Audit and Assurance (Vsep 2019,0) PDF

Study Material
For CAP II
Audit and Assurance
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL

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© The Institute of Chartered Accountants of Nepal
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Second Edition : December, 2015
Third Edition : September, 2019
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PREFACE
This study material on the subject of "Audit & Assurance" has been exclusively designed and
developed for the students of Chartered Accountancy Professional – II [CAP-II] Level. It aims
to provide the required knowledge to the students so as to enable them understand the purpose
and context of relevant auditing procedure, to display the ability to document the accounting
and internal control system of an enterprise and to identify the significant risks and apply risk
assessment tools in an audit engagement.
It broadly incorporates major areas of Nature and Concepts of Assurance and Audit, Planning
an assurance engagement, gathering evidence during an assurance engagement and completing
and reporting on an assurance engagement. A good deal of practical problems is included at
the end of most of the chapter which can be useful to the students for their self-assessment and
progress evaluation after thoroughly reading the material.
Students are requested to accustom with the syllabus of the subject and read each topic
thoroughly for understanding on the chapter. We believe this material will be of great help to
the students of CAP-II. In addition to the study material, they should update themselves and
refer recommended text-books given in the CA Education Scheme and Syllabus along with
other relevant materials in the subject.
Last but the most, we acknowledge the efforts of CA. Laba Khatri, who has meticulously
assisted to prepare this study material and CA. Sarita Duwal, who has assisted to review the
material thoroughly and helped in building them in the comprehensive shape.
Due care has been taken to make every chapter simple, comprehensive and relevant for the
students. In case students need any clarification, creative feedbacks or suggestions for the
further improvement on the material, they may be forwarded to CA. Himal Dahal, Deputy
Director or to the Education Department of the institute.
September, 2019
Education Department
The Institute of Chartered Accountants of Nepal
Table of Content
CHAPTER 1: PRINCIPLES AND CONCEPT OF ASSURANCE (1-42)
• Auditing and Assurance 2
• Benefits of Audit and Assurance 10
• Scope of Audit 10
• Objectives of Audit and Assurance 12
• Errors and Frauds 13
• Inherent Limitations of Audit 20
• Types of Audit 21
• Basic Principles Governing an Audit 26
• Relationship of Auditing with other Disciplines 27
• Difference Between Auditing and Related Fields 29
• Qualities of an Auditor 31
• International Auditing and Assurance Standards Board 31
• Origin and History of Audit - Nepalese Perspective 35
• Latest Development in Auditing Profession 36
CHAPTER 2: REGULATORY AND ETHICAL ISSUES (43-82)
• Background 44
• Regulatory Framework 44
• Companies Act 2063 44
• Banks and Financial Institutions Act, 2073 [BAFIA 2073] 44
• Nepal Financial Reporting Standards (NFRS) and Interpretations 48
• Quality Control 50
• Scope and Terms of an Assurance Engagement 56
• Code of Ethics 59
• General Introduction to Code of Ethics 61
• Provision of Code of Ethics on ICAN Act 1997 72
• Some Disciplinary Cases 77
CHAPTER 3: PLANNING AN ASSURANCE ENGAGEMENT (83-156)
• Understanding the Entity and its Environment 84
• Risk Assessment Procedures and sources of Information about the Entity and
its Environment 88
• Business Risk of the Clients and Application in Audit Risk Assessment Procedure 91
• Audit Risk 95
• Attitude of Professional Skepticism 101
• Information Technology in the Risk Analysis 103
• Planning an Audit 105
• Audit Programme 114
• Internal Control System 117
• Internal Control and the Computerised Environment 127
• Communication of Deficiencies in Internal Control System 132
• Knowledge of Committee on Sponsoring Organization (COSO) 133
• Concept of Materiality 137
• Going Concern Assessment at Planning Stage 141
• Audit Working Papers 148
• Audit Note Book 151
• Transaction Cycle 152
CHAPTER 4: AUDIT EVIDENCE AND INTERNAL AUDIT (157-218)
• Evaluation of Audit Assertions 158
• Audit Evidence 162
• Audit Procedures to Obtain Audit Evidence 163
• Quality of Audit Evidence 173
• Quality and Timeliness of Audit Evidence 176
• External Confimation 177
• Audit Sampling 184
• Written Representations 190
• Internal Check System 194
• Internal Audit 196
• Internal Audit and Corporate Governance 199
• Scope of Internal Audit Function 202
• Internal Audit Reports 203
• Corporate Governance & Role of Internal Audit 204
• Function and Extent of Internal Audit in Entities 205
• Outsourcing in Internal Audit 207
• Initial Audit Engagement 208
• Using the Work of Others 210
• Audit Committee and Relevant Legal Provision for Requirement of Audit Committee 214
CHAPTER 5: VOUCHING (219-248)
• Vouching 220
• Principle of Cut-off Arrangement 221
• Specific Cases of Vouching 221
• Audit of Purchase 221
• Audit of Sales 222
• Audit of Payment and General Expenses 230
• Audit of reconciliation of bank statements with cash book 234
• Audit of Receipt and Income 235
• Audit of Impersonal Ledgers 238
• Audit of Diferred Revenue Expenditure 241
• Few Illustrations on Vouching 242
CHAPTER 6: VERIFICATION OF ASSETS AND LIABILITIES (249-292)
• Verification of Assets and Liabilities 250
• Audit of Statement of Financial Position 251
• Audit of Profit Loss Account 251
• Verification of Assets 252
• Verification of Specific Assets 254
• Verification of Liabilities 262
• Verification of Specific Liabilities 263
• Examination of Disclosure 267
• Change in Accounting Policies and its Implication 268
• Auditing of Accounting Estimates 269
• Auditing of Incomplete Records 271
• Audit of Suppliers' Ledger and Debtors' Ledger 273
CHAPTER 7: COMPANY AUDIT (293-324)
• General Consideration in Company Audit 294
• Accounts and Records of Companty 295
• Specific Provisions as Regards to Accounts and Financial Reports in
the Companies Act, 2063 295
• Specifi c Provisions with Regards to Audit and Auditors in the Companies Act, 2063 300
• Audit of Share Capital and Transfer of Shares 304
• Other issues in Company Audit 315
• Special Considerations Involved in the Examination of Certain Documents 317
CHAPTER 8: AUDIT OF SPECIAL SECTORS (325-340)
• Audit of Non-Governmental Organizations (NGOs) 326
• Audit of Educational Institutions (School, College or University) 329
• Audit of Hospitals and Clinics 331
• Audit of Clubs and Recreational Center 332
• Audit of Hire Purchase and Leasing Companies 334
• Audit of Co-operative Society 336
• Audit of Joint Venture 338
CHAPTER 9: GOVERNMENT AUDIT (341-368)
• Government Audit 342
• Propriety Audit 346
• Performance Audit 348
• Audit of Local Bodies 349
• Audit of Public Sector Companies 349
• Elements of Public Sector Auditing 358
• Types of Engagement 359
• Principles of Public Sector Auditing 361
CHAPTER 10: COMPLETING AND REPORTING ON AN ASSURANCE ENGAGEMENT (369-424)
• Quality Control and Review Procedure 370
• Consideration of Subsequent Events 372
• Audit Finalization and Final Review 375
• Audit Conclusion: Reporting 388
• Audit Report: Nepalese Law Mandate 390
• Basic Elements of the Auditor's Report 391
• Types of Audit Opinion 397
• Circumstances that may result other than an Unqualified Opinion 402
• Auditors Library Regarding the Unaudited Supplementary Information
Presented with Audited Financial Statements 406
• Audit Report and Audit Certificate 408
• Notes to Accounts and Qualification Notes 409
• Manner of Qualifying Reports 410
• Contents of Reports and Certificates for Special Purposes 411
• Comparatives 412
• Assurance Engagement 415
• Engagements to Perform Agreed-Upon Procedures 417
• Engagements to Complete Financial Statements 420
CHAPTER 11: NEPAL STANDARDS ON AUDITING (NSA) (425-484)
• Background 426
• International Standards on Auditing 426
• Auditing Standards Board 427
• NSA 200: Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Nepal Standards on Audinting 431
• NSA 210: Terms of Audit Engagement 434
• NSA 230: Audit Documentation 437
• NSA 250: Consideration of Laws and Regulations in an Audit of Financial Statements 440
• NSA 300: Planning an Audit of Financial Statements 444
• NSA 315: Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and its Environment (Revised) 448
• NSA 320: Materiality in Planning and Performing an Audit 453
• NSA 500: Audit Evidence 456
• NSA 505: External Confirmations 460
• NSA 510: Initial Engagements - Opening Balances 464
• NSA 530: Audit Sampling 467
• NSA 610: Using the Work of Internal Auditors (Revised) 471
• NSA 620: Using the Work of an Auditors Expert 478
• The Concept of Audit and other Assurance Engagements 483
GLOSSARY OF TERMS (485-500)
ACRONYMS (501-502)
IMPORTANT LINKS 503
CHAPTER 1
PRINCIPLES AND CONCEPT

