Audit Conclusions and Reporting

1. Audit Conclusions and Reporting SA 700, SA 705, SA 706 & SA 720 • CA Sunil S Kothari 23rd June 2012

2. SA 700, Forming an Opinion and Reporting on Financial Statements

3. AAS 28 v SA 700(R)

4. Frameworks

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

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

7. Forming an opinion - requisites • Ensure that the financial reporting framework is adequately referred to Based on all above conclusions/ evaluations, auditor finally concludes whether the FS, as a whole, are free from material misstatement due to fraud or error

8. AAS 28 v SA 700(R)

9. AAS 28 v SA 700(R)

10. AAS 28 v SA 700(R)

11. AAS 28 v SA 700(R)

12. Existing report - structure • Firstly, talks about Financial Statements (FS)audit • Then refers to CARO reporting (regulatory requirement, not part of true and fair opinion reporting) • Then goes to specific matters required to be reported under Companies Act – e.g., books of account, qualifications of directors u/s 274(1)(g), etc. (regulatory requirement, not part of true and fair opinion reporting) • Then reverts back to true and fair opinion on FS audit Appears to users as if regulatory compliance is part of true and fair opinion on FS

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

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

15. What is the logic? • When we report on CARO, for example, we are responding to specific queries under the said Order. • CARO report is a report on specific financial information that may or may not be contained in the financial statements and should, therefore, not be intermingled with the Opinion on the financial statements because completely different audit procedures are applied to provide a CARO report as versus the procedures used to give a report on the financial statements

16. What is the logic? • Likewise, when we report on books of account, or agreement of financial statements with books of account, or on qualification of directors, we are reporting on matters that are not really covered by our Opinion on the financial statements

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

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

19. SA 705, Modifications to the Opinion in the Independent Auditor’s Report

20. Sufficient appropriate audit evidence obtained Sufficient appropriate audit evidence not obtained Auditor concludes that FS as a whole are not free from material misstatement Auditor is unable to conclude whether FS as a whole are free from material misstatement Qualified opinion Adverse opinion Disclaimer of opinion Depends on auditor’s judgement of Whether FS are materially misstated In absence of evidence whether FS may be materially misstated Whether misstatement is or is likely to be pervasive

21. What is PERVASIVE? Misstatements Possible misstatements That are not confined to specific components accounts or items If so confined, represent a substantial portion Where pertaining to disclosures, are fundamental to users’ understanding of FS

22. Individual misstatements After obtaining sufficient appropriate audit evidence Are MATERIAL but not PERVASIVE Auditor concludes that OR Aggregate of misstatements QUALIFIEDOPINION Auditor cannot obtain sufficient appropriate audit evidence Are MATERIAL but not PERVASIVE Possible effects of undetected misstatements Auditor concludes that

23. Individual misstatements After obtaining sufficient appropriate audit evidence Are MATERIAL AND PERVASIVE Auditor concludes that OR Aggregate of misstatements ADVERSEOPINION

24. Auditor cannot obtain sufficient appropriate audit evidence Are MATERIAL AND PERVASIVE Possible effects of undetected misstatements Auditor concludes that DISCLAIMER OFOPINION He cannot form an opinion on FS due to potential interaction of the uncertainties and their possible cumulative effect Auditor concludes that Multiple Uncertainties Even after auditor has obtained audit evidence

25. Auditor requests management to remove the scope limitation After accepting engagement, management imposes a scope limitation Auditor assesses that this may result in a qualified opinion or disclaimer Management does not remove it Auditor communicates this to Those charged with governance (TCWG) If he cannot obtain sufficient appropriate audit evidence, and concludes that effect of undetected misstatements is Considers alternative procedures QUALIFY Material but not pervasive RESIGN, if allowed to Material and pervasive GIVE DISCLAIMER

26. Summary of modification of opinion

27. Can auditor give unmodified opinion on a component while giving adverse/ disclaimer of opinion on the FS? • When expressing adverse opinion or disclaiming an opinion on the FS as a whole the auditor cannot also express an unmodified opinion on one or more specific elements, accounts or items in the FS with respect to the same financial reporting framework

28. Report to contain all elements per SA 700 + Basis for modification paragraph Just above the Opinion paragraph Describing matter of modification Heading to be Basis for Qualified Opinion Basis for Adverse Opinion Basis for Disclaimer of Opinion

