Financial statements are the board of directors responsibility. These are generally prepared by the management, reviewed by the audit committee before being sent for approval by the board of directors and the auditor.
ICAI has, inter alia, issued Accounting Standards (AS) and Standards on Auditing (SA). The Companies Act, 2013 requires compliance with both AS and SA.
AS-13 (Accounting for Investments) deals with the accounting and reporting requirements of the investment in the subsidiary by the holding company. It requires other than temporary (but not permanent) decline in the carrying amount of these investments to be recognised on individual basis. The auditor examines the latest financial statements of the subsidiary before opining on the value of these investments. It may ask for valuation by an expert. Here, it applies SA 620, or Using the Work of an Auditors Expert.
But where investment is in a subsidiary, the auditor needs to tread with more professional scepticism. It has to check for compliance with SA-550 (Related Parties) that expands on how SA-315 (Identifying and Assessing the Risks of Material Misstatements Through Understanding the Entity and its Environment), SA-330 (The Auditors Responses to Assessed Risks), and SA-240 (The Auditors Responsibilities Relating to Fraud in an Audit of Financial Statements) are applied in relation to risks of material misstatements associated with related-party relationships.
Not recognising, measuring and reporting other than temporary diminution may make financial statements materially misstated (diminutions impact the going concern of the holding company). This will necessitate the application of SA-570 (Going Concern), requiring the auditor to modify its audit opinion in terms of SA-705 (Modifications to the Opinion in the Independent Auditor Report). Where financial statements are materially misstated, the auditor qualifies its opinion if the effect or possible effect on the financial statements is material but not pervasive. But where the effects are material and pervasive, it gives an adverse opinion.
Section 227(3)(a) of the Companies Act, 1956, requires the auditor to state whether it has obtained all the information and explanations which to the best of its knowledge and belief were necessary for the purpose of audit. Section 143(3)(a) of the Companies Act, 2013, requires the auditor to state whether it has sought and obtained all the information and explanations which to the best of its knowledge and belief were necessary for the purpose of its audit and if not, the details thereof and the effect of such information on the financial statements (emphasis added).
When auditing CFS, the independent auditor follows AS-21 (Consolidated Financial Statements) and SA-600 (Using the Work of Another Auditor). It applies the Guidance Note on Consolidated Financial Statements. The auditor appreciates that the audit of the consolidated financial statement is not merely an extension of its role as an independent auditor of the standalone holding company. It is the principal auditor with independent requirements and application of both AS and SA.
SA-600 requires the principal auditor, before accepting the assignment, to consider its knowledge regarding the subsidiaries business, the risk of material misstatements in subsidiaries financial statements and additional procedures it needs to perform. The principal auditor should offer a qualified opinion or a disclaimer when it concludes that the work of the subsidiary auditor cannot be used. It is responsible in respect of the work entrusted to the subsidiary auditors in circumstances that should have aroused its suspicion.
CFS is prepared when mandated by stock exchanges listing agreements. The Companies Act, 1956 does not mandate CFS. However, section 129(3) of the Companies Act, 2013, requires CFS, and proviso to section 143(1) of the Companies Act, 2013, provides the principal auditor the right of access to the subsidiaries records in relation to CFS.
There could be situations, albeit rare, where despite application of all the relevant SA, certain unacceptable facts are discovered after the audit has been completed or after the issuance of audit report or even after adoption of the financial statements and the auditors report. SA 560 (Subsequent Events) takes care of these eventualities. One course open to the auditor is to withdraw its report. Section 143(12) of the Companies Act, 2013, requires auditors to report frauds to the central government immediately.
K K Tulshan
The author is senior partner, SS Kothari Mehta and Co
The audit profession has been in the eye of the storm for quite some time now. Instances of failure to meet the standards of quality that govern our profession have raised concerns about the role and value of audit. Good corporate reporting can help restore that confidence in the profession. Regulators, issuers, investors and public company auditors, all have important roles in the process. In this context, the larger and more fundamental issues about how firms do audit merit attention. There is a need to learn the lessons from the past and make audit quality a priority in anticipating, managing and meeting expectations from an audit.
ICAI is the apex body in India for the auditing profession. It is in the best position to influence audit quality through positive and constant reinforcement. It has taken a big leap by largely harmonising the auditing standards with International Standards of Auditing.
While the ICAI standards provide sound auditing principles, its implementation is the key for an effective quality audit. To facilitate this, ICAI can supplement the standards by providing implementation guidance. Apart from addressing implementation issues relating to standards on auditing, this can include a study of industry specific risks that the audit procedures should put specific focus on. The audit procedures are influenced by the size of the auditee as well as the nature of its business. As such, the procedures need to be tailored based on various factors including whether the entity is small or large or involves public interest or is part of a highly-regulated industry or entails industry specific risk or is a high risk client. Technical guides can sensitise auditors about the potential risks in a particular industry which require focused consideration during the audit. Similarly, guidance on audit workplan for smaller entities can help firms in performing effective yet efficient audits. Illustrative audit programs for specific topics such as fraud, going concern, compliance with laws and regulations can be particularly helpful in ensuring that these get the required special considerations. Initiatives that help build a common understanding of factors that influence good professional judgements and healthy auditor scepticism would go a long way in enhancing audit quality. ICAI has recently issued some guides; it is imperative that the members be educated about the guides and a continuous emphasis is maintained to issue additional guides/update existing ones.
The appeal of data analytics and continuous auditing appears to be rising. These can assist in increasing operational efficiencies, reducing costs, and detecting potential fraud, errors and providing a higher quality audit. Dissemination of guidance by ICAI for wider application of the techniques will benefit the firms in their audit process.
ICAI also plays a major role in educating members. Its continuing professional education programme needs to robust and be leveraged for creating awareness, better understanding and implementation of the auditing standards.
ICAI as a regulator has an important role in enforcement of the standards. The review mechanism such as peer review by ICAI, reviews by Quality Review Board can also aid in improving the quality of audit. Peer review board of the ICAI has been entrusted to provide transparent and expeditious auditing quality oversight. Its primary role is to examine and review the quality of audit. It is important that the measures taken by the Boards are corrective in nature rather than punitive. The scope of the reviews needs to be enlarged to cover more firms. These reviews can also provide the basis to share the best practices and frequently noticed errors.
To bridge the expectation gap, it is time for ICAI to enter the debate on reconsidering corporate reporting. There is an increasing feedback that the current reporting model needs to be improved. But it is a matter of debate as to how it should change. Integrated reporting, as currently being developed by the International Integrated Reporting Council, represents a significant evolution of current corporate reporting and provides a longer-term vision for the future which is gaining momentum. Integrated reporting tells the companys story and connects all the information that is important for understanding the long-term health of the company; it is forward-looking. But the debate is still young and it remains to be seen whether integrated reporting represents the best solution. This would represent a landmark change for the profession.
Some of the initiatives can be implemented in the near future, while others will play out over a longer time. ICAI is well placed to act as a catalyst for achieving high quality audits and strengthen investor confidence
The author is head of assurance, KPMG in India