OF ASSURANCE
Objectives of this Chapter:
To be able to understand-
 Definition and objective of assurance and audit
 The statutory requirement for audit
 Various types of audit in practice
 Principles governing an audit &
 What an audit is not .
 Concept of error and fraud
 Analyse the responsibility of auditor relating to fraud
 Difference between audit and investigation
 Different types of audit and relationship of auditing with other

disciples
The Institute of Chartered Accountants of Nepal 1

AUDIT AND ASSURANCE
1.1 AUDITING AND ASSURANCE
Proper records and accounts are crucial due to the fact that transactions take place at different points
of time with numerous persons and entities. The effects of all transactions have to be recorded and
suitably analysed to see the results as regards the business as a whole. Periodical statements of
account are drawn up to measure the success or failure of the activities in achieving the objective of
the organization. This would be impossible without a systematic record of transactions. Financial
statements are often the basis for decision making by the management and for corrective action so
as to even closing down the organisation or a part of it.
As per Para 7 of Nepal Accounting Standard (NAS) - 01 on Presentation of Financial Statements, a

complete set of financial statements comprises:
a) a statement of financial position as at the end of the period;
b) a statement of profit or loss and other comprehensive income for the period;
c) a statement of changes in equity for the period
d) a statement of cash flows for the period;
e) notes, comprising a summary of significant accounting policies and other explanatory
information; and
f) a statement of financial position as at the beginning of the earliest comparative period when
an entity applies an accounting policy retrospectively or makes a retrospective restatement
of items in its financial statements, or when it reclassifies items in its financial statements.
Error free Financial Statements is vital for the success of the business. If the business has really
earned a profit but because of wrong accounting, the annual accounts show a loss, the proprietor
may take the decision to sell the business at a loss. Thus, from the point of view of the management
itself, authenticity of financial statements is essential. It is more essential for those who have
invested their money in the business but cannot take part in its management, for example,
shareholders in a company, such persons certainly need an assurance that the annual statements
of accounts sent to them are reasonably reliable.
It is auditing which ensures that the accounting statements are presented fairly. The independent
audit of an entity’s financial statements is a vital service to the existing and prospective investors,
lenders, and other creditors in economic exchange.
An audit is 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.
The person conducting audit is known as the auditor; s/he makes a report to the person appointing
him after due examination of the accounting records and the accounting statements in the form of
2 The Institute of Chartered Accountants of Nepal

CHAPER 1 : PRINCIPLES AND CONCEPT OF ASSURANCE
an opinion on the financial statements. The opinion that s/he is called upon to express is whether
the financial statements reflect a fair view of financial position, operating results and cash flows in
accordance with applicable financial reporting framework.
The person conducting this process should perform work with knowledge of the use of the financial
statements discussed above and should take particular care to ensure that nothing contained in
the statements will materially mislead the users of those financial statements. This s/he can do
honestly by satisfying himself that:
i. the accounts have been drawn up with reference to entries in the books of account;
ii. the entries in the books of account are adequately supported by underlying documents
and by other evidence;
iii. none of the entries in the books of account has been omitted in the process of compilation
and nothing which is not in the books of account has found place in the statements;
iv. the information conveyed by the statements is clear and unambiguous;
v. the financial statements amounts are properly classified, described and disclosed in
conformity with financial reporting standards; and
vi. the financial statements taken as a whole, present a fair view of financial position as of
reporting date, and the operating results and cash flows for the period ended therein.
Auditing
The word ‘auditing’ has been derived from Latin word ‘audire’ which means to hear. In fact, such
an expression conveyed the manner in which the auditing was conducted during ancient time.
However, over a period of time, the manner of conducting audit has undergone revolutionary
change. According to Dicksee, traditionally auditing can be understood as an examination of
accounting records undertaken with a view to establishing whether they completely reflect the
transactions correctly for the related purpose. But this is not the end of matter. In addition, the
auditor also expresses auditor’s opinion on the character of the statements of accounts prepared
from the accounting records so examined as to whether they portray a true and fair picture.
An audit engagement is an assurance engagement, but not all assurance engagements are audits.
The objective of an audit of financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance with an applicable
financial reporting framework. An audit of financial statements is a type of assurance engagement.
Assurance
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. The outcome of the evaluation or

AUDIT AND ASSURANCE
measurement of a subject matter is the information that results from applying the criteria. Under
the “International Framework for Assurance Engagements”, there are two types of assurance
engagement a practitioner1 is permitted to perform: -
a. Reasonable Assurance Engagement: - The objective of a reasonable assurance engagement is

a reduction in assurance engagement risk to an acceptably low level in the circumstances of
the engagement as the basis for a positive form of expression of the practitioner’s conclusion.
b. Limited Assurance Engagement:- The objective of a limited assurance engagement is a

reduction in assurance engagement risk to a level that is acceptable in the circumstances of
the engagement, but where that risk is greater than for a reasonable assurance engagement,
as the basis for a negative form of expression of the practitioner’s conclusion.
The following are the elements of an assurance engagement:

a. A three party relationship involving a practitioner, a responsible party, and intended
users;
Assurance engagements involve three separate parties: a practitioner, a responsible party and
intended users. The responsible party and the intended users may be from different entities or
the same entity. As an example of the latter case, in a two-tier board structure, the supervisory
board may seek assurance about information provided by the management board of that
entity. The relationship between the responsible party and the intended users needs to be
viewed within the context of a specific engagement and may differ from more traditionally
defined lines of responsibility. For example, an entity’s senior management (an intended
user) may engage a practitioner to perform an assurance engagement on a particular aspect
of the entity’s activities that is the immediate responsibility of a lower level of management
(the responsible party), but for which senior management is ultimately responsible. The term
“practitioner” as used above is broader than the term “auditor” as used in NSAs and NSREs,
which relates only to practitioners performing audit or review engagements with respect to
historical financial information.
A practitioner may be requested to perform assurance engagements on a wide range of

subject matters. Some subject matters may require specialized skills and knowledge beyond
those ordinarily possessed by an individual practitioner.
The responsible party is the person (or persons) who:
(a) In a direct reporting engagement, is responsible for the subject matter; or
(b) In an assertion-based engagement, is responsible for the subject matter information (the
assertion), and may be responsible for the subject matter.
1 A professional accountant in public practice

An example of when the responsible party is responsible for both the subject matter information
and the subject matter is when an entity engages a practitioner to perform an assurance
engagement regarding a report it has prepared about its own sustainability practices. An
example of when the responsible party is responsible for the subject matter information but
not the subject matter is when a government organization engages a practitioner to perform an
assurance engagement regarding a report about a private company’s sustainability practices
that the organization has prepared and is to distribute to intended users. The responsible
party may or may not be the party who engages the practitioner (the engaging party).
The responsible party ordinarily provides the practitioner with a written representation that
evaluates or measures the subject matter against the identified criteria, whether or not it is
to be made available as an assertion to the intended users. In a direct reporting engagement,
the practitioner may not be able to obtain such a representation when the engaging party is
different from the responsible party.
The intended users are the person, persons or class of persons for whom the practitioner
prepares the assurance report. The responsible party can be one of the intended users, but
not the only one. Whenever practical, the assurance report is addressed to all the intended
users, but in some cases there may be other intended users. The practitioner may not be able
to identify all those who will read the assurance report, particularly where there is a large
number of people who have access to it. In such cases, particularly where possible readers
are likely to have a broad range of interests in the subject matter, intended users may be
limited to major stakeholders with significant and common interests. Intended users may
be identified in different ways, for example, by agreement between the practitioner and
the responsible party or engaging party, or by law. Whenever practical, intended users or
their representatives are involved with the practitioner and the responsible party (and the
engaging party if different) in determining the requirements of the engagement regardless
of the involvement of others however, and unlike an agreed-upon procedures engagement
(which involves reporting findings based upon the procedures, rather than a conclusion):
(a) The practitioner is responsible for determining the nature, timing and extent of
procedures; and
(b) The practitioner is required to pursue any matter the practitioner becomes aware of that
leads the practitioner to question whether a material modification should be made to the
subject matter information.
In some cases, intended users (for example, bankers and regulators) impose a requirement on,
or request the responsible party (or the engaging party if different) to arrange for, an assurance
engagement to be performed for a specific purpose. When engagements are designed for
specified intended users or a specific purpose, the practitioner considers including a restriction
in the assurance report that limits its use to those users or for that purpose.

