1 INTRODUCTION

What do we mean by auditing? What is its nature and scope? What it includes and
What it does not? What are its limitations? We shall try to find out answers to
these questions in succeeding paras.

2 ORIGIN OF AUDITING
Before we get to understand meaning and nature of auditing, let’s travel back in time
to know about origin of auditing. Auditing has existed even in ancient times in many
societies of world including India. The reference to auditing is found in Kautilya’s
Arthshastra even in 4th century BC. It talks about fixed accounting year, a process for
closure of accounts and audit for the same. Concepts of periodical checking and
verification existed even in those times.

The word “audit” originates from Latin word “audire” meaning “to hear”. In medieval
times, auditors used to hear the accounts read out to them to check that employees
were not careless and negligent. Industrial revolution in Europe led to astronomical
expansion in volume of trade and consequently demand of auditors.

Coming to more recent history, the first Auditor General of India was appointed in
British India in 1860 having both accounting and auditing functions. Later on, office
of Auditor General was given statutory recognition. Presently, Comptroller and Auditor
General of India is an independent constitutional authority responsible for auditing
government receipts and expenditures.

The Institute of Chartered Accountants of India was established as a statutory body

under an Act of Parliament in 1949 for regulating the profession of Chartered
Accountancy in the country.

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3 MEANING AND NATURE OF AUDITING
“An audit is 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 expressing an opinion thereon”.
Auditing provides assurance. Its basic nature lies in providing assurance to users -
providing confidence to users of financial statements. Such an assurance lends credibility
to financial statements. Audited financial statements provide confidence to users that
financial information reflected in financial statements can be relied upon.

4. INTERDISCIPLINARY NATURE OF AUDITING- RELATIONSHIP WITH DIVERSE

SUBJECTS
Auditing is interdisciplinary in nature. It draws from diverse subjects including accountancy,
law, behavioural science, statistics, economics and financial management and makes use of
these subjects. Since audit of financial statements is concerned with financial information,
a sound knowledge of accounting principles is a fundamental requirement for an auditor
of financial statements to conduct audit and express an opinion. Similarly, good knowledge
of business laws and various taxation laws helps auditor to understand financial statements
in a better way in accordance with applicable laws.

During course of audit, auditor has to interact with lot of persons for seeking
information and making inquiries. This can be done only if one has knowledge of human
behaviour. Auditors use statistical methods to draw samples in a scientific manner. It
is not possible for an auditor to check each and every transaction. So, use of statistical
methods to draw samples for conducting audit is made.

Knowledge of subject like economics helps auditor to be familiar with overall economic
environment in which specific business is operating. Financial management deals with
issues such as funds flow, working capital management, ratio analysis etc. and an
auditor is expected to be knowledgeable about these for applying some of audit
procedures and carrying out audit effectively. Besides, knowledge of financial markets
comprised in study of financial management is expected from a professional auditor.

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1. Auditing and Accounting
2. Auditing and Law
3. Auditing and Economics
4. Auditing and Behavioural Science
5. Auditing and Statistics & Mathematics
6. Auditing and Data Processing
7. Auditing and Financial Management
8. Auditing and Production

5 OBJECTIVES OF AUDIT
In conducting audit of financial statements, objectives of auditor in accordance with
SA-200 “Overall Objectives of the Independent auditor and the conduct of an audit
in accordance with Standards on Auditing” are: -
(a) To obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor’s findings.

An analysis of above brings out following points clearly: -

(1) Auditor’s objective is to obtain a reasonable assurance whether financial statements
as a whole are free from material misstatement whether due to fraud or error.
Reasonable assurance is to be distinguished from absolute assurance. Absolute assurance
is a complete assurance or a guarantee that financial statements are free from material
misstatements. However, reasonable assurance is not a complete guarantee. Although
it is a high-level of assurance but it is not complete assurance.
(2) Misstatements in financial statements can occur due to fraud or error or both. The
auditor seeks to obtain reasonable assurance whether financial statements as a whole
are free from material misstatements caused by fraud or error. He has to see effect
of misstatements on financial statements as a whole, in totality.

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(3) Obtaining reasonable assurance that financial statements as a whole are free from
material misstatements enables the auditor to express an opinion.
(4) The opinion is reported and communicated in accordance with audit findings through
a written report as required by Standards on Auditing.

6 SCOPE OF AUDIT-WHAT IT INCLUDES

Scope refers to range or reach of something. The purpose of an audit is to enhance
the degree of confidence of intended users in the financial statements.
The following points are included in scope of audit of financial statements: -
(1) Coverage of all aspects of entity
Audit of financial statements should be organized adequately to cover all aspects of
the entity relevant to the financial statements being audited.
(2) Reliability and sufficiency of financial information
The auditor should be reasonably satisfied that information contained in underlying
accounting records and other source data (like bills, vouchers, documents etc.) is
reliable and sufficient basis for preparation of financial statements.
The auditor makes a judgment of reliability and sufficiency of financial information by
making a study and assessment of accounting systems and internal controls and by
carrying out appropriate tests, enquiries and procedures.
(3) Proper disclosure of financial information
The auditor should also decide whether relevant information is properly disclosed in
the financial statements. He should also keep in mind applicable statutory requirements
in this regard.
It is done by ensuring that financial statements properly summarize transactions and
events recorded therein and by considering the judgments made by management in
preparation of financial statements.
The auditor evaluates selection and consistent application of accounting policies by
management; whether such a selection is proper and whether chosen policy has been
applied consistently on a period-to-period basis.

 Understand that financial statements of an entity are prepared on historical financial

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 information basis. “Historical financial information” means information expressed in
financial terms in relation to a particular entity, derived primarily from that entity’s
accounting system, about economic events occurring in past time periods or about
economic conditions or circumstances at points in time in the past.

6.1 Scope of audit-What it does not include

Auditor is not expected to perform duties which fall outside domain of his competence.
For example, physical condition of certain assets like that of sophisticated machinery
cannot be determined by him. Similarly, it is not expected from an auditor to
determine suitability and life of civil structures like buildings. These require different
skillsets which may be performed by qualified engineers in their respective fields.

An auditor is not an expert in authentication of documents. The genuineness of

documents cannot be authenticated by him because he is not an expert in this field.
An audit is not an official investigation into alleged wrong doing.

Audit is distinct from investigation. Investigation is a critical examination of the

accounts with a special purpose. For example, if fraud is suspected and it is specifically
called upon to check the accounts whether fraud really exists, it takes character of
investigation.
The scope of audit is general and broad whereas scope of investigation is specific and
narrow.

