Corporate Entities (Bank Borrowers) .....................17.36 Audit of Depositories ..................................................................................17.40

Note: Chapters 18-23 of Advanced Auditing And Professional Ethics and Appendices I-III are in Volume-2.

1AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES AN OVERVIEWIntroduction 1.1 The past decade has been one of unprecedented change in the global economy and capital markets. Key aspects of the current business environment include a globalized, highly competitive, expanding economy; explosive growth in the development and use of technology; dramatic increases in new economy service- and technology-based businesses with predominantly intangible assets; unparalleled expansion in the number of public entities; large increases in the number of individuals who directly or indirectly own equity securities; and unprecedented growth in the market value of those securities. The expanded use of technology in both the operating and financial systems of companies also has significantly affected the audit environment, forcing audit firms to recruit, train and deploy a large number of information technology specialists to support their audit efforts. It also has caused firms to reconsider their audit methods and techniques in an effort to harness technology to improve audit efficiency and effectiveness. In the changing environment, it is obvious that a professional accountant should to adhere to standards and procedures laid down by the professional accountancy bodies of which he is a member while discharging his duties in a responsible manner. In this direction, the role of a professional accounting body is to lay down such standards and procedures with the aim of providing guidance to members. The Institute of Chartered Accountants of India (ICAI) has been formulating auditing and accounting standards for the guidance of its members on its own volition in the larger interests of the society. In this chapter, we provide an overview of auditing standards and guidance notes issued by the Institute from time to time. Though these standards and guidance notes have been dealt at appropriate places, the main purpose is to acquaint and inculcate appreciation on the part of students in a focused manner as to significance of the standards in their day to day auditing activities. Towards the end of the Chapter, the clarification issued by the Council of the Institute is also included, which would go a long way in understanding as well as significance to the mandatory status of Statements and Standards.

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Advanced Auditing and Professional Ethics

Historical Retrospect 1.2 The Institute, since its inception, has been committed to research in the field of accountancy. As early as in 1955, the Council set up the Research Committee. The Council at that point of time felt the necessity to establish such a Committee to deal with the growing complexities of the problems faced by membership at large and with a view to ensuring the highest of traditions and technical competence in the discharge of the duties by chartered accountants. As back as in 1964, the Council published the Statement on Auditing Practices as prepared by the Research Committee not only for the benefit of its members but also for others outside the profession, who might be interested in this subject. It was hoped that this Statement would provide valuable guidance in the performance of audits, particularly of companies. The Council of the Institute fully realised that techniques of accounting and auditing had undergone and were undergoing important changes. Since the members were expected to keep pace with recent developments, this Statement attempted to set out practices which were generally accepted in other countries and which the Council considered desirable in the light of prevailing circumstances in India. The issuance of the Statement on Auditing Practices might be considered as a path break as far as establishing sound auditing practices is concerned. The Statement was further revised in 1968 and 1977. Prior to establishment of the Auditing Practices Committee (APC), the Research Committee issued the following Statements in Auditing: Statements on Qualifications in Auditors Report Statement on the Manufacturing and Other Companies (Auditors Report) Order, 1975/1988 (Issued under Section 227(4A) of the Companies Act, 1956) Statement on Responsibilities of Joint Auditors Statement on Payments to Auditors for Other Services

Auditing and Assurance Standards Board Scope and Functions 1.3 The Following are the important points as regards scope and functions of Auditing and Assurance Standards Board 1.3.1 Setting up of AASB - The International Federation of Accountants (IFAC) came into existence in 1977 and constituted International Auditing Practices Committee (IAPC) to formulate International Auditing Guidelines. These guidelines were later on converted into International Standards on Auditing (ISA). Considering the developments in the field of auditing at international level, the need for issuing Standards and Guidance Notes in tandem with international standards but conforming to national laws, customs, usages and business environments was felt. With this objective, our Institute constituted the Auditing Practices Committee (APC) on September 17, 1982, to spearhead the new framework of Statements on Standard Auditing Practices (SAPs) and Guidance Notes (GNs) inter alia to replace various chapters of the old omnibus Statement on Auditing Practices issued in 1964.