AUDIT AND ASSURANCE
b. An appropriate subject matter;

The subject matter, and subject matter information, of an assurance engagement can take
many forms, such as:
 Financial performance or conditions (for example, historical or prospective financial

position, financial performance and cash flows) for which the subject matter information
may be the recognition, measurement, presentation and disclosure represented in
financial statements.
 Non-financial performance or conditions (for example, performance of an entity) for

which the subject matter information may be key indicators of efficiency and effectiveness.
 Physical characteristics (for example, capacity of a facility) for which the subject matter
information may be a specifications document.
 Systems and processes (for example, an entity’s internal control or IT system) for which
the subject matter information may be an assertion about effectiveness.
 Behavior (for example, corporate governance, compliance with regulation, human

resource practices) for which the subject matter information may be a statement of
compliance or a statement of effectiveness.
Subject matters have different characteristics, including the degree to which information
about them is qualitative versus quantitative, subjective versus objective, historical versus
prospective, and relates to a point in time or covers a period. Such characteristics affect the:
(a) Precision with which the subject matter can be evaluated or measured against criteria; and
(b) The persuasiveness of available evidence.
The assurance report notes characteristics of particular relevance to the intended users.
An appropriate subject matter is:
(a) Identifiable, and capable of consistent evaluation or measurement against the identified
criteria; and
(b) Such that the information about it can be subjected to procedures for gathering sufficient
appropriate evidence to support a reasonable assurance or limited assurance conclusion,
as appropriate,
c. Suitable criteria;
Criteria are the benchmarks used to evaluate or measure the subject matter including, where
relevant, benchmarks for presentation and disclosure. Criteria can be formal, for example in
the preparation of financial statements, the criteria may be International Financial Reporting
Standards or International Public Sector Accounting Standards; when reporting on internal

control, the criteria may be an established internal control framework or individual control
objectives specifically designed for the engagement; and when reporting on compliance, the
criteria may be the applicable law, regulation or contract. Examples of less formal criteria
are an internally developed code of conduct or an agreed level of performance (such as the
number of times a particular committee is expected to meet in a year). Suitable criteria are
required for reasonably consistent evaluation or measurement of a subject matter within
the context of professional judgment. Without the frame of reference provided by suitable
criteria, any conclusion is open to individual interpretation and misunderstanding. Suitable
criteria are context-sensitive, that is, relevant to the engagement circumstances. Even for the
same subject matter there can be different criteria. For example, one responsible party might
select the number of customer complaints resolved to the acknowledged satisfaction of the
customer for the subject matter of customer satisfaction; another responsible party might
select the number of repeat purchases in the three months following the initial purchase.
Suitable criteria exhibit the following characteristics:
(a) Relevance: relevant criteria contribute to conclusions that assist decision-making by the
intended users.
(b) Completeness: criteria are sufficiently complete when relevant factors that could affect
the conclusions in the context of the engagement circumstances are not omitted. Complete
criteria include, where relevant, benchmarks for presentation and disclosure.
(c) Reliability: reliable criteria allow reasonably consistent evaluation or measurement of

the subject matter including, where relevant, presentation and disclosure, when used in
similar circumstances by similarly qualified practitioners.
(d) Neutrality: neutral criteria contribute to conclusions that are free from bias.
(e) Understandability: understandable criteria contribute to conclusions that are clear,

comprehensive, and not subject to significantly different interpretations.
The evaluation or measurement of a subject matter on the basis of the practitioner’s own
expectations, judgments and individual experience would not constitute suitable criteria.
The practitioner assesses the suitability of criteria for a particular engagement by considering
whether they reflect the above characteristics. The relative importance of each characteristic
to a particular engagement is a matter of judgment. Criteria can either be established or
specifically developed. Established criteria are those embodied in laws or regulations, or
issued by authorized or recognized bodies of experts that follow a transparent due process.
Specifically developed criteria are those designed for the purpose of the engagement. Whether
criteria are established or specifically developed affects the work that the practitioner carries
out to assess their suitability for a particular engagement.

AUDIT AND ASSURANCE
Criteria need to be available to the intended users to allow them to understand how the
subject matter has been evaluated or measured. Criteria are made available to the intended
users in one or more of the following ways:
(a) Publicly.
(b) Through inclusion in a clear manner in the presentation of the subject matter information.
(c) Through inclusion in a clear manner in the assurance report.
(d) By general understanding, for example the criterion for measuring time in hours and
minutes.
Criteria may also be available only to specific intended users, for example the terms of a
contract, or criteria issued by an industry association that are available only to those in the
industry. When identified criteria are available only to specific intended users, or are relevant
only to a specific purpose, use of the assurance report is restricted to those users or for that
purpose.
d. Sufficient appropriate evidence; and

The practitioner plans and performs an assurance engagement with an attitude of professional
skepticism to obtain sufficient appropriate evidence about whether the subject matter
information is free of material misstatement. The practitioner considers materiality, assurance
engagement risk, and the quantity and quality of available evidence when planning and
performing engagement, in particular when determining the nature, timing and extent of
evidence-gathering procedures.
e. Assurance Report
The practitioner provides a written report containing a conclusion that conveys the assurance
obtained about the subject matter information. NSAs, NSREs, NSRSs, NSQC, NSAEs & NAPN
establish basic elements for assurance reports. In addition, the practitioner considers other
reporting responsibilities, including communicating with those charged with governance
when it is appropriate to do so. In an assertion-based engagement, the practitioner’s
conclusion can be worded either:
(a) In terms of the responsible party’s assertion (for example: “In our opinion the responsible
party’s assertion that internal control is effective, in all material respects, based on XYZ
criteria, is fairly stated”); or
(b) Directly in terms of the subject matter and the criteria (for example: “In our opinion
internal control is effective, in all material respects, based on XYZ criteria”).
In a direct reporting engagement, the practitioner’s conclusion is worded directly in terms of

the subject matter and the criteria.

In a reasonable assurance engagement, the practitioner expresses the conclusion in the

positive form, for example: “In our opinion internal control is effective, in all material
respects, based on XYZ criteria.” This form of expression conveys “reasonable assurance.”
Having performed evidence gathering procedures of a nature, timing and extent that were
reasonable given the characteristics of the subject matter and other relevant engagement
circumstances described in the assurance report, the practitioner has obtained sufficient
appropriate evidence to reduce assurance engagement risk to an acceptably low level.
In a limited assurance engagement, the practitioner expresses the conclusion in the negative
form, for example, “Based on our work described in this report, nothing has come to our
attention that causes us to believe that internal control is not effective, in all material respects,
based on XYZ criteria.” This form of expression conveys a level of “limited assurance” that
is proportional to the level of the practitioner’s evidence-gathering procedures given the
characteristics of the subject matter and other engagement circumstances described in the
assurance report.
Three Parties
Relationship
Assurance
Report
Elements of
an assurance
engagement
An
appropriate Suitable
subject Criteria
matter
Sufficient
Appropriate
Evidence

AUDIT AND ASSURANCE
1.2 BENEFITS OF AUDIT AND ASSURANCE
Though the fact that audit, usually, is compulsory by law, it should demonstrate the value and
benefits. The main benefit of audit lies in reliable financial statements on the basis of which the state
of affairs may be easy to understand. Apart from this obvious benefit, there are other advantages
of audit. Some or all of these are of considerable value even to those enterprises and organisations
where audit is not compulsory, these advantages are given below:
1. It safeguards the financial interest of persons who are not associated with the management
of the entity, whether they are partners or shareholders.
2. It acts as a moral check on the employees from committing defalcation or embezzlement.
3. Audited statements of account are helpful in settling liability for taxes, negotiating loans
and for determining the purchase consideration for a business.
4. These are also useful for settling trade disputes for higher wages or bonus as well as
claims in respect of damage suffered by property, by fire or some other calamity.
5. An audit can also help in the detection of wastages and losses to show the different
ways by which these might be checked, especially those that occur due to the absence of
inadequacy of internal checks or internal control measures.
6. Audit ascertains whether the necessary books of account and allied records have been
properly kept and helps the client in correcting deficiencies or inadequacies in this
respect.
7. As an appraisal function, audit reviews the existence and operations of various controls
in the organisations and reports weaknesses, inadequacies, etc., in them.
8. Audited accounts are of great help in the settlement of accounts at the time of admission
or death of partner.
9. Government may require audited and certified financial statements before it gives
assistance or issues a license for a particular trade.
1.3 SCOPE OF AUDIT
NSA - 200 provides the scope of audit as:
‘The auditor’s opinion on the financial statements deals with whether the financial statements are
prepared, in all material respects, in accordance with the applicable financial reporting framework.
Such an opinion is common to all audits of financial statements. The auditor’s opinion therefore does
not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which
management has conducted the affairs of the entity. In some jurisdictions, however, applicable law or

regulation may require auditors to provide opinions on other specific matters, such as the effectiveness
of internal control, or the consistency of a separate management report with the financial statements.
While the NSAs include requirements and guidance in relation to such matters to the extent that
they are relevant to forming an opinion on the financial statements, the auditor would be required to
undertake further work if the auditor had additional responsibilities to provide such opinions.’
The scope of an audit of financial statements is determined by the auditor for having regard to:-
 the terms of the engagement,
 the requirement of relevant legislation and regulations,
 the pronouncements of relevant professional bodies (ICAN),
 Requirements of NASs, NFRS and NSAs, and
 Reporting requirements.
The terms of engagement cannot, however, restrict the scope of an audit in relation to matters
which are prescribed by legislation or by the pronouncements of the Institute.
The audit should be organized to cover adequately all aspects of the enterprise as far as they are
relevant to the financial statements being audited. To form an opinion on the financial statements,
the auditor should be reasonably satisfied as to whether the information contained in the underlying
accounting records and other source data is reliable and sufficient as the basis for the preparation of the
financial statements. In forming auditor’s opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to statutory requirements and
requirements of the profession, where applicable. The auditor assesses the reliability and sufficiency of
the information contained in the underlying accounting records and other source data by:
1. studying and evaluating of accounting systems and internal controls on which an auditor
wishes to rely and testing those internal controls to determine the nature, extent and
timing of other auditing procedures; and
2. carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as an auditor considers appropriate in the particular
circumstances.
The auditor determines whether the relevant information is properly disclosed in the financial
statements by:
1. comparing the financial statements with the underlying accounting records and other
source data to see whether they properly summarize the transactions and events
recorded therein; and
2. considering the judgments that management has made in preparing the financial
statements accordingly, the auditor assesses the selection and consistent application of
accounting policies, the manner in which the information has been classified, and the
adequacy of disclosure.