An Overview of Scope of Audit

Check box Scope of audit of financial statements
 Coverage of all aspects of entity relevant to the financial statements
being audited.
 Reliability and Sufficiency of financial information
 Proper disclosure of financial information
 Expression of an opinion on financial statements
X Responsibility of preparation and presentation of financial statements
X Duties outside scope of competence of auditor

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 X Expertise in authentication of documents
X Investigation

TEST YOUR UNDERSTANDING 1

Lalji Bhai has purchased shares of a company listed on NSE. The audited financial
statements of the company provide picture of healthy financial performance having
robust turnover, low debt and good profits. On above basis, he is absolutely satisfied
that money invested by him is safe and there is no chance of losing his money. Do
audited results and audit reports of companies provide such assurance to investors
like Lalji Bhai? Is thinking of Lalji Bhai correct?
SOLUTION

TEST YOUR UNDERSTANDING 2

Good deeds Limited is engaged in business of recycling of wastes from dumping
grounds of municipal corporation of Indore to usable manure. It is, in this way,
also, helping to make the city clean.
During course of audit by Zoha & Zoha, a firm of auditors, it is observed by auditors
that company has received a notice from Central Bench of National Green Tribunal
for not following certain environmental regulations involving imposition of hefty
monetary penalty on the company. The company is yet to reply to the notice. The
auditors point out that same is not stated in notes to accounts in financial
statements. The company points out that auditors are going beyond scope of their
work. Does such a matter fall within scope of audit?

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SOLUTION

TEST YOUR UNDERSTANDING 3

A huge fire broke out in NOIDA plant of KT Limited. Plant assets comprising building,
machinery and inventories were insured from branch of a public sector insurance
company. Apart from an insurance surveyor who was deputed for assessing loss, the
regional office of insurance PSU also appointed a CA for verification of books of
accounts/ financial records of the company and circumstances surrounding the loss. He
was also requested to submit an early report. Would the report by CA in nature
of audit report?
SOLUTION

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 7. INHERENT LIMITATIONS OF AUDIT
The process of audit suffers from certain inbuilt limitations due to which an auditor
cannot obtain an absolute assurance that financial statements are free from
misstatement due to fraud or error. These fundamental limitations arise due to the
following factors: -
(1) Nature of financial reporting
Preparation of financial statements involves making many judgments by management.
These judgments may involve subjective decisions or a degree of uncertainty. Therefore,
auditor may not be able to obtain absolute assurance that financial statements are
free from material misstatements due to frauds or errors.
One of the premises for conducting an audit is that management acknowledges its
responsibility of preparation of financial statements in accordance with applicable
financial reporting framework and for devising suitable internal controls. However, such
controls may not have operated to produce reliable financial information due to their
own limitations.

(2) Nature of Audit procedures

The auditor carries out his work by obtaining audit evidence through performance of
audit procedures. However, there are practical and legal limitations on ability of
auditor to obtain audit evidence. For example, an auditor does not test all transactions
and balances. He forms his opinion only by testing samples. It is an example of practical
limitation on auditor’s ability to obtain audit evidence.
Management may not provide complete information as requested by auditor. There is no
way by which auditor can force management to provide complete information as may be
requested by auditor. In case he is not provided with required information, he can only
report. It is an example of legal limitation on auditor’s ability to obtain audit evidence.
The management may consist of dishonest and unscrupulous people and may be, itself,
involved in fraud. It may be engaged in concealing fraud by designing sophisticated and
carefully organized schemes which may be hard to detect by the auditor. It may
produce fabricated documents before auditor to lead him to believe that audit evidence
is valid. However, in reality, such documents could be fake or non-genuine.

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(3) Not in nature of investigation
As already discussed, audit is not an official investigation.

(4) Timeliness of financial reporting and decrease in relevance of information over time
The relevance of information decreases over time and auditor cannot verify each and
every matter. Therefore, a balance has to be struck between reliability of information
and cost of obtaining it.
Consider, for example, an auditor who is conducting audit of a company since last two
years. During these two years, he has sought detailed information from management
of company regarding various matters. During his third- year stint, he chooses to rely
upon some information obtained as part of audit procedures of second year. However,
it could be possible that something new has happened and that information is not
relevant. So, the information being relied upon by auditor is not timely and may have
lost its reliability.

(5) Future events

Future events or conditions may affect an entity adversely. Adverse events may
seriously affect ability of an entity to continue its business. The business may cease
to exist in future due to change in market conditions, emergence of new business
models or products or due to onset of some adverse events.

Therefore, it is in view of above factors, that an auditor cannot provide a guarantee

that financial statements are free from material misstatements due to frauds or
errors.

8. WHAT IS AN ENGAGEMENT?
Engagement means an arrangement to do something. In the context of auditing, it
means a formal agreement between auditor and client under which auditor agrees to
provide auditing services. It takes the shape of engagement letter.

8.1 External audit engagements

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 The purpose of external audit engagements is to enhance the degree of confidence of
intended users of financial statements. Such engagements are also reasonable assurance
engagements.

9. BENEFITS OF AUDIT-WHY AUDIT IS NEEDED?

♦ Audited accounts provide high quality information. It gives confidence to users
♦ In case of companies, shareholders may or may not be involved in daily affairs of the
company. The financial statements are prepared by management consisting of directors.
As shareholders are owners of the company, they need an independent mechanism so
that financial information is qualitative and reliable.
♦ An audit acts as a moral check on employees from committing frauds for the fear of
being discovered by audit.
♦ Audited financial statements are helpful to government authorities for determining
tax liabilities.
♦ Audited financial statements can be relied upon by lenders, bankers for making their
credit decisions i.e. whether to lend or not to lend to a particular entity.
♦ An audit may also detect fraud or error or both.
♦ An audit reviews existence and operations of various controls operating in any entity.
Hence, it is useful at pointing out deficiencies.

10. AUDIT- MANDATORY OR VOLUNTARY?

It is not necessary that audit is always legally mandatory. There are entities like
companies who are compulsorily required to get their accounts audited under law.
Even non-corporate entities may be compulsorily requiring audit of their accounts
under tax laws. For example, in India, every person is required to get accounts audited
if turnover crosses certain threshold limit under income tax law.
It is also possible that some entities like schools may be required to get their accounts
audited for the purpose of obtaining grant or assistance from the Government.
Audit is not always mandatory. Many entities may get their accounts audited
voluntarily because of benefits from the process of audit. Many such concerns have
their internal rules requiring audit due to advantages flowing from an audit.

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11. WHO APPOINTS AN AUDITOR?
Generally, an auditor is appointed by owners or in some cases by constitutional or
government authorities in accordance with applicable laws and regulations. For example,
in case of companies, auditor is appointed by members (shareholders) in Annual General
Meeting (AGM). Shareholders are owners of a company and auditor is appointed by
them in AGM.
However, in case of government companies in India, auditor is appointed by Comptroller
and Auditor General of India (CAG), an independent constitutional authority.
Take case of a firm who engages an auditor to audit its accounts. In such a case,
auditor is appointed by partners of firm.
There may be a situation in which auditor may be appointed by a government authority
in accordance with some law or regulation. For example, an auditor may be appointed
under tax laws by a government authority.

12. TO WHOM REPORT IS SUBMITTED BY AN AUDITOR?

The outcome of an audit is written audit report in which auditor expresses an opinion.
The report is submitted to person making the appointment.