Auditing Standards, Statements and Guidance Notes An Overview

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In July, 2002, the Auditing Practices Committee has been converted into an Auditing and Assurance Standards Board by the Council of the Institute, to be in line with the international trend. A significant step has been taken aimed at bringing in the desired transparency in the working of the Auditing and Assurance Standards Board, through participation of representatives of various segments of the society and interest groups, such as, regulators, industry and academics. The nomenclature of SAPs has also been changed to Auditing and Assurance Standards (AASs). 1.3.2 Scope and Functions of AASB - The main function of the AASB is to review the existing auditing practices in India and to develop Statements on Auditing and Assurance Standards (AASs) so that these may be issued by the Council of the Institute. While formulating the AASs, the AASB takes into consideration the ISAs issued by the IAPC, applicable laws, customs, usages and business environment in India. The AASs are issued under the authority of the Council of the Institute. The AASB also issues Guidance Notes on the issues arising from the AASs wherever necessary. The AASB has also been entrusted with the responsibility to review the AASs at periodical intervals. 1.3.3 Scope of AASs - The AASs apply whenever an independent audit is carried out; that is, in the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size, or legal form (unless specified otherwise) when such an examination is conducted with a view to expressing an opinion. The AASs may also have application, as appropriate, to other related functions of auditors. Any limitation on the applicability of a specific AAS is made clear in the introductory paragraph of the AAS. 1.3.4 Procedure for issuing AASs - Broadly, the following procedure is adopted for the formulation of AASs: The AASB determines the broad areas in which the AASs need to be formulated and the priority in regard to the selection thereof. In the preparation of AASs, the AASB is assisted by Study Groups constituted to consider specific subjects. In the formation of Study Groups, provision is made for participation of a cross-section of members of the Institute. On the basis of the work of the Study Groups, an exposure draft of the proposed AAS is prepared by the Committee and issued for comments by members of the Institute. After taking into consideration the comments received, the draft of the proposed AAS is finalised by the AASB and submitted to the Council of the Institute. The Council of the Institute considers the final draft of the proposed AAS, and, if necessary, modifies the same in consultation with the AASB. The AAS is then issued under the authority of the Council.

1.3.5 Compliance with the AASs - While discharging their attest function, it is the duty of the members of the Institute to ensure that the AASs are followed in the audit of financial information covered by their audit reports. If for any reason a member has not been able to perform an audit in accordance with the AASs, his report should draw attention to the material

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departures therefrom. Auditors are expected to follow AASs in the audits commencing on or after the date specified in the Standard. 1.3.6 Linkage between AASs and Disciplinary Proceedings - The AASs (as well as other statements on auditing) represent the generally accepted procedure(s) of audit. As such, a member who does not perform his audit in accordance with these statements and fails to disclose the material departures therefrom, becomes liable to the disciplinary proceedings of the Institute under clause (9) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 which specifies that a member of the Institute shall be guilty of professional misconduct if he fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances. Framework of AASs and Guidance Notes on Related Services 1.4 Framework of Auditing and Assurance Standards and Guidance Notes on Related Services issued recently distinguishes audits from related services. Related services comprise reviews, agreed-upon procedures and compilations. As illustrated in the diagram below, audits and reviews are designed to enable the auditor to provide high and moderate levels of assurance respectively, such terms being used to indicate their comparative ranking. Engagements to undertake agreed-upon procedures and compilations are not intended to enable the auditor to express assurance. Auditing Nature of service Audit _____Related Services_____ Review Agreedupon Procedures No assurance Compilation

High, but Comparative level of not absolute assurance assurance provided by the auditor Report provided Positive assurance on assertion(s)

Moderate assurance

No assurance

Negative assurance on assertion(s)

Factual findings of procedures

Identificatio n of information compiled

Assurance in the above context refers to the auditor's satisfaction as to the reliability of an assertion being made by one party for use by another party. To provide such assurance, the auditor assesses the evidence collected as a result of procedures conducted and expresses a conclusion. The degree of satisfaction achieved and, therefore, the level of assurance


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which may be provided is determined by the procedures performed and their results. In an audit engagement, the auditor provides a high, but not absolute, level of assurance that the information subject to audit is free of material misstatement expressed positively in the audit report. In a review engagement, the auditor provides a moderate level of assurance that the information subject to review is free of material misstatement. This is expressed in the form of negative assurance. For agreed-upon procedures, auditor simply provides a report of the factual findings, no assurance is expressed. Instead, users of the report draw their own conclusions from the auditor's work. In a compilation engagement, although the users of the compiled information derive some benefit from the involvement of a member of the Institute, no assurance is expressed in the report. Objective of an audit is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework "give a true and fair view". Absolute assurance in auditing is not attainable as a result of such factors as the need for judgement, the use of test checks, the inherent limitations of any accounting and internal control systems and the fact that most of the evidence available to the auditor is persuasive, rather than conclusive, in nature. The objective of a review of financial statements is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would be required in an audit, anything has come to the auditor's attention that causes the auditor to believe that the financial statements are not prepared, in all material respects, in accordance with an identified financial reporting framework. While a review involves the application of audit skills and techniques and the gathering of evidence, it does not ordinarily involve on assessment of accounting and internal control systems, tests of records and of responses to inquiries by obtaining corroborating evidence through inspection, observation, confirmation and computation, the auditor attempts to become aware of all significant matters, the procedures of a review make the achievement less likely than in an audit engagement, thus the level of assurance provided in a review report is correspondingly less than that given in an audit report. In an engagement to perform agreed-upon procedures and auditor is engaged to carry out those procedures of an audit nature to which the auditor and the entity and any appropriate third parties have agreed and to report on factual findings. The report is restricted to those parties that have agreed to the procedures to be performed since others, unaware of the reasons for the procedures, may misinterpret the results. In a compilation engagement, a member of the Institute is engaged to use accounting expertise as opposed to auditing expertise to collect, classify, and summaries financial information. The procedures employed are not designed and do not enable the member to express any assurance on the financial information. However, users derive some benefit as a result of the member's involvement because the service has been performed with due professional skill and care. An auditor is associated with financial information when the auditor attaches a report to that information or consents to the use of the auditor's name in a professional connection. If the auditor is not associated in this manner, third parties can assume no responsibility of the auditor.