AUDIT AND ASSURANCE
1.4 OBJECTIVES OF AUDIT AND ASSURANCE
As per NSA 200, the overall objectives of the auditor 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 NSAs, in
accordance with the auditor’s findings.
The primary objective of an audit is to enhance the degree of confidence of intended users in the
financial statements. This is achieved by the expression of an opinion by the auditor on whether
the financial statements are prepared, in all material respects, in accordance with an applicable
financial reporting framework. In the case of most general purpose frameworks, that opinion is on
whether the financial statements are presented fairly, in all material respects, or give a true and fair
view in accordance with the framework.
Earlier, the principal objective was on arithmetical accuracy; adequate attention was not paid to
appropriate application of accounting principles and disclosure, for ensuring preparation of accounting
statements in such a way as to enable the reader of the accounting statement to form a fair view of the
state of affairs. But some of the organization took advantage of the situation and manipulated profit or
loss and assets and liabilities to highlight or conceal affairs according to their own design.
There has been a shift of emphasis from arithmetical accuracy to the question of reliability of the
If there remains a deep laid fraud in the accounts, which in the normal course of examination of
accounts may not come to light, it will not be construed as failure of audit, provided the auditor
was not negligent in the carrying out auditor’s normal work as required by the profession. This
principle was established as early as in 1896 in the leading case in Re-Kingston Cotton Mills Co [a
case study from United Kingdom].
To judge whether the financial Statements give a true and fair view of affairs, following bases
could be taken:
 Reasonable evidences are available to support all recorded transactions,
 All accounting entries are passed in conformity with applicable Accounting Standard
and continuously followed,
 The financial Statements represents the true summary of transaction taken place,
 Process of classification and aggregation followed in preparation of financial statements is fair,
 The financial Statements neither hide material fact nor highlight something which may
distort true picture,

 The financial Statements do not contain any material misstatements,
 Material transaction recorded are neither illegal nor beyond power of client,
 All statutory and relevant disclosures have been made
The user, however, should not assume that the auditor’s opinion is an assurance as to the future
viability of an enterprise or the efficiency or effectiveness with which the management has
conducted the affairs of the enterprise.
Summarizing above, it can be said that auditing has the principal objective of seeing whether or not
the financial statements portray a true and fair view, detect frauds and making recommendations
to prevent their occurrence.
1.5 ERRORS AND FRAUDS
NSA 240 on ‘The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements'
provides that misstatements in the financial statements can arise from fraud or error. The
distinguishing factor between fraud and error is whether the underlying action that results in the
misstatement of the financial statements is intentional or unintentional.
Error refers to an unintentional misstatement in financial statements, including the omission of an

amount or a disclosure, such as:
 A mistake in gathering or processing data,
 An incorrect accounting estimate arising from oversight or misinterpretation of facts and
 A mistake in the application of accounting principles relating to measurement,

recognition etc.
Fraud refers to an intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal
advantage. Fraud involving one or more members of management or those charged with governance
is referred to as management fraud and fraud involving only employees of the entity is referred to as
employee fraud. In either case, there may be collusion with third parties outside the entity.
If the books of account are not properly maintained and if the control system is weak, the possibility of
frauds and errors are enormous and the auditor, even with the best of auditor’s efforts, may not be able
to detect all of them. The auditor’s performance is judicially viewed by applying the following tests:
a. whether the auditor has exercised reasonable care and skill in carrying out auditor’s
work;
b. whether the errors and frauds were such as could have been detected in the ordinary
course of checking without the aid of any special efforts;

AUDIT AND ASSURANCE
c. whether the auditor had any reason to suspect the existence of the errors and frauds; and
d. Whether the error or fraud was so deep laid that the same might not have been detected
by the application of normal audit procedures.
The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and management. It is important that management, with
the oversight of those charged with governance, place a strong emphasis on fraud prevention,
which may reduce opportunities for fraud to take place, and fraud deterrence, which could
persuade individuals not to commit fraud because of the likelihood of detection and punishment.
This involves a commitment to creating a culture of honesty and ethical behavior which can be
reinforced by an active oversight by those charged with governance.
The auditor should perform procedures to determine whether the financial statements are materially
misstated. An audit conducted in accordance with NSAs or relevant practices is designed to
provide reasonable assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error. The fact that an audit is carried out may act as a
deterrent so the auditor is not and cannot be held responsible for the prevention of fraud and error.
Reasons for errors and Frauds

a. Ignorance on the part of employees of accounting developments, generally accepted accounting
principles, appropriate account classification and good accounting practices in general.
b. Carelessness on the part of those doing the accounting work.
c. A desire to conceal the effect of defalcations or shortages of one kind or another.
d. A tendency of the management to permit prejudice or bias to influence the interpretation

of transactions or events or their presentation in the financial statements.
e. An ever present desire to hold taxes on income to minimum.
f. Show up the picture depicted by the statements;
g. Depress the picture depicted by the statements; and
h. Convert the error to a personal benefit
Misstatements in the financial

statements may be due to-
Frauds- Intentional acts or omissions Errors- Unintentional acts or omissions

As discussed above, error is an involuntary act whereas fraud is a deliberate act. Errors can
be classified as:-
1. Self-revealing and not self-revealing:- These are such errors the existence of which becomes
apparent in the process of compilation of accounts. Unrecorded cheque details are apparent
while preparing bank reconciliations. If errors could not be noticed during normal course,
such errors are not self-revealing errors. If an item of expense which should have been charged
to repairs account has been charged by mistake to the building account or if the amount of
depreciation is calculated incorrectly, there is nothing in the book-keeping system which will
bring the error to notice. Such errors are not self-revealing errors.
2. Unintentional and intentional:- Fraud is the word used to mean intentional error. This is done
deliberately which implies that there is intent to deceive, to mislead or at least to conceal the
truth. It follows that other things being equal, they are more serious than unintentional errors
because of the implication of dishonesty which accompanies them.
3. Unconcealed and concealed:- Mistakes are unconcealed but frauds are deliberately concealed.
Mistakes become concealed if compensated by another or more mistakes in the opposite
direction. Mistakes may as well be concealed for wrong arithmetical calculations or for a
faulty process of verification.
Two types of intentional misstatements are relevant to the auditor’s consideration of misstatements
due to fraud:
1. Fraudulent Financial Reporting: It involves intentional misstatements or omissions of amounts

or disclosures in financial statements to deceive financial statement users. Fraudulent financial
reporting may involve:
i. Deception such as manipulation, falsification, or alteration of accounting records or

supporting documents from which the financial statements are prepared. For example,
in a period of rising prices, sales contract documents may be ante-dated to record sales
at prices lower than the prices at which sales have actually taken place.
ii. Misrepresentation in or intentional omission from, the financial statements of events,

transactions or other significant information. For example, goods sold may not be
recorded as sales but included in inventories.
iii. Intentional misapplication of accounting principles relating to measurement, recognition,

classification, presentation, or disclosure. For example, where a contracting firm follows
the ‘completed contract’ method of accounting but does not provide for a known loss on
incomplete contracts.
2. Misappropriation of Assets: It involves the theft of an entity’s assets. Misappropriation of assets

can be accomplished in a variety of ways (including embezzling receipts, stealing physical or
intangible assets, or causing an entity to pay for goods and services not received); it is often

AUDIT AND ASSURANCE
accompanied by false or misleading records or documents in order to conceal the fact that the
assets are missing.
Defalcation of Cash: - Defalcation of cash has been found to be perpetrated generally in the following
ways:
(a) By inflating cash payments

Examples of inflation of payments:
1. Making payments against fictitious vouchers.
2. Making payments against vouchers, the amounts whereof have been inflated.
3. Manipulating totals of wage rolls either by including therein names of dummy workers
or by inflating them in any other manner.
4. Casting larger totals for petty cash expenditure and adjusting the excess in the totals of
the detailed columns so that cross totals show agreement.
(b) By suppressing cash receipts. Few Techniques of how receipts are suppressed are:
1. Teeming and Lading :

Amount received from a customer being misappropriated; also to prevent its detection
the money received from another customer subsequently being credited to the account
of the customer who has paid earlier. Similarly, moneys received from the customer
who has paid thereafter being credited to the account of the second customer and
such a practice is continued so that no one account is outstanding for payment for
any length of time, which may lead the management to either send out a statement
of account to him or communicate with him. Adjusting unauthorised or fictitious,
rebates, allowances, discounts, etc. customer accounts and misappropriating amount
paid by them.
2. Writing off as debts in respect of such balances against which cash has already been
received but has been misappropriated.
3. Not accounting for cash sales fully.
4. Not accounting for miscellaneous receipts, e.g., sale of scrap, residence allotted to the
employees, etc.
5. Writing down asset values in entirety, selling them subsequently and misappropriating
the proceeds.
(c) By casting wrong totals in the cash book