TEST YOUR UNDERSTANDING 4

Zeeba Products is a partnership firm engaged in trading of designer dresses. The firm
has appointed JJ & Co, Chartered accountants to audit their accounts for a year.
The auditors were satisfied with control systems of firm, carried out required
procedures and necessary verifications. In particular, they carried out sample checking
of purchases, traced purchase bills to GST portal and also made confirmations from
suppliers. They were satisfied with audit evidence obtained by them as part of audit
exercise. An audit report was submitted to the firm giving an opinion that financial
statements reflected true and fair view of state of affairs of the firm.
However, later on, it was discovered that purchase manager responsible for procuring
dresses from one location was also booking fake purchases of small values by colluding
with unethical dealers. Payments to these dealers were also made in connivance with
accountant through banking channel.

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 The partners of firm blame auditors for futile audit exercise. Are partners of firm
correct in their view point? Imagine any probable reason for such a situation.
SOLUTION

13. MEANING OF ASSURANCE ENGAGEMENT

“Assurance engagement” means an engagement in which a practitioner expresses a
conclusion designed to enhance the degree of confidence of the intended users other
than the responsible party about the outcome of the evaluation or measurement of
a subject matter against criteria.

13.1 Elements of an Assurance Engagement

Following elements comprise an assurance engagement: -
1. A three-party relationship involving a practitioner, a responsible party, and intended
users
A practitioner is a person who provides the assurance. The term practitioner is broader
than auditor.
A responsible party is the party responsible for preparation of subject matter.
Intended users are the persons for whom an assurance report is prepared. These
persons may use the report in making decisions.
2. An appropriate subject matter
It refers to the information to be examined by the practitioner.
3. Suitable criteria
These refer to benchmarks used to evaluate the subject matter like standards,
guidance, laws, rules and regulations.

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4. Sufficient appropriate evidence
The practitioner performs an assurance engagement to obtain sufficient appropriate
evidence. It is on the basis of evidence that conclusions are arrived and an opinion is
formed by auditor.
5. A written assurance report in appropriate form
A written report is provided containing conclusion that conveys the assurance about
the subject matter. A written assurance report is the outcome of an assurance
engagement.

13.2 Meaning of Review; Audit Vs. Review

We have learnt that audit is a reasonable assurance engagement. It provides reasonable
assurance. However, review is a limited assurance engagement. It provides lower level
of assurance than audit. Further, review involves fewer procedures and gathers
sufficient appropriate evidence on the basis of which limited conclusions can be drawn
up. However, both “audit” and “review” are related to financial statements prepared
on the basis of historical financial information.

13.3 Types of Assurance Engagements- Reasonable assurance engagement vs. Limited

assurance engagement
Reasonable assurance engagement Limited assurance engagement
Reasonable assurance engagement Limited assurance engagement provides
provides high level of assurance. lower level of assurance than reasonable
assurance engagement.
It performs elaborate and extensive It performs fewer procedures as compared
procedures to obtain sufficient to reasonable assurance engagement.
appropriate evidence.
It draws reasonable conclusions on the It involves obtaining sufficient appropriate
basis of sufficient appropriate evidence. evidence to draw limited conclusions.
Example of reasonable assurance Example of limited assurance engagement
engagement is an audit engagement. is review engagement.

“Prospective financial information” means financial information based on assumptions

about events that may occur in the future and possible actions by an entity.

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It can be in the form of a forecast or projection or combination of both.
It is to be noted that in such type of assurance engagements, examination is not of
historical financial information.

Here, it is important to note the difference between “Historical financial information”

and “Prospective financial information.” The former relates to information expressed
in financial terms of an entity about economic events, conditions or circumstances
occurring in past periods. The latter relates to financial information based on
assumptions about occurrence of future events and possible actions by an entity.
Therefore, historical financial information is rooted in past events which have already
occurred whereas prospective financial information is related to future events.

In assurance reports involving prospective financial information, the practitioner obtains

sufficient appropriate evidence to the effect that management’s assumptions on which
the prospective financial information is based are not unreasonable, the prospective
financial information is properly prepared on the basis of the assumptions and it is
properly presented and all material assumptions are adequately disclosed.

Therefore, in such assurance engagements, practitioner provides a report assuring that

nothing has come to practitioner’s attention to suggest that these assumptions do
not provide a reasonable basis for the projection.

Hence, such type of assurance engagement provides only a “moderate” level of

assurance.
Examples of assurance engagements
Checkbox Example of assurance Type of assurance engagement
engagement
 Audit of financial statements Reasonable assurance engagement
 Review of financial statements Limited assurance engagement

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  Examination of Prospective Provides assurance regarding
financial information reasonability of assumptions forming
basis of projections and related
matters
 Report on controls operating Provides assurance regarding design
at an organization and operation of controls

Assurance Engagements

Reasonable Assurance Limited Assurance Assurance Engagements dealing

Engagement Engagement with matters other than
historical financial information
Audit Review

Examination of prospective
financial information (like
forecast) or assurance
regarding operations of
controls

TEST YOUR UNDERSTANDING 5

The management of Exotic Tours and Travels Limited requests its auditor Raja &
Co.to provide an assurance report on the financial information for first quarter of a
year by skipping required detailed procedures.
Can Raja & Co. provide such a report? What would be nature of such a report? Would
it be necessary for them to obtain sufficient appropriate evidence in such a case?
SOLUTION

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 14. QUALITIES OF AUDITOR
An auditor is concerned with the reporting on financial matters of business and other
institutions. Financial matters inherently are to be set with the problems of human
fallibility; errors and frauds are frequent.
Tact, caution, firmness, good temper, integrity, discretion, industry, judgement,
patience, clear headedness and reliability are some of qualities which an auditor should
have. In short, all those personal qualities that go to make a good businessman
contribute to the making of a good auditor.
In addition, he must have the shine of culture for attaining a great height. He must
have the highest degree of integrity backed by adequate independence.
The auditor, who holds a position of trust, must have the basic human qualities apart
from the technical requirement of professional training and education. He is called
upon constantly to critically review financial statements and it is obviously useless for
him to attempt that task unless his own knowledge is that of an expert. An exhaustive
knowledge of accounting in all its branches is the sine qua non of the practice of
auditing. He must know thoroughly all accounting principles and techniques.

15. ENGAGEMENT AND QUALITY CONTROL STANDARDS: AN OVERVIEW

The following Standards issued under authority of ICAI Council are collectively known
as Engagement Standards: -
1. Standards on auditing (SAs) which apply in audit of historical financial information.
2. Standards on review engagements (SREs) which apply in review of historical financial
information.
3. Standards on Assurance engagements (SAEs) which apply in assurance engagements
other than audits and review of historical financial information.
4. Standards on Related Services (SRSs) which apply in agreed upon procedures to
information, compilation engagements and other related service engagements.