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Auditing Standards 1.5 Till date, AASB has issued thirty four AASs. A brief summary of each AAS is given below: 1.5.1 AAS 1 : Basic Principles Governing an Audit - The Statement defines audit as an independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to express an opinion thereon. This Statement also describes the basic principles which govern the auditor's professional responsibilities and which should be complied with whenever an audit is carried out. These basic principles, as laid down by the Standard, are as follows: Integrity, objectivity and independence Confidentiality Skills and competence Work performed by others Documentation Planning Audit evidence Accounting systems and internal controls Audit conclusions and reporting

Compliance with the aforestated basic principles requires the application of auditing procedures and reporting practices appropriate to the particular circumstances. This AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1985. 1.5.2 AAS 2 : Objective and Scope of the Audit of Financial Statements - This AAS describes the overall objective and scope of the audit of general purpose financial statements of an enterprise by an independent auditor. The Statement lays down that the objective of an audit of financial statements, prepared within a framework of recognised accounting policies and practices and relevant statutory requirements, if any, is to enable an auditor to express an opinion on such financial statements. However, the auditor's opinion is in no way an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise. Besides, the Statement also states that the scope of an audit of financial statements will be determined by the auditor having regard to the terms of the engagement, the requirements of the relevant legislation and the pronouncements of the Institute. However, the terms of engagement cannot restrict the scope of an audit in relation to matters which are prescribed by statute or the pronouncements of the Institute. The statement also requires the auditor to assess the reliability and sufficiency of the information contained in the underlying accounting records and other source data and also determine whether the relevant information is properly disclosed in the financial statements.


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The statement furthermore clarifies that due to pervasive rather than conclusive nature of audit evidence, test nature and other inherent limitations of an audit, together with the inherent limitations of any system of internal control, there is always an unavoidable risk that some material misstatement might remain undiscovered. The auditor should also set out the constraints on the scope of the audit, in his audit report. This standard is operative for all audits relating to accounting periods beginning on or after April 1, 1985. 1.5.3 AAS 3 : Documentation - The AAS deals with the working papers prepared or obtained by the auditor and retained by him, in connection with the performance of his audit and the advantages of maintaining working papers. The AAS, broadly, lays down that the working papers should record the audit plan, the nature, timing and extent of audit procedures performed, and the conclusion drawn from evidence obtained. The AAS divides working papers into two categories first, permanent audit files which are updated currently with information of continuing importance to succeeding audits; and second, current audit files which contain information relating primarily to the audit of a single period. The AAS also lays down that working papers are the property of the auditor, however, the latter may at his discretion make portions thereof or extracts therefrom available to his clients. The AAS also prescribes the duration for which working papers are to be retained. This AAS became operative for all audits relating to accounting periods beginning on or after July 1, 1985. 1.5.4 AAS 4 (Revised) : The Auditor's Responsibility to Consider Fraud and Error in an Audit of Financial Statement - The purpose of this AAS is to establish standards on the auditor's responsibility to consider fraud and error in an audit of financial statements. While this AAS focuses on the auditor's responsibilities with respect to fraud and error, the primary responsibility for the prevention and detection of fraud and error rests with both those charged with governance and the management of an entity. In this Standard, the term 'financial information' encompasses 'financial statements'. In some circumstances, specific legislations and regulations may require the auditor to undertake procedures additional to those set out in this AAS. This AAS becomes operative for all audits relating to accounting periods commencing on or after April 1, 2003. When planning and performing audit procedures and evaluating and reporting the results thereof, the auditor should consider the risk of material misstatements in the financial statements resulting from fraud or error. In planning the audit, the auditor should discuss with other members of the audit team, the susceptibility of the entity to material misstatements in the financial statements resulting from fraud or error. When planning the audit, the auditor should make inquiries of management: to obtain an understanding of:

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Advanced Auditing and Professional Ethics management's assessment of the risk that the financial statements may be materially misstated as a result of fraud; and the accounting and internal control systems management has put in place to address such risk; to obtain knowledge of management's understanding regarding the accounting and internal control systems in place to prevent and detect error; to determine whether management is aware of any known fraud that has affected the entity or suspected fraud that the entity is investigating; and to determine whether management has discovered any material errors.