Misappropriation of Goods: Fraud in the form of misappropriation of goods is still more difficult
to detect; for this management has to rely on various measures. Apart from the various

requirements of record keeping about the physical quantities and their periodic checks, there
must be rules and procedures for allowing persons inside the area where goods are kept.
Manipulation of Accounts: Detection of manipulation of accounts with a view to presenting

a false state of affairs is a task requiring great tact and intelligence because generally
management personnel in higher management cadre are associated with this type of fraud
and this is perpetrated in methodical way. This type of fraud is generally committed:
i. to avoid incidence of income-tax or other taxes;
ii. for declaring a dividend when there are insufficient profits;
iii. to withhold declaration of dividend even when there is adequate profit (this is often
done to manipulate the value of shares in stock market to make it possible for selected
persons to acquire shares at a lower cost); and
iv. for receiving higher remuneration where managerial remuneration is payable by

reference to profits.
There are numerous ways of committing this type of fraud. Some of the methods are given below:
a. inflating or suppressing purchases and expenses;
b. inflating or suppressing sales and other items of income,
c. inflating or deflating the value of closing stock;
d. failing to adjust outstanding liabilities or prepaid expenses; and
e. charging items of capital expenditure to revenue or by capitalising revenue expenses
Procedural Errors: Sometimes we become so obsessed with the general ledger and its supporting
records that we neglect other important features of the accounting system. An accounting
system includes both records and procedure. Errors can appear in either or both. Whatever
errors occur in the implementation of the procedures may be termed as procedural errors
(which include frauds also). For example, the sales procedure of a company may include the
following steps:
a) Receipt of an order through salesman,
b) Review of order by the credit department to determine whether the customer should be
given credit as requested,
c) Clearance with inventory department to be sure that the order can be executed,
d) Preparation of forwarding note with copies to obtain the customer’s acknowledgement
of the receipt of goods,
e) Preparation of invoice and dispatch of the same to the customer.

AUDIT AND ASSURANCE
Circumstances that Indicate the Possibility of Fraud or Error

a) Discrepancies in the accounting records, including:
 Transactions that are not recorded in a complete or timely manner or are improperly
recorded as to amount, accounting period, classification, or entity policy.
 Unsupported or unauthorized balances or transactions.
 Last-minute adjustments that significantly affect financial results.
 Evidence of employees’ access to systems and records inconsistent with that necessary to
perform their authorized duties.
 Tips or complaints to the auditor about alleged fraud.
b) Conflicting or missing evidence, including:
 Missing documents.
 Documents that appear to have been altered.
 Significant unexplained items on reconciliations.
 Unusual balance sheet changes, or changes in trends or important financial statement
ratios or relationships – for example, receivables growing faster than revenues.
 Inconsistent, vague, or implausible responses from management or employees arising
from inquiries or analytical procedures.
 Unusual discrepancies between the entity's records and confirmation replies.
 Large numbers of credit entries and other adjustments made to accounts receivable
records.
 Unexplained or inadequately explained differences between the account receivable sub-
ledger and the control account, or between the customer statements and the accounts
receivable sub-ledger.
 Missing or non-existent cancelled checks in circumstances where cancelled checks are
ordinarily returned to the entity with the bank statement.
 Missing inventory or physical assets of significant magnitude.
 Unavailable or missing electronic evidence, inconsistent with the entity’s record retention
practices or policies.
c) Problematic or unusual relationships between the auditor and management, including:

 Denial of access to records, facilities, certain employees, customers, vendors, or others
from whom audit evidence might be sought.
 Undue time pressures imposed by management to resolve complex or contentious issues.
 Unusual delays by the entity in providing requested information.

 Unwillingness to facilitate auditor access to key electronic files for testing through the
use of computer-assisted audit techniques.
 Denial of access to key IT operations staff and facilities, including security, operations,
and systems development personnel.
 An unwillingness to add or revise disclosures in the financial statements to make them
more complete and understandable.
 An unwillingness to address identified deficiencies in internal control on a timely basis.
d) Other
 Unwillingness by management to permit the auditor to meet privately with those
charged with governance.
 Accounting policies that appear to be at variance with industry norms.
 Frequent changes in accounting estimates that do not appear to result from changed
circumstances.
 Tolerance of violations of the entity’s code of conduct.
Responsibility of Auditor in detection of fraud and error

The primary responsibility for the prevention and detection of fraud rests with both those charged
with governance of the entity and management. An auditor conducting an audit in accordance
with NSAs is responsible for obtaining reasonable assurance that the financial statements taken
as a whole are free from material misstatement, whether caused by fraud or error. Owing to the
inherent limitations of an audit, there is an unavoidable risk that some material misstatements
of the financial statements may not be detected, even though the audit is properly planned and
performed in accordance with the NSAs.
As described in NSA 200, the potential effects of inherent limitations are particularly significant in the
case of misstatement resulting from fraud. The risk of not detecting a material misstatement resulting
from fraud is higher than the risk of not detecting one resulting from error. This is because fraud
may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery,
deliberate failure to record transactions, or intentional misrepresentations being made to the auditor.
Such attempts at concealment may be even more difficult to detect when accompanied by collusion.
Collusion may cause the auditor to believe that audit evidence is persuasive when it is, in fact, false.
The auditor’s ability to detect a fraud depends on factors such as the skillfulness of the perpetrator, the
frequency and extent of manipulation, the degree of collusion involved, the relative size of individual
amounts manipulated, and the seniority of those individuals involved. While the auditor may be able
to identify potential opportunities for fraud to be perpetrated, it is difficult for the auditor to determine
whether misstatements in judgment areas such as accounting estimates are caused by fraud or error.
Furthermore, the risk of the auditor not detecting a material misstatement resulting from
management fraud is greater than for employee fraud, because management is frequently in a

AUDIT AND ASSURANCE
position to directly or indirectly manipulate accounting records, present fraudulent financial

information or override control procedures designed to prevent similar frauds by other employees.
When obtaining reasonable assurance, the auditor is responsible for maintaining professional
skepticism throughout the audit, considering the potential for management override of controls
and recognizing the fact that audit procedures that are effective for detecting error may not
be effective in detecting fraud. The requirements in this ISA are designed to assist the auditor
in identifying and assessing the risks of material misstatement due to fraud and in designing
procedures to detect such misstatement.
Note: Students are advised to refer NSA 240 for more information about the Auditor’s responsibilities
relating to Fraud in an audit of financial statements.
1.6 INHERENT LIMITATIONS OF AUDIT
NSA-200 makes clear that an opinion expressed by the auditor is neither an assurance as to the
future viability of the enterprise nor the efficiency or effectiveness with which management has
conducted affairs of the enterprise.
Further, NSA 240 provides that an auditor cannot obtain absolute assurance that material
misstatements in the financial statements will be detected. Owing to the inherent limitations of an
audit, there is an unavoidable risk that some material misstatements of the financial statements
will not be detected, even though the audit is properly planned and performed in accordance
with NSAs. Accordingly the subsequent discovery of a material misstatement of the financial
statements resulting from fraud or error does not itself indicate a failure to conduct an audit in
accordance with NSAs.
Further, the process of auditing is such that it suffers from certain inherent limitations, i.e., the
limitation which cannot be overcome irrespective of the nature and extent of audit procedures. It
is very important to understand these inherent limitations of an audit since understanding of the
same would only provide clarity as to the overall objectives of an audit. The factors due to which
limitations of audit arises as recognized by NSA 200 read with NSA 240 are:
i. Use of testing and judgment: Auditor’s work involves exercise of judgment, for example,
in deciding the extent of audit procedures and in assessing the reasonableness of the
judgment and estimates made by the management in preparing the financial statements.
Further, much of the evidence available to the auditor can enable him to draw only
reasonable conclusions there from.
ii. Inherent Limitation of Internal Controls: The entire audit process is generally
dependent upon the existence of an effective system of internal control. Further, it is
clearly evident that there always be some risk of an internal control system failing to

operate as designed. No doubt, internal control system also suffers from certain inherent
limitations. Any system of internal control may be ineffective against fraud involving
collusion among employees or fraud committed by management. The inherent limitations
of any accounting and internal control system (e.g. the possibility of collusion).
iii. The fact that most audit evidence is persuasive rather than conclusive: Persuasive
evidence is evidence that has the power to influence or persuade someone to believe in
its truth. For example: Your job is to check the receivable account balance, to accomplish
this you send confirmation mail to the big clients and the sum of these clients is almost
75 % of the total percentage, if all customer replies with positive responses then you have
enough persuasive evidence to issue an opinion on the accuracy of overall receivable
account.
Conclusive evidence is a solid evidence after which no further proof or inquiry is required
& evidence in itself is complete. Conclusive evidence would be if you sent confirmation
letter to all customer and pursued all customer until they respond which is not practical
in audit.
1.7 TYPES OF AUDIT
Audit is not legally obligatory for all types of business organisations or institutions. On this basis
audits may be of two broad categories:-
(a) Statutory Audit (Required under Law):- Statutory audit is the examination of the books
of accounts of the business by external auditor/statutory auditor and to report that the
a statement of profit or loss and other comprehensive income and statement of financial
position are drawn according to provisions of law and the financial statements reveal the true
and fair view of the results of operations and financial state of affairs of the business. This
audit shall be conducted as per the requirement of applicable law and regulation governing
the enterprises. The organisations which are required audit under law are the following:
a. Companies incorporated under the The Companies Act, 2063;
b. Bank and Financial Institutions governed by the Bank and Financial Institutions Act,
2073 and by the Central Bank Directives;
c. Cooperatives Act 2074;
d. Other Acts which specifically provides for audit requirement.
(b) Voluntary Audit (Not required under law):- In the voluntary category, the audits of the
accounts of proprietary entities, partnership firms, etc. are covered, in respect of such accounts,
there is no basic legal requirement of audit. Many of such enterprises, as a matter of internal
rules require audit. Some may be required to get their accounts audited on the directives of
Government for various purposes like sanction of grants, loans, etc. But the important motive