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15.1 Standards on Auditing
Standards on Auditing apply in the context of an audit of financial statements by an
independent auditor. It is important to remember that Standards on Auditing apply
in audit of historical information. These establish high quality benchmarks and are
followed by auditors in conducting audit of financial statements.
Some examples of Standards on Auditing are: -
♦ SA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit
in accordance with Standards on Auditing
♦ SA 230 Audit Documentation
♦ SA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment
♦ SA 500 Audit Evidence
♦ Revised SA 700 Forming an Opinion and Reporting on Financial Statements

15.2 Standards on Review Engagements

Standards on review engagements apply in the context of review of financial
statements.
Examples of Standards on Review engagements are:
♦ SRE 2400 (Revised) Engagements to Review Historical Financial Statements
♦ SRE 2410 Review of Interim Financial Information Performed by the Independent
Auditor of the Entity
It is to be noted that both Standards on auditing and Standards on review
engagements apply to engagements involving historical financial information.

15.3 Standards on Assurance Engagements

There is another set of standards which apply in assurance engagements dealing with
subject matters other than historical financial information. Such assurance engagements
do not include “audit” or “review” of historical financial information. These standards
are known as Standards on Assurance Engagements.
Examples of Standards on Assurance Engagements are:
♦ SAE 3400 The Examination of Prospective Financial Information

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 ♦ SAE 3420 Assurance Engagements to Report on the Compilation of Pro Forma
Financial Information Included in a Prospectus

15.4 Standards on Related Services

Lastly, there are standards on related services. These standards apply in engagements
to perform agreed-upon procedures regarding financial information.
For example, an engagement to perform agreed-upon procedures may require the
auditor to perform certain procedures concerning individual items of financial data,
say, accounts payable, accounts receivable, purchases from related parties and sales
and profits of a segment of an entity, or a financial statement, say, a balance sheet
or even a complete set of financial statements.
An engagement in which practitioner may be called upon to assist management with
the preparation and presentation of historical financial information without obtaining
assurance on that information. Such type of compilation engagements fall in the
category of related services and practitioner issues a report clearly stating that it is
not an assurance engagement and no opinion is being expressed.
These types of services are called related services and standards have been issued to
deal with practitioner’s responsibilities in this regard.
Examples of Standards on related services are:
♦ SRS 4400 Engagements to perform agreed-upon procedures regarding financial information
♦ SRS 4410 (Revised) Compilation engagements
Engagement Standards issued under the authority of Council of ICAI deal with
responsibilities of auditor/practitioner.

15.5 Standards on Quality Control

Standards on Quality Control (SQCs) have been issued to establish standards and
provide guidance regarding a firm’s responsibilities for its system of quality control
for the conduct of audit and review of historical financial information and for other
assurance and related service engagements.
Further, it is also to be remembered that Standards on Quality Control (SQCs)
are to be applied for all services covered by Engagement Standards.

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15.6 Why are Standards needed?
 Standards ensure carrying out of audit against established benchmarks at par with
global practices.
 Standards improve quality of financial reporting thereby helping users to make diligent
decisions.
 Standards promote uniformity as audit of financial statements is carried out following
these Standards.
 Standards equip professional accountants with professional knowledge and skill.
 Standards ensure audit quality.

15.7 Duties in relation to Engagement and Quality Control Standards

It is the duty of professional accountants to see that Standards are followed in
engagements undertaken by them. Ordinarily, these are to be followed by professional
accountants. However, a situation may arise when a specific procedure as required in
Standards would be ineffective in a particular engagement. In such a case, he is
required to document how alternative procedures performed achieve the purpose of
required procedure. Also, reason for departure has also to be documented unless it is
clear. Further, his report should draw attention to such departures. It is also to be
noted that a mere disclosure in the report does not absolve a professional accountant
from complying with applicable Standards.

TEST YOUR UNDERSTANDING 6

CA. P Babu is conducting audit of financial statements of Quick Buy Private Limited.
He was not able to obtain external confirmations from certain debtors due to practical
difficulties and peculiar circumstances. However, such a procedure is mandated under
one of Standards on Auditing.
Unable to obtain external confirmations from these debtors, he relied upon sale details
to these parties, e-invoices, e-way bills and also traced payments from these parties
in bank accounts of the company. He was reasonably satisfied with audit evidence
obtained. Is there any other reporting duty cast upon him relating to not following
a mandated procedure in one of Standards on Auditing?

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SOLUTION

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 1. MEANING OF ETHICS – A STATE OF MIND
The term “Ethics” means moral principles which govern a person’s behaviour or his
conducting of an activity. It is the branch of knowledge that deals with moral
principles. Ethics is something which comes from an individual intrinsically.

2. NEED FOR PROFESSIONAL ETHICS

Professions like law, medicine have their code of ethics. Auditing profession is no
exception. Rather, in the profession of auditing, requirement of ethics is manifold.
It is due to the reason that society in general, governments, clients, taxing
authorities, employees, investors, the business and financial community in particular,
have reposed tremendous trust in services rendered by Chartered Accountants.
A distinguishing feature of the accountancy profession is its acceptance of the responsibility
to act in the public interest. Professional ethics seek to protect the interests of the
profession as a whole and act as a shield that enables us to command respect.
A Chartered Accountant, either in practice or in service, has to abide by ethical
behaviours. They are expected to follow the fundamental principles of professional
ethics while performing their duties. Service users of professionals should be able to
feel secure that there exists a framework of professional ethics which governs the
provision of those services.
It is in this spirit of things that the Institute of Chartered Accountants of India
(ICAI) requires its members to comply with the principles of ethics while performing
their duties. The ethics for Chartered Accountants have, therefore, been codified as
ethical compliance has always been a philosophy of the profession. Chartered
accountants, whether in practice or in service, are required to comply with the
provisions of Code of Ethics.
Any deviation from the ethical responsibilities brings the disciplinary mechanism into
action against the Chartered Accountants which may result into fines, suspension of
membership, removal from membership or other disciplinary actions.

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3. PRINCIPLES BASED APPROACH VS RULES BASED APPROACH TO ETHICS
(ETHICAL OR LEGAL)
Ethical guidance may follow principles-based approach or rules-based approach. The
essence of principles-based approach to ethics is that it requires compliance with spirit
of ethics. It requires accountants to exercise professional judgment in every situation
based upon their professional knowledge, skill and expertise. It requires that accountants
should use professional judgment to evaluate every situation to arrive at conclusions.
However, rules-based approach to ethics strictly follows clearly established rules. It
may lead to a narrow outlook and spirit of ethics may be overlooked while strictly
adhering to rules. Further, rules- based approach is somewhat rigid as it may not
be possible to deal with every practical situation relying upon rules.
Therefore, it is necessary that spirit of code is followed.

4. FUNDAMENTAL PRINCIPLES OF PROFESSIONAL ETHICS

The fundamental principles of professional ethics are as under:-
1. Integrity
A professional accountant shall comply with the principle of integrity, which requires
an accountant to be straightforward and honest in all professional and business
relationships. Integrity implies fair dealing and truthfulness.
A professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the accountant believes that the
information contains a materially false or misleading statement; contains statements
or information provided negligently or omits or obscures required information where
such omission or obscurity would be misleading.

2. Objectivity
The principle of objectivity requires an auditor not to compromise professional
judgment because of bias, conflict of interest or undue influence of others.
It requires that a professional accountant shall not undertake a professional activity
if a circumstance or relationship unduly influences the accountant’s professional
judgment regarding that activity.