When assessing inherent risk and control risk in accordance with AAS 6 (Revised), Risk Assessments and Internal Control, the auditor should consider how the financial statements might be materially misstated as a result of fraud or error. In considering the risk of material misstatement resulting from fraud, the auditor should consider whether fraud risk factors are present that indicate the possibility of either fraudulent financial reporting or misappropriation of assets. Based on the auditor's assessment of inherent and control risks (including the results of any tests of controls), the auditor should design substantive procedures to reduce to an acceptably low level the risk that misstatements resulting from fraud and error that are material to the financial statements taken as a whole will not be detected. In designing the substantive procedures, the auditor should address the fraud risk factors that the auditor has identified as being present. When the auditor encounters circumstances that may indicate that there is a material misstatement in the financial statements resulting from fraud or error, the auditor should perform procedures to determine whether the financial statements are materially misstated. When the auditor identifies a misstatement, the auditor should consider whether such a misstatement may be indicative of fraud and if there is such an indication, the auditor should consider the implications of the misstatement in relation to other aspects of the audit, particularly the reliability of management representations. When the auditor confirms that, or is unable to conclude whether, the financial statements are materially misstated as a result of fraud or error, the auditor should consider the implications for the audit. The auditor should document fraud risk factors identified as being present during the auditor's assessment process and document the auditor's response to any such factors. If during the performance of the audit, fraud risk factors are identified that cause the auditor to believe that additional audit procedures are necessary, the auditor should

Auditing Standards, Statements and Guidance Notes An Overview document the presence of such risk factors and the auditor's response to them.

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When the auditor identifies a misstatement resulting from fraud, or a suspected fraud, or error, the auditor should consider the auditor's responsibility to communicate that information to management, those charged with governance and, in some circumstances, when so required by the laws and regulations, to regulatory and enforcement authorities also. If the auditor has identified a material misstatement resulting from error, the auditor should communicate the misstatement to the appropriate level of management on a timely basis, and consider the need to report it to those charged with governance. The auditor should inform those charged with governance of those uncorrected misstatements aggregated by the auditor during the audit that were determined by management to be immaterial, both individually and in the aggregate, to the financial statements taken as a whole. If the auditor has: identified a fraud, whether or not it results in a material misstatement in the financial statements; or obtained evidence that indicates that fraud may exist (even if the potential effect on the financial statements would not be material);

the auditor should communicate these matters to the appropriate level of management on a timely basis, and consider the need to report such matters to those charged with governance. If the auditor concludes that it is not possible to continue performing the audit as a result of a misstatement resulting from fraud or suspected fraud, the auditor should: consider the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities; consider the possibility of withdrawing from the engagement; and if the auditor withdraws: discuss with the appropriate level of management and those charged with governance, the auditor's withdrawal from the engagement and the reasons for the withdrawal; and consider whether there is a professional or legal requirement to report to the person or persons who made the audit appointment or, in some cases, to

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Advanced Auditing and Professional Ethics regulatory authorities, the auditor's withdrawal from the engagement and the reasons for the withdrawal.

1.5.5 AAS 5 : Audit Evidence - The AAS deals with the various aspects of `audit evidence' on the basis of which the auditor expresses his opinion. The AAS lists the factors which may affect the sufficiency and appropriateness of audit evidence. The AAS also deals with the compliance and substantive procedures to be performed for obtaining assurance regarding various assertions such as existence, effectiveness, continuity, completeness, valuation, measurement etc., of assets/liabilities. The Statement, inter alia, prescribes the various methods for obtaining audit evidence - inspection, observation, enquiry and confirmation, computation and analytical review. The AAS also lays down general rules regarding the extent of reliability of evidence having regard to source and nature of audit evidence. This AAS is operative for all audits relating to accounting periods beginning on or after January 1, 1989. 1.5.6 AAS 6 (Revised) : Risk Assessments and Internal Control - The purpose of this AAS is to establish standards on the procedures to be followed to obtain an understanding of the accounting and internal control systems and on audit risk and its components: inherent risk, control risk and detection risk. This Standard becomes operative for all audit relating to accounting periods beginning on or after April 1, 2002. The auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and develop an effective audit approach. The auditor should use professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level. In developing the overall audit plan, the auditor should assess inherent risk at the level of financial statements. In developing the audit programme, the auditor should relate such assessment to material account balances and classes of transactions at the level of assertions made in the financial statements, or assume that inherent risk is high for the assertion, taking into account factors relevant both to the financial statements as a whole and to the specific assertions. When the auditor makes an assessment that the inherent risk is not high, he should document the reasons for such assessment. The auditor should obtain an understanding of the accounting system sufficient to identify and understand: major classes of transactions in the entity's operations; how such transactions are initiated; significant accounting records, supporting documents and specific accounts in the financial statements; and the accounting and financial reporting process, from the initiation of significant transactions and other events to their inclusion in the financial statements.


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The auditor should obtain an understanding of the control environment sufficient to assess management's attitudes, awareness and actions regarding internal controls and their importance in the entity. The auditor should obtain an understanding of the control procedures sufficient to develop the audit plan. After obtaining an understanding of the accounting system and internal control system, the auditor should make a preliminary assessment of control risk, at the assertion level, for each material account balance or class of transactions. The preliminary assessment of control risk for a financial statement assertion should be high unless the auditor: is able to identify internal controls relevant to the assertion which are likely to prevent or detect and correct a material misstatement; and plans to perform tests of control to support the assessment.