AUDIT AND ASSURANCE
for getting accounts audited lies in the advantages that flow from an independent professional
audit. This is perhaps the reason why large numbers of proprietary and partnership business
get their accounts audited.
Besides above, following are the types of audit:-
External audit: - External Audit is a periodic examination of the books of account and records of
an entity carried out by an independent professional (the auditor), to ensure that they have been
properly maintained, are accurate and comply with established concepts, principles, accounting
standards, legal requirements and give a true and fair view of the financial state of the entity. It
is performed in accordance with specific laws or rules on the financial statements of a company.
Internal audit: - It is an independent, objective assurance and consulting activity designed to add value
and improve an organization's operations. It helps an organization accomplish its objectives by bringing
a systematic, disciplined approach to evaluate and improve the effectiveness of risk management,
control, and governance processes. The objectives of internal audit can be stated as follows:
i. To verify the accuracy and authenticity of the financial accounting and underlying
records presented to the management.
ii. To ascertain that the standard accounting practices, as have been decided to be followed
by the organisation, are being adhered to.
iii. To establish that there is a proper authority for every acquisition, retirement and disposal
of assets.
iv. To confirm that liabilities have been incurred only for the legitimate activities of the
organisation.
v. To analyse and improve the system of internal check; in particular to see:
(i) that it is working;
(ii) that it is sound; and
(iii) that it is economical.
vi. To facilitate the prevention and detection of frauds.
vii. To examine the protection afforded to assets and the uses to which they are put.
viii. To make special investigations for management.
ix. To provide a channel whereby new ideas can be brought to the attention of management.
x. To review the operation of the overall internal control system and to bring material
departures and non-compliances to the notice of the appropriate level of management ;
the review also generally aims at locating unnecessary and weak controls for making the
entire control system effective and economical.

Internal audit operates in one or more of the following areas:
 Review of accounting system and related internal controls
 Examination for management of financial and operating information
 Examination of the economy, efficiency and effectiveness of operations including

nonfinancial controls of an organization
 Physical examination and verification
c) Performance audit: - This refers to an examination of a program, function, operation or

the management systems and procedures of a governmental or non-profit entity to assess
whether the entity is achieving economy, efficiency and effectiveness in the employment of
available resources. Therefore, performance auditing is concerned with the audit of economy,
efficiency and effectiveness and embraces:
(a) audit of the economy of administrative activities in accordance with sound administrative
principles and practices, and management policies;
(b) audit of the efficiency of utilization of human, financial and other resources, including
examination of information systems, performance measures and monitoring
arrangements, and procedures followed by audited entities for correcting identified
deficiencies; and
(c) audit of the effectiveness of performance in relation to achievement of the objectiveness

of the audited entity, and audit of the actual impact of activities compared with the
intended impact.
Economy
Effciency Effectiveness
The examination is objective and systematic and generally using, structured and professionally
adopted methodologies.

AUDIT AND ASSURANCE
d) Continuous Audit/Concurrent Audit: The audit that remains continue throughout the
financial year is called continuous audit. It is a systematic and timely examination of financial
transaction on a regular basis to ensure accuracy, compliance with procedure and guidelines.
e) Social Audit: Social audit is performed to know the social responsibility of economic entities.
Social Audit is an independent evaluation of the performance of an organisation as it relates to
the attainment of its social goals. It is an instrument of social accountability of an organisation.
In other words, Social Audit may be defined as an in-depth scrutiny and analysis of the
working of any public utility vis-a-vis its social relevance. Social Auditing is a process that
enables an organisation to assess and demonstrate its social, economic and environmental
benefits. It is a way of measuring the extent to which an organisation lives up to the shared
values and objectives it has committed itself to. It provides an assessment of the impact of
an organisation's nonfinancial objectives through systematic and regular monitoring based
on the views of its stakeholders. Stakeholders are defined as those persons or organisations
who have an interest in, or who have invested resources in the organisation. Stakeholders
include employees, clients, volunteers, funders, contractors, suppliers and the general public
affected by the organisation. Social welfare Council of Nepal has recently issued social audit
guidelines in NGO sectors and already in practice.
f) Tax Audit:
Tax audit is the examination and verification of tax accounts and records maintained by
the entity in accordance with the applicable tax laws and certification of tax return to be
submitted by the entity to tax authorities. A tax auditor is a professional who evaluates
financial records to determine whether they comply with the laws. They check if companies,
individuals, agencies and organizations comply with the federal, state and local tax laws.
Basically, tax audit involves ensuring compliance of the Income Tax Act 2058, VAT Act 2053
and other local taxation laws, which emphasizes on providing the error free income tax return
to tax authorities by assessing the correct taxable income and tax liability, applicable interest,
fines and penalties as a result of non submission or delay submission or short submission of
tax return or tax amount of the assessee as per the tax laws.
In Nepal, there is no any legal provision for appointing tax auditor for the Tax audit. However,
in practice, generally statutory auditor has been assigned with that responsibility.
Even though there is no specific provision for appointing tax auditor in Income Tax act 2058,
following provisions has been explained in Income Tax Directive 2073 related to tax audit and
responsibilities of tax auditor:.
 The income tax return to be submitted by the taxpayers shall be certified by the
professional accountant having obtained certificate of practice from ICAN except
taxpayers submitting presumptive tax or professional natural person having annual
income from business and employment less than Rs. 20 lakhs or taxpayer having annual
income from business and employment less than Rs. 1 crore.

 Tax auditor certifying the tax return has following duties:
 Income tax return shall be prepared in the prescribed format and the related
statements and documents shall be attached therewith. Such return should verify
the assets, liabilities, income, expenses and taxable income.
 Tax officer shall examine the books of accounts and records maintained as per tax
laws like purchase and sales register, all expenditures etc.
 The tax auditor’ report should mention that the books of accounts of taxpayer
have been examined and those reflect the income, expenditure and profit or loss of
taxpayer.
 Tax auditor should mention in his report, whether the taxpayer has deducted
withholding taxes as per tax laws.
 The tax auditor shall certify by keeping signature and stamp on income tax return
prepared by or assisted for preparation by tax auditor.
If an auditor intentionally helps, advises or instigates any other person to commit any offense
under Income Tax Act, he or she shall be punished with half of the punishment due to the
offender. [Section 127 of the Income Tax Act 2058]
g) Environmental Audit: It is a general term that can reflect various types or evaluations
intended to identify environmental compliance and management system implementation
gaps, along with related corrective actions. A management tool comprising a systematic,
documented periodic and objective evaluation of how well environmental organisation,
management and equipment are performing with the aim of helping to safeguard the
environment by:
(i) facilitating management control of environmental practices; and
(ii) assessing compliance with company policies, which would include meeting regulatory
requirements.
There are generally two types of environmental audit: compliance audit and management
systems audit. As a management tool, environmental auditing can be used in different ways
to suit different company attitudes and levels of environmental attainment. These can be
divided into three main groups:
(a) to achieve compliance - usually first with technological issues, such as regulatory
requirements, rather than with those of policy, and then progressively to the assessment
of management systems;
(b) to demonstrate compliance - to management, the regulatory authorities, customers,

insurers, stake holders and the public etc.

AUDIT AND ASSURANCE
(c) to go beyond compliance - the process of continual improvement and/or for commercial
benefit via waste minimisation.
h) Interim Audit: It is an audit conducted by external auditors during the fiscal year usually as
a means of minimizing the work and time involved in concluding the audit after the fiscal
year. A corporation might have an interim audit covering the first nine months of the fiscal
year so that at the end of the fiscal year most of the auditing will focus on the last three
months of the fiscal year thus allowing for a comprehensive audit and early completion
of the audit reports. An interim audit does not usually yield any formal reports from the
external auditors.
i) Information System Audit: Information Systems Audit gives assurance that the
IT systems are adequately protected, provide reliable information to users, and
are properly managed to achieve their intended benefits. It also reduces the risk of
data tampering, data loss or leakage, service disruption and poor management of IT
systems. Nepal Rastra Bank Directive No. 22 has provision for the mandatory audit of
Information Technology System of all commercial banks every year starting from fiscal
year 2075/76 for minimizing cyber crime arising from online banking transactions and
promoting cyber security.
j) Other Audit: Besides above there are other types of the audit depending upon the objectivity
and scope of the work. These can be Cost Audit, Forensic Audit, Energy Audit, Due diligence
audit etc.
1.8 BASIC PRINCIPLES GOVERNING AN AUDIT
NSA-200 describes about ethical requirements as spelled out in Code of Ethics which govern the
auditor’s professional responsibilities and which should be complied with whenever an audit is
carried out. The basic principles are outlined below:
A. Integrity: Auditors should act with integrity, discharging their responsibilities with
honesty, fairness and truthfulness in all professional and business relationships.
Integrity helps to insulate auditors from matters of conflict of interests and elevate their
objectivity.
B. Objectivity and Independence: Auditors should not allow bias, conflict of interest or undue
influence of others to override professional or business judgments. They should express their
opinion independent of the entity and its directors
C. Professional Competence and due care: The auditor should perform professional services
with due care and competence and has a continuing duty to maintain professional knowledge
and skill at a level required to ensure that the client receives the advantage of competent
professional service. Auditing and Assurance activities demands understanding of financial