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3. Professional competence and due care
A professional accountant shall comply with the principle of professional competence
and due care, which requires an accountant to attain and maintain professional
knowledge and skill at the level required to ensure that a client or employing
organization receives competent professional service, based on current technical and
professional standards and relevant legislation; and act diligently and in accordance
with applicable technical and professional standards.
Diligence includes responsibility to act carefully, thoroughly and on a timely basis in
accordance with requirements of an assignment.

4. Confidentiality
Confidentiality principle requires a professional accountant to respect the
confidentiality of information acquired as a result of professional or business
relationships. Confidentiality serves the public interest because it facilitates the free
flow of information from the professional accountant’s client or employing organization
to the accountant with the understanding that the information will not be disclosed
to a third party.
However, such confidential information may be disclosed, for example, when it is
required by law, when it is permitted by law and is authorised by the client or
employer or there is a professional duty or right to disclose when not prohibited
by law.

5. Professional Behaviour
It requires an accountant to comply with relevant laws and regulations and avoid any
conduct that the accountant knows or should know might discredit the profession. A
professional accountant shall not knowingly engage in any employment, occupation or
activity that impairs or might impair the integrity, objectivity or good reputation of
the profession, and as a result would be incompatible with the fundamental principles.

TEST YOUR UNDERSTANDING 1

CA P. Suryakantam has conducted audit of accounts of an entity for a particular

CA AMIT TATED AT ACADEMY - MUMBAI 2.3

 year. ICAI has issued a letter to him relating to certain matters concerning audit. He
didn’t even bother to reply to the letter despite reminders. Discuss which
fundamental principle governing professional ethics is disregarded by him.
SOLUTION

TEST YOUR UNDERSTANDING 2

A Chartered accountant in practice issued a certificate showing original cost of plant
and machinery installed in premises of a client for Rs. 9 crores to save some regulatory
fees for his client. However, original cost of plant and machinery was Rs.15 crore as
per records of client. Which fundamental principle governing professional ethics is
violated in this case?
SOLUTION

5. INDEPENDENCE OF AUDITORS
Professional integrity and independence are essential characteristics of all the
professions but are more so in the case of accountancy profession. Independence implies
that the judgement of a person is not subordinate to the wishes or direction of
another person who might have engaged him, or to his own self-interest.

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 It is not possible to define “independence” precisely. Rules of professional conduct
dealing with independence are framed primarily with a certain objective. The rules,
by themselves, cannot create or ensure the existence of independence.
There are two interlinked perspectives of independence of auditors, one, independence
of mind and two, independence in appearance.
(a) Independence of mind – the state of mind that permits the provision of an opinion
without being affected by influences that compromise professional judgment, allowing
an individual to act with integrity, and exercise objectivity and professional skepticism;
and

(b) Independence in appearance – the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all relevant
information, including any safeguards applied, would reasonably conclude a firm’s, or
a member of the assurance team’s, integrity, objectivity or professional skepticism
had been compromised.
Independence of the auditor has not only to exist in fact, but also appear to so
exist to all reasonable persons.

Independence is dependent on the state of mind and character of a person and is a

very subjective matter. One person might be independent in a particular set of
circumstances, while another person might feel he is not independent in similar
circumstances. It is therefore the duty of every Chartered Accountant to determine
for himself whether or not he can act independently in the given circumstances of a
case and quite apart from legal rules, in no case to place himself in a position which
would compromise his independence.

6. THREATS TO INDEPENDENCE
Following five types of threats to independence of auditors are discussed below:-
1. Self-interest threats
Self-interest threats occur when an auditing firm, its partner or associate could
benefit from a financial interest in an audit client. Examples include

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(i) direct financial interest or materially significant indirect financial interest in a client
(ii) loan or guarantee to or from the concerned client
(iii) undue dependence on a client’s fees and, hence, concerns about losing the engagement
(iv) close business relationship with an audit client
(v) potential employment with the client and
(vi) contingent fees for the audit engagement

2. Self-review threats
Self-review threats occur when during a review of any judgement or conclusion
reached in a previous audit or non-audit engagement, or when a member of the
audit team was previously a director or senior employee of the client. Non audit
services include any professional services provided to an entity by an auditor, other
than audit or review of the financial statements. These include management services,
internal audit, investment advisory service etc. Instances where such threats come
into play are: -
(i) when an auditor having recently been a director or senior officer of the company
(ii) when auditors perform services that are themselves subject matters of audit.

3. Advocacy threats
Advocacy threats occur when the auditor promotes, or is perceived to promote, a
client’s opinion to a point where people may believe that objectivity is getting
compromised, e.g., when an auditor deals with shares or securities of the audited
company, or becomes the client’s advocate in litigation and third party disputes. In
such situations, auditor can be perceived as backing and championing causes of auditee
client and it may lead to belief that auditor is not acting and working objectively.

4. Familiarity threats
Familiarity threats are self-evident, and occur when auditors form relationships with
the client where they end up being too sympathetic to the client’s interests. This
can occur in many ways including:
(i) close relative of the audit team working in a senior position in the client company

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(ii) former partner of the audit firm being a director or senior employee of the client
(iii) long association between specific auditors and their specific client counterparts and
(iv) acceptance of significant gifts or hospitality from the client company, its directors
or employees.

5. Intimidation threats
Intimidation threats occur when auditors are deterred from acting objectively with an
adequate degree of professional skepticism. Basically, these could happen because of
threat of replacement over disagreements with the application of accounting principles,
or pressure to disproportionately reduce work in response to reduced audit fees or
being threatened with litigation. Such threats attempt to intimidate auditors to
deter them from acting objectively.

7. SAFEGUARDS TO INDEPENDENCE
Safeguards are actions, individually or in combination, that the professional
accountant takes that effectively reduce threats to comply with the fundamental
principles to an acceptable level.
To address the issue, the following guiding principles are to be applied:-
 For the public to have confidence in the quality of audit, it is essential that auditors
should always be and appears to be independent of the entities that they are auditing.
 Before taking on any work, an auditor must conscientiously consider whether it involves
threats to his independence.
 When such threats exist, the auditor should either desist from the task or eliminate
the threat or at the very least, put in place safeguards which reduce the threats to
an acceptable level. All such safeguards measures need to be recorded in a form that
can serve as evidence of compliance with due process.
 If the auditor is unable to fully implement credible and adequate safeguards, then he
must not accept the work.

8. PROFESSIONAL SKEPTICISM
Professional skepticism refers to an attitude that includes a questioning mind, being

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 alert to conditions which may indicate possible misstatement due to error or fraud,
and a critical assessment of audit evidence.
It signifies that auditor has to remain alert forever. The auditor’s attitude should
be of questioning mind- of challenging the things in light of available evidence.
The auditor shall plan and perform an audit with professional skepticism recognising
that circumstances may exist that cause the financial statements to be materially
misstated.
Professional skepticism includes being alert to, for example:
 Audit evidence that contradicts other audit evidence obtained.
 Information that brings into question the reliability of documents and responses to
inquiries to be used as audit evidence.
 Conditions that may indicate possible fraud.
 Circumstances that suggest the need for audit procedures in addition to those
required by the SAs.