The auditor should document in the audit working papers, the understanding obtained of the entity's accounting and internal control systems; and the assessment of control risk. When control risk is assessed at less than high, the auditor would also document the basis for the conclusions. The auditor should obtain audit evidence through tests of control to support any assessment of control risk which is less than high. The lower the assessment of control risk, the more evidence the auditor should obtain that accounting and internal control systems are suitably designed and operating effectively. Based on the results of the tests of control, the auditor should evaluate whether the internal controls are designed and operating as contemplated in the preliminary assessment of control risk. Before relying on procedures performed in prior audits, the auditor should obtain audit evidence which supports this reliance. The auditor should consider whether the internal controls were in use throughout the period. Before the conclusion of the audit, based on the results of substantive procedures and other audit evidence obtained by the auditor, the auditor should consider whether the assessment of control risk is confirmed. In case of deviations from the prescribed accounting and internal control systems, the auditor would make specific inquiries to consider their implications. Where, on the basis of such inquiries, the auditor concludes that the deviations are such that the preliminary assessment of control risk is not supported, he would amend the same unless the audit evidence obtained from other tests of control supports that assessment. Where the auditor concludes that the

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Advanced Auditing and Professional Ethics assessed level of control risk needs to be revised, he would modify the nature, timing and extent of his planned substantive procedures.

The auditor should consider the assessed levels of inherent and control risks in determining the nature, timing and extent of substantive procedures required to reduce audit risk to an acceptably low level. Regardless of the assessed levels of inherent and control risks, the auditor should perform some substantive procedures for material account balances and classes of transactions. The higher the assessment of inherent and control risks, the more audit evidence the auditor should obtain from the performance of substantive procedures. When the auditor determines that detection risk regarding a financial statement assertion for a material account balance or class of transactions cannot be reduced to an acceptable level, the auditor should express a qualified opinion or a disclaimer of opinion as may be appropriate. The auditor should make management aware, as soon as practical and at an appropriate level of responsibility, of material weaknesses in the design or operation of the accounting and internal control systems, which have come to the auditor's attention.

1.5.7 AAS 7 : Relying upon the Work of an Internal Auditor - This AAS deals with the procedures which should be applied by the external auditor in assessing the work of an internal auditor for the purpose of placing reliance upon that work. The AAS, inter alia, states that, the external auditor should evaluate the internal audit function and also internal audit work to the extent he considers that it will be relevant in determining the nature, timing and extent of his compliance and substantive procedures. However, the report given by him is his sole responsibility which is not in any way reduced because of the reliance he places on internal auditor's work. The AAS also deals with scope and objectives of internal audit function, aspects to be considered in general evaluation of internal audit function such as organisational status, scope of functions, technical competence and due professional care, specific evaluation of internal audit work, as also the coordination between the internal and the external auditor. This AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1989. 1.5.8 AAS 8 : Audit Planning - The purpose of this AAS is to amplify various principles regarding `planning', i.e., the auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner; that plans should be based on knowledge of client's business; and that plans should cover, among other things, knowledge of client's accounting systems, policies and internal control procedures, establishing the expected degree of reliance to be placed on internal control; determining nature, timing and extent of audit procedures; and, coordinating the work to be performed. The AAS also deals with the


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factors to be considered in audit planning and development of audit plan, and acquiring the knowledge of client's business, as also the timing for audit plan. This AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1989. 1.5.9 AAS 9 : Using the Work of an Expert - Though an auditor is responsible for forming and expressing his opinion on financial information, he is entitled to rely on the work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. The auditor should obtain reasonable assurance that work performed by other auditors/experts is adequate for his purpose. This AAS discusses auditor's responsibility in relation to, and the procedures the auditor should consider in using the work of an expert as audit evidence. The AAS also deals with factors to be considered in determining the need to use an expert's work, evaluating skill, competence and objectivity of the expert and his work. The AAS also lays down the considerations in referring to an expert's work in the auditor's report. This AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1991. 1.5.10 AAS 10 (Revised) : Using the Work of Another Auditor - This AAS discusses the procedures to be applied in situations where an independent auditor reporting on the financial statements of an entity, uses the work of an independent auditor with respect to the financial statements of one or more divisions or branches included in the financial statement of the entity. The Statement also discusses the principal auditor's responsibility in relation to his use of the work of other auditor. This Standard becomes operative for all audit relating to accounting periods beginning on or after April 1, 1995. When the principal auditor uses the work of another auditor, the principal auditor should determine how the work of the other auditor will affect the audit. The auditor should consider whether the auditor's own participation is sufficient to be able to act as the principal auditor. When planning to use the work of another auditor, the principal auditor should consider the professional competence of the other auditor in the context of specific assignment if the other auditor is not a member of the Institute of Chartered Accountants of India. The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the specific assignment. The principal auditor should consider the significant findings of the other auditor. There should be sufficient liaison between the principal auditor and the other auditor. The other auditor, knowing the context in which his work is to be used by the principal auditor, should co-ordinate with the principal auditor. When the principal auditor concludes, based on his procedures, that the work of the

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Advanced Auditing and Professional Ethics other auditor cannot be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/ branches/subsidiaries or other components audited by other auditors.