reporting and business issues, together with expertise in accumulating and assessing the
evidence necessary to form an opinion. So, auditor should exhibit competence and due care
derived from auditor’s education, experience and training.
D. Confidentiality: The auditor should respect the confidentiality of information acquired in

the course of auditor’s work and should not disclose any such information to a third party
without specific authority or unless there is a legal or professional duty to disclose.
E. Professional Behaviour: The auditor should act in a manner consistent with the good
reputation of the profession and refrain from any conduct that might bring discredit to the
profession.
1.9 RELATIONSHIP OF AUDITING WITH OTHER DISCIPLINES
As we discussed above, the audit is a logical process with linkages to various subject. The field of
auditing as a discipline in simple words involves review of various assertions; both in financial as
well as in non-financial terms. The relationships with few of the disciplines are as under:
a) Auditing and Accounting: - Accounting and auditing are closely related with each other
as auditing reviews the financial statements which are nothing but a result of the overall
accounting process. It naturally calls on the part of the auditor to have a thorough and sound
knowledge of generally accepted principles, accounting concepts, bases, and assumptions of
accounting before an auditor can review the financial statements.
b) Auditing and Law: - The relationship between auditing and law is very close one. Auditing
involves examination of various transactions from the view point of whether or not these
have been properly entered into with full compliance of relevant laws. It necessitates that
an auditor should have a good knowledge of business laws affecting the entity. an auditor
should be familiar with the law of contracts, company laws, banking laws and negotiable
instruments, etc.
c) Auditing and Economics: - This is well known fact that accounting is concerned with the
accumulation and presentation of data relating to economic activity. Though the concept of
income as put forward by economists is different as compared to the accountants’ concept of
income, still, there are lot of similar grounds on which the accounting has flourished. From
the auditing view point, the auditors are more concerned with Micro economics rather than
with the Macro economics. The knowledge of Macro economics should include the nature
of economic force that affect the firm, relationship of price, productivity and the role of
Government etc. Auditor is expected to be familiar with the demand, supply and overall
economic environment in which auditor’s client is operating.

AUDIT AND ASSURANCE
d) Auditing and Behavioural Science:- The discipline of behavioural science is also closely
linked with the subject of auditing. While it may be said that an auditor, particularly the
financial auditor, deals basically with the figures contained in the financial statements but
an auditor shall be required to interact with a lot of people in the organisation. As against
the financial auditor, the internal auditor or a management auditor is expected to deal with
human beings rather than financial figures. As it will be made clear in the chapter of ‘Internal
Control’ that one of the basic elements in designing the internal control system is personnel. In
that chapter, it has been made amply clear that howsoever a sound internal control structure
is designed, it cannot work until and unless the people who are working in the organisation
are competent and honest. The knowledge of human behaviour is indeed very essential for
an auditor so as to effectively discharge auditor’s duties.
e) Auditing and Statistics & Mathematics:- With the passage of time, test check procedures in
auditing have become part of generally accepted auditing procedures. With the emergence
of test check procedure, discipline of statistics has come quite close to auditing as the auditor
is also expected to have the knowledge of statistical sampling so as to arrive at meaningful
conclusions. The knowledge of mathematics is also required on the part of auditor particularly
at the time of verification of inventories.
f) Auditing and Data Processing: - Organisations are witnessing revolution in the field of
data processing of accounts. Many organisations are carrying out their financial accounting
activities with the help of computers which can document, record, collate, allocate and value
accounting data and information in very large quantity at very high speed. The dependence
on the accuracy of the programmed instructions given today, the computer is able to carry out
each of these activities with complete accuracy.
g) Auditing and Financial Management:- Auditing is also closely related with other
functional fields of business such as finance. With the overgrowing field of auditing,
the financial services sector occupies a dominant place in our system. While in general
terms, the auditor is expected to have knowledge about various financial management
techniques such as working capital management, funds flow, ratio analysis, capital
budgeting etc.
h) Auditing and Production: A good auditor is one who understands the client and auditor’s
business. While carrying out the audit activity, the auditor is required to evaluate transactions
from the accounting aspect in relation to the process through which it has passed through as
accounting for by-products; joint-products may also require to be done.

1.10 DIFFERENCE BETWEEN AUDITING AND RELATED FIELDS
a. Auditing and Accounting

Particulars Auditing Accounting
An independent examination of Accounting is the art of recording,
financial information of any entity classifying and summarizing
Meaning when such an examination is financial information, transaction
conducted with a view of expressing and events and preparation of
an opinion thereon. reports thereon.
Verification of underlying vouchers Recording of the transaction
and records and obtaining evidence from underlying vouchers and
Objective
on the true and fair view presented preparation of financial statement.
by financial statement
Auditor is appointed by the owners It the responsibility of the
of the entity. The responsibility management to maintain and
Responsibility is to be reviewed the accounting implement an effective accounting
and other control and express the system.
opinion.
Independent examination of the Measurement and communication
Deals with financial information prepared by of information to shareholders and
the management of the entity others user of the financial statement.
Aspects of Auditing review the efficacy of Accounting involves recording
transaction recording financial information. aspects of the financial information.
b. Auditing and Management

Particulars Auditing Management
An independent examination of An approach of getting things
financial information of any entity done from persons entrusted
when such an examination is with responsibility of various
conducted with a view of expressing organizational functions.
Meaning an opinion thereon. For example-
Day to day operation of sale
and purchase, managing human
resources and other resources,
tactical and strategic planning etc.
Propriety aspect is not considered. Propriety and efficiency are
Propriety considered as a quality of
management.

AUDIT AND ASSURANCE
Particulars Auditing Management

Verification of underlying vouchers Preparation of those vouchers and
and records and obtaining evidence doing jobs based upon objectives,
Objective on the true and fair view presented policies, procedures, structure,
by financial statement. control, system, resources and
results of an entity.
Auditor is appointed by the owners Generally Senior management
of the entity. The responsibility team is responsible. This includes,
Responsibility is to be reviewed the accounting CEO, General Manager, Managing
and other control and express the director etc.
opinion.
Independent examination of the Overall functioning and performance
Deals with financial information prepared by of the organization
the management of the entity
c. Auditing and Investigation

Investigation is a critical examination of the accounts with a special purpose. For example,
if fraud is suspected and an accountant is called upon to check the accounts to whether
fraud really exists and if so, the amount involved, the character of the enquiry changes into
investigation. Investigation may be undertaken in numerous areas of accounts, e.g., the extent
of waste and loss, profitability, cost of production, etc. It normally concerns only specified
areas, but at times, it may involve the whole field of accounting. Its essence lies in going into
the matter with some pre-conceived notion suited to the objective. The techniques fit the
circumstances of the case.
For auditing on the other hand, the general objective is to find out whether the accounts
show a true and fair view of the affairs of the entity. Audit never undertakes discovery of
specific happenings and is never started with a preconceived notion about the state of affairs.
The auditor seeks to report what an auditor finds in the normal course of examination of
the accounts adopting generally followed techniques unless circumstances call for a special
probe: fraud, error, irregularity, whatever comes to the auditor’s notice in the usual course
of checking, are all looked into in depth and sometimes investigation results from the prima
facie findings of the auditor.

The difference can be summarized as under:
Basis Audit Investigation

Objective To Judge truthfulness and fairness of financial To establish factual findings
statements
Scope Determined by laws and Auditing Standards By term of engagement
Period Generally yearly As per requirements
Nature General Detailed
Inherent More because of use of judgment and test Less because of detailed
limitation checking checking
Evidence Persuasive Conclusive
Reporting General purpose i.e. to all user of financial Confidential i.e. only to
statements needful person
Approval No doubtful approach Doubtful approach
By whom Chartered Accountants and Registered Auditors Expert person or team
having Certificate of Practice (COP)
1.11 QUALITIES OF AN AUDITOR
The qualities required are tact, caution, firmness, good temper, integrity, discretion, industry, judgment,
patience, clear headedness and reliability. In short, all those personal qualities contribute to be a good
auditor. In addition, s/he must have the shine of culture for attaining a great height. an auditor must
have the highest degree of integrity backed by adequate independence. An auditor must have a
thorough knowledge of the general principles of law which govern matters with which an auditor
is likely to be in intimate contact. an auditor must pursue an intensive programme of theoretical
education in subjects like financial and management accounting, general management, business and
corporate laws, computers and information systems, taxation, economics, etc. an auditor must be
honest that is, an auditor must not certify what an auditor does not believe to be true and must take
reasonable care and skill before an auditor believes that what an auditor certifies is true.
1.12 INTERNATIONAL AUDITING AND ASSURANCE STANDARDS

BOARD
Professional accountant should to adhere to standards and procedures laid down by the professional
accountancy bodies of which an auditor is a member while discharging auditor’s duties in a
responsible manner. In this respect, the role of a professional accounting body is to lay down
such standards and procedures with the aim of providing guidance to members. The Institute of
Chartered Accountants of Nepal (ICAN) has been issuing auditing and accounting standards for
the guidance of its members on its own volition in the larger interests of the society. In this chapter,
we provide an overview of auditing standards and guidance notes issued by the Institute from
time to time. Though these standards and guidance notes have been dealt at appropriate places,