Maintaining professional skepticism throughout the audit is necessary if the auditor

is to reduce the risks of:
 Overlooking unusual circumstances.
 Over generalising when drawing conclusions from audit observations.
 Using inappropriate assumptions in determining the nature, timing, and extent of the
audit procedures and evaluating the results thereof.

Nevertheless, the auditor is required to consider the reliability of information to be

used as audit evidence. In cases of doubt about the reliability of information or
indications of possible fraud, the SAs require that the auditor investigate further
and determine what modifications or additions to audit procedures are necessary
to resolve the matter.

TEST YOUR UNDERSTANDING 3

CA Raman Gupta is offered appointment as auditor of a company. One of his distant
uncles held some shares in the same company. Holding of such shares, by a distant

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relative, is not prohibited under provisions of law nor does it affect his independence.
Before he could accept appointment, he received unfortunate news of death of his
uncle who had died without any children. He came to know that he was nominee of
these shares having substantial value. It landed him in a tricky situation. What should
be proper course of action for him?
SOLUTION

TEST YOUR UNDERSTANDING 4

A Chartered accountant receives about 40% of his total audit fees from a single
client. Discuss how it could affect independence of Chartered accountant as auditor
of this client. What are such types of threats referred to as?
SOLUTION

TEST YOUR UNDERSTANDING 5

CA Murli Madhavan provides accounting and book keeping services to a leading NGO
engaged in environmental protection work. He is also offered audit of the accounts
of NGO. Identify and discuss what kind of threat to independence may be involved in
accepting such an engagement.

CA AMIT TATED AT ACADEMY - MUMBAI 2.9

 SOLUTION

TEST YOUR UNDERSTANDING 6

The auditors of a company have only relied upon management representation letter
regarding treatment of certain tax matters under appeal by the company. The
auditors have not carried out any other audit procedures to justify management’s
treatment of the said tax matters under appeal in the financial statements. What
is lacking on part of auditors in such a situation?
SOLUTION

9. AGREEING THE TERMS OF AUDIT ENGAGEMENTS

SA 210 deals with the auditor’s responsibilities in agreeing the terms of the audit
engagement with management and, where appropriate, those charged with governance.
This includes establishing that certain preconditions for an audit, responsibility for
which rests with management and, where appropriate, those charged with governance,
are present.

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 The objective of the auditor is to accept or continue an audit engagement only when
the basis upon which it is to be performed has been agreed, through:
(A) Establishing whether the preconditions for an audit are present and
(B) Confirming that there is a common understanding between the auditor and
management and, where appropriate, those charged with governance of the terms of
the audit engagement.

9A Preconditions for an audit

As per SA 210 “Agreeing the Terms of Audit Engagements”,
In order to establish whether the preconditions for an audit are present, the auditor
shall:
(a) Determine whether the financial reporting framework is acceptable and
(b) Obtain the agreement of management that it acknowledges and understands its
responsibility:
(i) For the preparation of the financial statements in accordance with the applicable
financial reporting framework including where relevant their fair representation;
(ii) For such internal control as management considers necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to
fraud or error; and
(iii) To provide the auditor with:
 Access to all information of which management is aware that is relevant to the
preparation of the financial statements such as records, documentation and other
matters;
 Additional information that the auditor may request from management for the
purpose of the audit; and
 Unrestricted access to persons within the entity from whom the auditor determines
it necessary to obtain audit evidence.

9B. Agreement on audit engagement terms

Except in the cases where it is required under law to get accounts audited
(for example in case of companies), audit is a matter of contract between auditor

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 and client. It is, therefore, important, both for the auditor and client, that each
party should be clear about the nature of the engagement. It must be reduced to
writing and should exactly specify the scope of the work.
Such a letter includes:-
(a) The objective and scope of the audit of the financial statements
(b) The responsibilities of the auditor
(c) The responsibilities of management
(d) Identification of the applicable financial reporting framework for the preparation of
the financial statements and
(e) Reference to the expected form and content of any reports to be issued by the
auditor and a statement that there may be circumstances in which a report may
differ from its expected form and content.
If law or regulation prescribes in sufficient detail the terms of the audit engagement,
the auditor need not record them in a written agreement, except for the fact that
such law or regulation applies and that management acknowledges and understands
its responsibilities.

10. LIMITATION ON SCOPE PRIOR TO AUDIT ENGAGEMENT ACCEPTANCE

If management or those charged with governance impose a limitation on the scope of
the auditor’s work in the terms of a proposed audit engagement such that the
auditor believes the limitation will result in the auditor disclaiming an opinion on
the financial statements, the auditor shall not accept such a limited engagement as
an audit engagement, unless required by law or regulation to do so.

11. ACCEPTANCE OF A CHANGE IN THE TERMS OF THE AUDIT ENGAGEMENT

The auditor shall not agree to a change in the terms of the audit engagement where
there is no reasonable justification for doing so.
11.1 Request from Entity to change the Terms of Audit Engagement-When Reasonable
Justification Exists?
A request from the entity for the auditor to change the terms of the audit
engagement may result from a change in circumstances affecting the need for the

CA AMIT TATED AT ACADEMY - MUMBAI 2.12

 service, a misunderstanding as to the nature of an audit as originally requested or
a restriction on the scope of the audit engagement, whether imposed by management
or caused by other circumstances. The auditor considers the justification given for
the request, particularly the implications of a restriction on the scope of the audit
engagement.
A change in circumstances that affects the entity’s requirements or a misunderstanding
concerning the nature of the service originally requested may be considered a reasonable
basis for requesting a change in the audit engagement.
In contrast, a change may not be considered reasonable if it appears that the change
relates to information that is incorrect, incomplete or otherwise unsatisfactory.

11.2 What should auditor consider before agreeing to change the audit engagement to the
engagement providing lower level of assurance?
If, prior to completing the audit engagement, the auditor is requested to change
the audit engagement to an engagement that conveys a lower level of assurance,
the auditor shall determine whether there is reasonable justification for doing so
Before agreeing to change an audit engagement to a review or a related service,
an auditor who was engaged to perform an audit in accordance with SAs may also
need to assess any legal or contractual implications of the change.
If the auditor concludes that there is reasonable justification to change the audit
engagement to a review or a related service, the audit work performed to the date
of change may be relevant to the changed engagement. However, the work required
to be performed and the report to be issued would be those appropriate to the
revised engagement. In order to avoid confusing the reader, the report on the
related service would not include reference to:
(a) The original audit engagement or
(b) Any procedures that may have been performed in the original audit engagement,
except where the audit engagement is changed to an engagement to undertake
agreed- upon procedures and thus reference to the procedures performed is a normal
part of the report.
If the terms of the audit engagement are changed, the auditor and management shall

CA AMIT TATED AT ACADEMY - MUMBAI 2.13

 agree on and record the new terms of the engagement in an engagement letter or
other suitable form of written agreement.