1.5.11 AAS 11 : Representations by Management - This AAS establishes standards on the use of management representations as audit evidence, the procedures to be applied in evaluating and documenting management representations, and the action to be taken if management refuses to provide appropriate representations. The AAS also deals with the basic elements of a management representation letter, covering items like accounting policies, fixed assets, capital commitments, investments, inventories, current assets and liabilities etc. The AAS lays down, among other things, that in respect of management representation relating to matters material to the financial statements, the auditor should seek corroborative audit evidence from sources inside/outside the entity; evaluate whether the representations appear to be reasonable and consistent with other audit evidence obtained; and consider whether the individuals making the representations can be expected to be well-informed on the matter. The AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1995. 1.5.12 AAS 12 : Responsibility of Joint Auditors - This AAS deals with the professional responsibilities which the auditors undertake in accepting appointments as joint auditors. The AAS, inter alia, lays down that the joint auditors should, normally, by mutual discussion, divide the audit work among themselves. The division of work among joint auditors as also the areas of work to be covered by all of them should be adequately documented and preferably communicated to the entity. The AAS also states that each joint auditor is responsible only for the work allotted to him, whether or not he has prepared a separate report on the work performed by him. The AAS describes the areas for which joint auditors are jointly and severally responsible. As per the AAS, each joint auditor is entitled to assume that the other joint auditors have carried out their part of the audit work in accordance with generally accepted audit procedures. It also deals with the reporting responsibilities of the joint auditors. The AAS became effective for all audits relating to accounting periods commencing on or after April 1, 1996. 1.5.13 AAS 13 : Audit Materiality - The AAS 13 establishes standards on the concept of materiality and its relationship with audit risk. The AAS states that information is material if its


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misstatement could influence the economic decisions of the users taken on the basis of the financial information and that materiality depends on the size and nature of the items, judged in the particular circumstances of its misstatements. Materiality should be considered by the auditor in determining nature, timing and extent of his audit procedures and in evaluating the effect of misstatements. The AAS also states that materiality should be considered both at overall financial information level and in relation to individual account balances and classes of transactions. Besides, there exists an inverse relationship between materiality and the degree of audit risk. This AAS also deals with the factors influencing materiality, factors to be considered relating to materiality and audit risk in evaluating audit evidence as also the duties of an auditor when uncorrected misstatements approach materiality level. The AAS became effective in respect of audits relating to accounting periods beginning on or after April 1, 1996. 1.5.14 AAS 14 : Analytical Procedures - AAS 14 establishes standards on application of analytical procedures during an audit. The AAS, inter alia, lays down that the auditor should apply analytical procedures at the planning and overall review stages of the audit. The auditor should apply analytical procedures at the planning stage to assist in understanding the business and in identifying areas of potential risk and at or near the end of the audit to corroborate conclusions formed during the audit of individual elements of financial statements and to arrive at overall conclusion as to reasonableness of the financial statements. The AAS also deals with advantages of performing analytical procedures, matters comprising analytical procedures, factors to be considered when performing analytical procedures as substantive procedures, and the factors influencing the extent of reliance that can be placed on results of analytical procedures. The AAS became operative for all audits relating to accounting periods beginning on or after April 1, 1997. 1.5.15 AAS 15 : Audit Sampling - The AAS establishes standards on the design and selection of an audit sample and evaluation of the sample results, and applies to both statistical and non-statistical sampling methods. The AAS, inter alia, lays down that performing audit procedures on samples and evaluating sampling results can provide sufficient appropriate audit evidence. When designing an audit sample, the auditor should consider the specific audit objectives, the population from which auditor wishes to draw sample, the sample size, sampling risk, tolerable error and the expected error. The AAS also extensively deals with each of the aforesaid items and illustrates the factors influencing sample size for tests of control and those for substantive procedures. The AAS became effective for all audits relating to accounting periods beginning on or after April 1, 1998. 1.5.16 AAS 16 : Going Concern - This AAS, inter alia, states that when planning and performing audit procedures and in evaluating the results thereof, the auditor should consider the appropriateness of the going concern assumption underlying the preparation of financial statements. When the going concern assumption becomes doubtful, the auditor should gather sufficient appropriate audit evidence to attempt to resolve, to the auditors satisfaction, the said doubt. The AAS also deals with the factors to be considered in evaluating the going concern