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

30. Opinion paragraph • Heading • “Qualified Opinion”, “Adverse Opinion” or “Disclaimer of Opinion” • Qualified opinion due to material misstatement • In our opinion, except for the effects of matters described in the Basis for Qualified Opinion paragraph • The FS give true and fair view in accordance… • The FS have been prepared, in all material respects, in accordance with… • If qualified for inability to obtain sufficient appropriate audit evidence • ….except for the possible effects of the matters…

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

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

33. Requirements when the auditor disclaims an opinion • When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor should state in the opinion paragraph that, because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, the auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion and, accordingly, the auditor does not express an opinion on the financial statements

34. Auditor’s responsibility • When the auditor expresses a qualified or adverse opinion • Requires to state that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s modified audit opinion • When the auditor disclaims an opinion • Need to state that they were unable to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion

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

36. SA 706, Emphasis of Matter Paragraphs and Other Matter(s) Paragraphs in the Independent Auditor’s Report

37. Comparison with AAS 28 • The Modified Opinion section of AAS 28 refers to matters that affect the auditor's opinion and matters that don't • Matters that don't, are reported in an Emphasis of Matter paragraph (EMP) • EMP amounts to a modificationof the auditor's report, but does not affect the opinion • EMP is placed in the report preceding the opinion paragraph

38. Comparison with AAS 28 • EMP is to be given where a going concern question is not resolved and adequate disclosure is made • EMP is to be given where there is a significant uncertainty (other than going concern), whose resolution depends on future events and which may affect the FS – e.g. a lawsuit • EMP is considered adequate in dealing with the above except in extreme cases(e.g. situations involving multiple uncertainties) where a disclaimer should be given

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

40. EMP: requirements

41. EMP: requirements

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

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

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

45. Examples of circumstances necessitating OMP • Users' understanding of audit • Auditor appointed by law is unable to resign when management imposes a pervasive scope limitation • Users' understanding of auditor's responsibility or auditor's report • Law requires auditor to elaborate on matters that provide further explanation of his responsibilities in the audit or the auditor's report

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

47. Case Studies What is the type of opinion in the following cases? Case - 1 • Inventories are misstated. Say it is 15 % of the profits for the year. The misstatement is deemed to be material but not pervasive to the financial statements. Case – 2 • The auditor was unable to obtain sufficient appropriate audit evidence about multiple elements of the financial statements. That is, say, the auditor was unable to obtain audit evidence about the entity’s inventories and accounts receivable. The possible effects of this inability to obtain sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements.

48. Solution1 • Qualified The Company’s inventories are carried in the Balance Sheet at Rs. XXX. Management has not stated the inventories at the lower of cost and net realisable value but has stated them solely at cost, which constitutes a departure from the Accounting Standards referred to in sub-section (3C) of section 211 of the Act. The Company’s records indicate that had management stated the inventories at the lower of cost and net realisable value, an amount of Rs. XXX would have been required to write the inventories down to their net realisable value. Accordingly, cost of sales would have been increased by Rs. XXX, and income tax, net profit and shareholders’ funds would have been reduced by Rs. XXX, Rs. XXX and Rs. XXX, respectively. Qualified Opinion In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

49. Solution 2 • Disclaimer of opinion We were appointed as auditors of the Company after March 31, 20XX and thus could not observe the counting of physical inventories at the beginning and end of the year. Accordingly, we were unable to satisfy ourselves by alternative means concerning the inventory quantities held at December 31, 20X0 and March 31, 20X1 which are stated in the Balance Sheet at Rs. XXX and Rs. XXX, respectively. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable. As of the date of our audit report, management was still in the process of rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts receivable included in the Balance Sheet at a total amount of Rs. XXX as at March 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the Statement of Profit and Loss and Cash Flow Statement. • Disclaimer of Opinion Because of the significance of the matters described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the financial statements.

50. Case Studies • Case 3 • The auditor of ABC Ltd. was unable to obtain sufficient appropriate audit evidence regarding existence of investments in XYZ Ltd in a foreign branch. The possible effects of the inability to obtain sufficient appropriate audit evidence are deemed to be material but not pervasive to the financial statement. • Case 4 • You are the auditor of XYZ Ltd. There is uncertainty relating to a pending exceptional litigation Matter – say there is a law suit filed against the company for tax or some other matter. You cannot conclude that it should be provided for.