11.3 Recourse available to auditor in situation of non- agreement to a change in terms of

engagement and lack of permission from management to continue original audit
engagement
The auditor shall:
(a) Withdraw from the audit engagement where possible under applicable law or
regulation and
(b) Determine whether there is any obligation, either contractual or otherwise, to report
the circumstances to other parties, such as those charged with governance, owners or
regulators.

12. TERMS OF ENGAGEMENT IN RECURRING AUDITS

Recurring audit is an audit which is performed by an auditor over years.
The auditor may decide not to send a new audit engagement letter or other written
agreement each period. However, the following factors may make it appropriate to
revise the terms of the audit engagement or to remind the entity of existing
terms:
(i) Any indication that the entity misunderstands the objective and scope of the audit.
(ii) Any revised or special terms of the audit engagement.
(iii) A recent change of senior management.
(iv) A significant change in ownership.
(v) A significant change in nature or size of the entity’s business.
(vi) A change in legal or regulatory requirements.
(vii) A change in the financial reporting framework adopted in the preparation of the
financial statements.
(viii) A change in other reporting requirements.

TEST YOUR UNDERSTANDING 7

Chirag, as part of articled training, is part of an engagement team conducting audit

CA AMIT TATED AT ACADEMY - MUMBAI 2.14

of a company. He has read somewhere that engagement letter issued by auditor to
client also includes expected form and content of the auditor’s report. He was at a
loss to understand how could an auditor include form and content of the report
beforehand. Try to help Chirag by making things clear to him.
SOLUTION

TEST YOUR UNDERSTANDING 8

The management of an entity feels that it is not necessary for it to give in writing
explicitly to the auditor that it understands its responsibilities for preparation of
financial statements in accordance with applicable financial reporting framework.
Discuss, whether, it is necessary for the management to do so. In case management
refuses, why should an auditor not accept the proposed engagement?
SOLUTION

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13. AUDIT QUALITY
The purpose of an independent audit is to provide confidence to users of audited
financial statements. Therefore, high audit quality is essential to maintain confidence
in the independent assurance provided by the auditors. It is the responsibility of
auditor to maintain high audit quality.
SQC 1 and SA 220 both deal with quality control. Whereas SQC 1 deals with all
engagements including audits, reviews and other assurance and related service
engagements, SA 220 applies to audit engagements only.
Further, SQC 1 applies to entire firm. However, SA 220 applies to a particular audit
engagement.

14. SQC 1 – “QUALITY CONTROL FOR FIRMS THAT PERFORM AUDITS AND REVIEWS
OF HISTORICAL FINANCIAL INFORMATION, AND OTHER ASSURANCE AND
RELATED SERVICES ENGAGEMENTS”
SQC 1 requires that the firm should establish a system of quality control designed
to provide it with reasonable assurance that the firm and its personnel comply with
professional standards and regulatory and legal requirements and that reports issued
by the firm or engagement partners are appropriate in the circumstances. Firm’s
system of quality control should consist of policies designed to achieve these objectives.

15. ELEMENTS OF SYSTEM OF QUALITY CONTROL

The firm’s system of quality control should include policies and procedures
addressing each of the following elements: -
(A) Leadership responsibilities for quality within the firm
(B) Ethical requirements
(C) Acceptance and continuance of client relationships and specific engagements
(D) Human resources
(E) Engagement performance
(F) Monitoring

15A. Leadership responsibilities for quality within the firm

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 SQC 1 requires firms to establish policies and procedures designed to promote an
internal culture based on the recognition that quality is essential in performing
engagements. Such policies and procedures should require the firm’s chief executive
officer or the firm’s managing partners to assume ultimate responsibility for the
firm’s system of quality control. Firm’s chief executive officer or managing partners
should have sufficient and appropriate experience, ability and the necessary authority
to assume that responsibility.

15B. Ethical requirements

The Code establishes the fundamental principles of professional ethics which include
integrity, objectivity, professional competence and due care, confidentiality and
professional behaviour.
Observance of “Independence” in all engagements is the basic requirement. The firm
should establish policies and procedures designed to provide it with reasonable
assurance that the firm, its personnel and (including experts contracted by the firm
and network firm personnel) maintain independence where required by the Code. Such
policies and procedures should enable the firm to:-
(a) Communicate its independence requirements to its personnel
(b) Identify and evaluate circumstances and relationships that create threats to
independence, and to take appropriate action to eliminate those threats or reduce
them to an acceptable level by applying safeguards, or, if considered appropriate, to
withdraw from the engagement.
(c) There should exist a mechanism in the firm by which engagement partners provide
the firm with relevant information about client engagements and personnel of firm
promptly notify firm of circumstances and relationships that create a threat to
independence. All breaches of independence should be promptly notified to firm for
appropriate action. Its objective is to ensure that independence requirements are
satisfied.
(d) At least annually, the firm should obtain written confirmation of compliance with
its policies and procedures on independence from all firm personnel required to be
independent in terms of the requirements of the Code.

CA AMIT TATED AT ACADEMY - MUMBAI 2.17

15C. Acceptance and Continuance of Client Relationships and Specific Engagements
A firm before accepting an engagement should acquire vital information about the
client. Such an information should help firm to decide about: -
 Integrity of Client
 Competence (including capabilities, time and resources) to perform engagement
 Compliance with ethical requirements

With regard to the integrity of a client, matters that the firm considers include, for
example:
 The identity and business reputation of the client’s principal owners, key
management, related parties and those charged with its governance.
 The nature of the client’s operations, including its business practices.
 Information concerning the attitude of the client’s principal owners, key management
and those charged with its governance towards such matters as aggressive
interpretation of accounting standards and the internal control environment.
 Whether the client is aggressively concerned with maintaining the firm’s fees as low
as possible.
 Indications of an inappropriate limitation in the scope of work.
 Indications that the client might be involved in money laundering or other criminal
activities.
 The reasons for the proposed appointment of the firm and non-reappointment of the
previous firm.
Where the firm obtains information that would have caused it to decline an
engagement if that information had been obtainable earlier, policies and procedures
on the continuance of the engagement and the client relationship should include
consideration of:
(a) The professional and legal responsibilities that apply to the circumstances, including
whether there is a requirement for the firm to report to the person or persons
who made the appointment or, in some cases, to regulatory authorities; and
(b) The possibility of withdrawing from the engagement or from both the engagement
and the client relationship.

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15D. Human resources
The firm should establish policies and procedures designed to provide it with reasonable
assurance that it has sufficient personnel with the capabilities, competence, and
commitment to ethical principles necessary to perform its engagements in accordance
with professional standards and regulatory and legal requirements and to enable the
firm or engagement partners to issue reports that are appropriate in the circumstances.
Such policies and procedures should address relevant HR issues including recruitment,
compensation, training, career development, performance evaluation etc. There should
be emphasis on the continuing professional development of firm’s personnel.