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assumption; the procedures for evaluating the audit evidence regarding appropriateness of going concern; the duties of the auditor and reporting requirements in case going concern question is either not resolved or going concern assumption is considered inappropriate. This AAS became effective for all audits relating to accounting periods beginning on or after April 1, 1999. 1.5.17 AAS 17 : Quality Control for Audit Work - The AAS establishes standards on quality control policies and procedures of an audit firm regarding audit work generally; and procedures regarding the work delegated to assistants on an individual audit. At firm level, the objectives of the quality control policies to be adopted by an audit firm normally include professional requirements, skills and competence, assignment, delegations, consultation, acceptance and intention of clients and monitoring. The AAS, inter alia, lays down that audit firm should implement quality control policies and procedures designed to ensure that all audits are conducted in accordance with AASs. At individual audit level, the AAS also deals with aspects like providing direction and supervision to the assistants to whom work on individual audits has been delegated, and also reviewing their performance. The AAS became effective for all audits relating to accounting periods beginning on or after April 1, 1999. Having regard to the importance of AAS for the auditor, this has been discussed at length later in the Chapter. 1.5.18 AAS 18 : Audit of Accounting Estimates - The objective of this AAS is to establish standards on the audit of accounting estimates contained in financial statements viz, the auditor should obtain sufficient appropriate audit evidence regarding accounting estimates. However, the AAS is not applicable to the examination of prospective financial information. Since, accounting estimates are the responsibility of the management, the auditor needs to obtain sufficient appropriate audit evidence as to whether and accounting estimate is reasonable in the circumstances, and when required, appropriately disclosed in the financial statements. According to the AAS, the auditor should follow either or all of the following procedures to audit an accounting estimates:(A) Review and test the process used by management to develop the estimate; including evaluation of date and evaluation of assumptions underlying the estimates; testing the calculations involved in the estimate; comparison of estimates and actual results of prior periods; and evaluation of the approval procedures of the management. (B) Comparison of the managements estimate with an independent estimate; (C) Review of subsequent events which confirm the estimates. The final assessment of reasonableness of an accounting estimates would be based on the auditors knowledge of the clients business and its consistency with other audit evidence obtained during the audit. If the auditor is of the opinion that the accounting estimate prepared by the management is significantly different from that assessed by him, he should request the management to revise the same. If the management refuses to revise its estimate, it would be considered as a misstatement and the auditor would need to consider its effect on the financial statements. This AAS became operative for all audits commencing on or after April 1, 2000.


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1.5.19 AAS 19 : Subsequent Events - This AAS outlines the auditors responsibility in respect of subsequent events; viz, the auditor should consider the effect of subsequent events on the financial statements and on the auditors report. The AAS defines subsequent Events as significant events occurring between the balance sheet date and the date of the auditors report. The AAS also refers to Accounting Standard 4, Contingencies & Events Occurring After the Balance Sheet Date for the purposes of Subsequent Events. The AAS requires the auditor to obtain sufficient appropriate audit evidence that all subsequent events, have been identified and adjusted/disclosed, where required, in the financial statements, by employing the following procedures: Review of managements procedures to identify subsequent events. Reading of minutes of meetings of shareholders, board of directors etc. Reading the latest available interim financial information, budgets, forecasts etc. Inquiring the lawyers of the entity as to the litigations and claims. Inquiring management as to any subsequent events after the balance sheet date, affecting the financial statements.

In case of subsequent events materially affecting the financial statements, the auditor would consider whether such events have been properly accounted for in the financial statements. Where the management does not account for such events, the auditor would need to express a qualified or an adverse opinion as appropriate. The AAS becomes operative for all audits commencing on or after 1st April, 2000. 1.5.20 AAS 20 : Knowledge of the Business - This AAS deals with the definition of the knowledge of the business, its importance to the auditor and the audit staff, its relevance to the audit; and how the auditor obtains and uses the knowledge. The auditor should have or should obtain knowledge of the business efficient to identity and understand the events, transactions and practices, which in his judgement might have a significant effect on the financial statements or on examination or audit report. The auditor should be such knowledge to assess inherent and control risks and to determine the nature, timing and extent of audit procedures. Auditors level of knowledge would include a general knowledge of the economy and the industry within which the entity operates and a more particular knowledge of how the entity operates. In case of a new engagement, the auditor would need to obtain a preliminary knowledge of the industry and of nature of ownership/management and operations of the entity. For continuing engagements, the auditor would need to update and reevaluate information gathered previously and would also perform procedures designed to identify significant changes that have taken place since the last audit. The AAS illustrates a number of sources from which the knowledge can be obtained, viz., previous experience with entity/industry, discussion with senior operating personnel of the entity, discussion with internal auditors, review of internal audit reports, discussion with legal advisors etc.

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The knowledge so obtained would assist the auditor in assessing risks and identifying problems, planning and performing audit effectively and efficiently, evaluating audit evidence, and providing better services to clients. The auditor should ensure that the audit staff should obtain sufficient knowledge of the business. Effective use of knowledge requires the auditor to consider its effect on the financial statements taken as a whole and also consider whether the financials statement assertions are consistent with his knowledge of the business. The AAS is operative for all audits commencing on or after 1st April, 2000. 1.5.21 AAS 21 : Consideration of Laws and Regulations in an Audit of Financial Statements The AAS lays down the standards in respect of the auditors responsibility regarding consideration of laws and regulations in an audit of financial statements, viz., in planning and performing audit procedures and in evaluating results thereof, the auditor should recognize that non-compliance by the entity with laws and regulations may materially affect the financial statements. The AAS, however, provides that: (a) Whether an act constitutes non-compliance is a legal determination that is ordinarily beyond the auditors professional competence, and is generally based on the advice of an informed expert qualified to practice law but ultimately can only be decided by a court of law. (b) The responsibility of ensuring that the entitys operations are carried out in accordance with laws and regulations and that of prevention and detection of non-compliance is that of the management. (c) The auditor is not and cannot be held responsible for preventing non-compliance, and audit, however, may act as a deterrent. (d) The risk that some material misstatements of financial statements are not detected by audit is higher in case of material misstatements resulting from non-compliance with laws and regulations. (e) The auditor should recognise that the audit may reveal conditions or events that would lead to questioning the compliance with laws and regulations by the entity and should, accordingly, plan and perform the audit. After obtaining a general understanding of the legal and regulatory framework applicable to the entity, and its compliance therewith, the auditor should perform procedures to identify the instances the non-compliance affecting the financial statements. The auditor should also obtain evidence regarding compliance with such laws and regulations which effect the determination of material amounts and disclosures in financial statements. The AAS requires the auditor to obtain written representations from management regarding possible or actual non-compliance with laws and regulations whose affects should be considered while preparing financial statements. When the auditor becomes aware of information regarding a non-compliance, he should obtain an understanding of the nature of the act, the circumstances in which it had occurred, and sufficient other information to evaluate the possible effect on the financial statements. The auditor should also document the findings and discuss them with management. When the


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aforesaid information cannot be obtained, the auditor should consider the effect of lack of evidence on his report. The AAS also requires that the auditor should as soon as practicable communicate the noncompliance to the appropriate level of management. If the auditor concludes that the non-compliance materially affects the financial statements, the auditor should express a qualified or an adverse opinion. In case where the entity does not take remedial steps deemed necessary by the auditor, even though the non-compliance is not material to the financial statements, the auditor must withdraw from the engagement. The AAS is operative for all audits commencing on or after 1st July, 2001. 1.5.22 AAS 22 : Initial Engagements - Opening Balances - This AAS establishes standards regarding audit of opening balances in case of initial engagements, i.e., when the financial statements are audited for the first time or when the financial statements for the preceding period were audited by another auditor. The auditor should obtain sufficient For initial audit engagements the auditor should obtain sufficient audit evidence that the closing balances of the preceding period have been correctly brought forward to the current period; that the opening balances do not contain misstatements that materially affect the financial statements for the current period; also that appropriate accounting policies are consistently applied. The auditor would also need to be satisfied regarding the following matters in respect of the opening balances: Accounting policies followed by the entity; Nature of audit report of the preceding period - clean/ qualified etc.; Nature of opening balances and the risk of their misstatement in the current period; Materiality of opening balances relative to the financial statements for the current period.

If the auditor is unable to obtain sufficient appropriate audit evidence concerning opening balances, the auditor should express a qualified or a disclaimer of opinion, as appropriate. If the opening balances contain misstatements which materially affect the financial statements for the current period and the effect of the same is not properly accounted for and adequately disclosed, the auditor should express qualified opinion or an adverse opinion, as adequate. The AAS is effective for all audits commencing on or after 1st July, 2001. 1.5.23 AAS 23 : Related Parties - This AAS establishes standards on the auditors responsibilities and audit procedures regarding related parties and transactions with such parties. It requires that the auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence regarding the identification and disclosure by management of related parties and the related party transactions that are material to the financial statements. AAS requires that the auditor should review information provided by the management of the entity identifying the names of all known related parties and should perform the necessary procedures such as review of records, minutes books, income-tax

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returns, relevant agreements, etc. to enable completeness of this information. AAS also requires the auditor to satisfy himself that where the financial reporting framework requires disclosure of related party relationships, such disclosure is adequate. While auditing transactions with related parties, the auditor should review information provided by directors and key management personnel of the entity identifying related party transactions and should be alert for other material related party transactions. The auditor should also consider the adequacy of control procedures over the authorisation and recording of related party transactions. In examining the identified related party transactions, AAS requires that the auditor should obtain sufficient appropriate audit evidence as to whether these transactions have been properly recorded and disclosed. The auditor should obtain a written representation from management concerning the completeness of information provided regarding the identification of related parties; and the adequacy of related party disclosures in the financial statements. Finally, if the auditor is unable to obtain sufficient appropriate audit evidence concerning related parties and transactions with such parties or concludes that their disclosure in the financial statements is not adequate, the auditor should express a qualified opinion or a disclaimer of opinion in the audit report, as may be appropriate. Appendix to the AAS also gives an example of a management representation letter regarding