15E. Engagement Performance

Consistency in quality of engagement performance is achieved through briefing of
engagement teams of their objectives, processes for complying with engagement
standards, processes of engagement supervision and training, methods of reviewing
performance of work, appropriate documentation of work performed.
Consultation should take place in difficult or contentious matters pertaining to an
engagement. Consultation includes discussion, at the appropriate professional level,
with individuals within or outside the firm who have specialized expertise, to resolve
a difficult or contentious matter.
Significant judgments made in an engagement should be reviewed by an engagement
quality control reviewer for taking an objective view before the report is issued. The
extent of the review depends on the complexity of the engagement and the risk
that the report might not be appropriate in the circumstances. The review does not
reduce the responsibilities of the engagement partner.
Engagement quality control review is mandatory for all audits of financial statements
of listed entities. In respect of other engagements, firm should devise criteria to
determine cases requiring performance of engagement quality control review.
There might be difference of opinion within engagement team, with those consulted
and between engagement partner and engagement quality control reviewer. The report
should only be issued after resolution of such differences. In case, recommendations
of engagement quality control reviewer are not accepted by engagement partner

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 and matter is not resolved to reviewer’s satisfaction, the matter should be resolved
by following established procedures of firm like by consulting with another practitioner
or firm, or a professional or regulatory body.
Besides, the firm should establish policies and procedures for engagement teams to
complete the assembly of final engagement files on a timely basis after the engagement
reports have been finalized. The assembly of engagement files should be completed in
not more than 60 days after date of auditor’s report in case of audit engagements
and in other cases within the limits appropriate to engagements.
Policies and procedures should be designed to maintain the confidentiality, safe
custody, integrity, accessibility and retrievability of engagement documentation.
Unless otherwise specified by law or regulation, engagement documentation is the
property of the firm. The firm may, at its discretion, make portions of, or
extracts from, engagement documentation available to clients, provided such disclosure
does not undermine the validity of the work performed, or, in the case of assurance
engagements, the independence of the firm or its personnel.
Engagement documentation has to be retained for a period of time sufficient to permit
those performing monitoring procedures to evaluate the firm’s compliance with its
system of quality control, or for a longer period if required by law or regulation.
In the specific case of audit engagements, the retention period ordinarily is no shorter
than seven years from the date of the auditor’s report, or, if later, the date of
the group auditor’s report.

15F. Monitoring
The firm should ensure that policies and procedures relating to the system of quality
control are relevant, adequate, operating effectively and complied with in practice.

16. SA 220- “QUALITY CONTROL FOR AN AUDIT OF FINANCIAL STATEMENTS”

As per SA 220, the objective of the auditor is to implement quality control
procedures at the engagement level that provide the auditor with reasonable assurance
that: -
(a) The audit complies with professional standards and regulatory and legal requirements and

CA AMIT TATED AT ACADEMY - MUMBAI 2.20

 (b) The auditor’s report issued is appropriate in the circumstances.
SA 220 is modelled on lines of SQC 1.

16A. Leadership responsibilities for quality on audits

Leadership responsibility of an engagement partner is to take responsibility for the
overall quality on each audit engagement.
(a) The importance to audit quality of:-
(i) Performing work that complies with professional standards and regulatory and legal
requirements;
(ii) Complying with the firm’s quality control policies and procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the circumstances; and
(i) The engagement team’s ability to raise concerns without fear of reprisals.
(b) The fact that quality is essential in performing audit engagements.

16B. Relevant ethical requirements

The responsibilities of an engagement partner in relation to ethical requirements
in an audit engagement are as under:-
 Identifying a threat to independence regarding the audit engagement that safeguards
may not be able to eliminate or reduce to an acceptable level.
 Reporting by engagement partner to the relevant persons within the firm to
determine appropriate action, which may include eliminating the activity or interest
that creates the threat, or withdrawing from the audit engagement, where withdrawal
is legally permitted.

16C. Acceptance and Continuance of Client Relationships and audit Engagements

The responsibility of an engagement partner in this regard in an audit engagement
is on lines of SQC 1 which requires the firm should obtain such information as it
considers necessary in the circumstances before accepting an engagement with a new
client, when deciding whether to continue an existing engagement, and when considering
acceptance of a new engagement with an existing client.

CA AMIT TATED AT ACADEMY - MUMBAI 2.21

16D. Assignment of engagement teams
It should be ensured by engagement partner that the engagement team and any
auditor’s experts who are not part of the engagement team, collectively have the
appropriate competence and capabilities to perform the engagement in accordance
with professional standards and regulatory and legal requirements.

16E. Engagement Performance

Engagement partner has the responsibility for direction, supervision and performance
of audit engagement in accordance with professional standards and regulatory and legal
requirements. He is responsible for auditor’s report being appropriate in circumstances.

For audits of financial statements of listed entities, and those other audit
engagements, if any, for which the firm has determined that an engagement quality
control review is required, the engagement partner shall:
(a) Determine that an engagement quality control reviewer has been appointed.
(b) Discuss significant matters arising during the audit engagement, including those
identified during the engagement quality control review, with the engagement quality
control reviewer.
(c) Not date the auditor’s report until the completion of the engagement quality control
review.
If differences of opinion arise within the engagement team, with those consulted
or, where applicable, between the engagement partner and the engagement quality
control reviewer, the engagement team shall follow the firm’s policies and procedures
for dealing with and resolving differences of opinion.

16F. Monitoring
An effective system of quality control includes a monitoring process designed to provide
the firm with reasonable assurance that its policies and procedures relating to the
system of quality control are relevant, adequate, and operating effectively. The
engagement partner shall consider the results of the firm’s monitoring process as
evidenced in the latest information circulated by the firm and, if applicable, other

CA AMIT TATED AT ACADEMY - MUMBAI 2.22

 network firms and whether deficiencies noted in that information may affect the
audit engagement.
The engagement partner should document following matters pertaining to an audit
engagement: -
(a) Issues identified with respect to compliance with relevant ethical requirements and
how they were resolved.
(b) Conclusions on compliance with independence requirements that apply to the audit
engagement, and any relevant discussions with the firm that support these
conclusions.
(c) Conclusions reached regarding the acceptance and continuance of client relationships
and audit engagements.
(d) The nature and scope of, and conclusions resulting from, consultations undertaken
during the course of the audit engagement.

TEST YOUR UNDERSTANDING 9

CA PK Nair is offered appointment as auditor of a company engaged in providing
tourism services. While making due diligence of the proposed client, he comes to know
that there have been raids on premises of the company and residences of its directors
by National Investigation Agency (NIA) on suspicion of links with terror outfits. It
has been followed up with searches by Enforcement Directorate hunting for illicit
money trail. There is a strong suspicion of tourism services provided by company
being façade of terror funds. Should proposed offer be accepted by him?
SOLUTION

CA AMIT TATED AT ACADEMY - MUMBAI 2.23

TEST YOUR UNDERSTANDING 10
CA Arpita has joined a mid-sized CA firm recently. She finds that partners remain
too busy and the firm is proposing to accept audit work in areas in which it has no
experience or capabilities. The firm is proposing to accept audit of some entities
engaged in emerging “fin-tech” sector. Such audits may be requiring extensive use
of technology and data analytics. However, the said firm has no such capabilities
and trained personnel. Discuss, whether, firm should accept such audits with reason.
SOLUTION

CA AMIT TATED AT ACADEMY - MUMBAI 2.24