AUDIT AND ASSURANCE
the main purpose is to acquaint and inculcate appreciation on the part of students in a focused
manner as to significance of the standards in their day to day auditing activities.
International Standards on Auditing

International Standards on Auditing (ISA) are professional standards for the performance of
financial audit of financial information. These standards are issued by International Federation of
Accountants (IFAC) through the International Auditing and Assurance Standards Board (IAASB).
The International Auditing and Assurance Standards Board (IAASB) is an independent standard-
setting body that serves the public interest by setting high-quality international standards
for auditing, assurance, and other related standards, and by facilitating the convergence of
international and national auditing and assurance standards. In doing so, the IAASB enhances the
quality and consistency of practice throughout the world and strengthens public confidence in the
global auditing and assurance profession.
IFAC is the global organization for the accountancy profession dedicated to serving the
public interest by strengthening the profession and contributing to the development of strong
international economies. IFAC is comprised of 175 members and associates in 130 countries and
jurisdictions, representing approximately 3.0 million accountants in public practice, education,
government service, industry, and commerce as on 2018.
IFAC provides the structures and processes that support the development, adoption, and
implementation of high quality international standards. The standards IFAC supports—in the
areas of auditing, assurance, and quality control; public sector accounting; accounting education;
and ethics—are an important part of the global financial infrastructure and contribute to economic
stability around the world. In addition, working closely with its member bodies, IFAC provides
tools and guidance to support professional accountants in business and small and medium
practices. IFAC supports the development of the accountancy profession in emerging economies,
and speaks out on public interest issues where the profession’s voice is most relevant. Through all
of these activities, IFAC promotes its values of integrity, transparency, and expertise.
ISA and NSA

In 2006 the Auditing Standards Board (AuSB) adopted an official position of convergence to ISAs
- aligning its agenda with that of the IAASB and using the ISAs as a base. AuSB started redrafting
Nepal Auditing Standards in line with relevant ISAs, including the Preface and Framework.
AuSB has formulated 37 NSAs in line with ISA and recommended for issue and application to the
Institute of Chartered Accountants of Nepal.
Auditing Standards Board

The International Federation of Accountants (IFAC) came into existence in 1977 and constituted
International Auditing Practices Committee (IAPC) to formulate International Auditing
Guidelines. These guidelines were later on converted into International Standards on Auditing

(ISA). Considering the developments in the field of auditing at international level, the need for
issuing Standards and Guidance Notes in tandem with international standards but conforming
to national laws, customs, usages and business environments was felt. With this objective, ICAN
constituted the Auditing Standards Board (AuSB) on March 10, 2003 by Government under
Nepal Chartered Accountants Act, 1997 (first amendment 2002) to spearhead the new framework
of Nepal Standard on Auditing (NSA) and Guidance Notes (GNs) inter alia to replace various
chapters of the old omnibus Auditing Standard. AuSB believes that the issue of such standards
will improve the degree of uniformity of auditing practices in Nepal. The main function of AuSB
is to review existing practices in Nepal and to develop Nepal Standards on Auditing (NSAs) so
that these may be issued and regulated by the Council of the ICAN. While formulating NSA(s),
the AuSB considers the applicable laws, customs, usages and business environments in Nepal. The
NSAs are issued under the authority of the Chartered Accountants Act, 1997 (first amendment
2002). The AuSB issues Guidance notes on the issues arising from the NSAs wherever necessary.
AuSB reviews and revises the NSAs at periodical intervals or as per the need of the respective
standards. The AuSB determines the broad areas in which the NSAs need to be formulated and
the priority in regards to the selection thereof.
The AuSB, till date, has formulated 37 Nepal Standards on Auditing and a practice note. It has
revised and updated its 36 NSAs and a new standard, NSA 701, has been introduced in 2018.
Scope and Functions of AuSB

 The main function of AuSB is to review existing practices in Nepal and to develop Nepal
Standards on Auditing (NSAs) so that these may be issued and regulated by the Council
of the ICAN.
 While formulating NSA(s), the AuSB will take into consideration the applicable laws,
customs, usage and business environments in Nepal.
 The NSAs will be issued under the authority of the Council of the ICAN.
 The AuSB will issue Guidance Notes on the issues arising from the NSAs wherever
necessary.
 AuSB will review the NSA(s) at periodical intervals.
Working Procedures of AuSB

 The AuSB will determine the broad areas in which the NSAs need to be formulated and
the priority in regard to the selection thereof.
 The quorum for a meeting is 51% of the total board members. Standards and statements
require approval of three quarter of members present at the meeting.
 The preparation of NSAs shall be in accordance with the working procedure formulated
by the AuSB.

AUDIT AND ASSURANCE
 The NSAs will be submitted by the AuSB to the Council to issue and regulate under the
authority of the ICAN.
Scope of the NSAs

The NSAs apply whenever an independent audit is carried out; that is, in the independent
examination of financial information of any entity, whether profit oriented or not, and irrespective
of its size, or legal form (unless specified otherwise) when such an examination is conducted with
a view to expressing an opinion. The NSAs may also have application, as appropriate, to other
related functions of auditors. Any limitation on the applicability of a specific NSA is made clear in
the introductory paragraph of the NSA. In short, the scope can be listed as under:
 The NSAs are to be applied in the audit of FS carried out with a view to expressing an
opinion.
 The NSAs may also have application as, appropriate, to other related functions of the
auditors.
 Any limitation of the applicability of a specific NSA will be made clear in the introductory
paragraph of the relevant NSAs.
Procedure for issuing NSAs

Broadly, the following procedure is adopted for the formulation and issuance of NSAs:
 The AuSB determines the broad areas in which the NSAs need to be formulated and the
priority in regard to the selection thereof.
 In the preparation of NSAs, the AuSB is assisted by Study Groups constituted to consider
specific subjects. In the formation of Study Groups, provision is made for participation of
a cross-section of members of the Institute.
 On the basis of the work of the Study Groups, an exposure draft of the proposed NSA is
prepared by the Committee and issued for comments by members of the Institute.
 After taking into consideration the comments received, the draft of the proposed NSA is
finalised by the AuSB and submitted to the Council of the Institute.
 The Council of the Institute considers the final draft of the proposed NSA, and, if
necessary, modifies the same in consultation with the AuSB. The NSA is then issued
under the authority of the Council.
Compliance with the NSA

 While discharging their attest function, the members of the ICAN are under obligation
to ensure that the NSAs are followed in the audit of FS covered by their audit reports.
 If a member is not able to perform an audit in accordance with the NSAs, auditor’s report
should draw attention to the material departures therefrom.

 Members are expected to follow NSAs in the audits commencing on or after the date
specified in the relevant NSA.
 The NSAs (as well as other statements on auditing) represent the generally accepted
procedure(s) of audit.
 A member, who does not perform auditor’s audit in accordance with these statements
and fails to disclose the material departures therefrom, becomes liable to the disciplinary
proceedings of the Nepal Chartered Accountants Act, 1997.
So far AuSB has issued the following standards and notes for implementations:
1.13 ORIGIN AND HISTORY OF AUDIT - NEPALESE PERSPECTIVE
In Nepal, the system of auditing and accounting is believed to have existed in our country long
back during the Lichhavi and Malla period. Since financial transactions were very few in numbers,
and audit on those days was simply a comparison of the records of the cash receipts and payments
with vouchers thereof. Looking back at the history of auditing in Nepal, the work of auditing
started after the establishment of the office named “Kumari Chowk Adda” in Baisakh 6, 1826
BS by late king Prithvi Narayan Shah. It was assigned the duty of examining the revenue and
expenditure of the country. Thus it can be said that Auditing began in Nepal in form of examining
governmental revenue and expenditure through “Kumari Chowk Adda”.
After the beginning of the Rana Regime in 1903 BS, Prime Minister Jung Bdr Rana made a provision
that every Office (Then called as Adda) has to submit the income and expenditure accounts to
“Kumari Chowk Adda” and take clearance from it. Further Prime Minister Chandra Shamsher
introduced a predetermined format and prescribed the time for Office (Adda) to submit Accounts
to “Kumari Chowk Adda”. “Kumari Chowk Adda” used to examine whether the expenditures
were made as per the prevailing provisions and rules. Further it was sanctioned to submit the list
of the dues along with the account report to Prime Minister.
After the political change in 2007 BS, Budget system was implemented in 2008 BS. For successful
implementation of budget system, the need for proper accounting and auditing was realized. Hence,
Accountant General’s Office was established in 2013 BS for maintaining booksof accountants in
government offices. However, the work of auditing of accounts remained with “Kumari Chowk
Adda”. Constitution of Kingdom of Nepal 2015 BS made the provision of Auditor General as a
constitutional body for auditing the books of Accounts of government offices and “Kumari Chowk
Adda” was assigned the duty of protecting old documents and disposing records.
After the political change in 217 BS, Auditing Act 2018 was enacted which provide Auditor
General (AG) an authority to register the auditors and to appoint auditor for fully owned stated
enterprises and to recommend auditors in case of partly owned government enterprises. It states
that the provision that AG to submit the result of annual audit to King. Further new accounting
system based on double entry system was implemented in Nepal from FY 2020/21.

AUDIT AND ASSURANCE
In the meantime after the adoption of liberalization policy in 2037 BS the country saw substantive
movement in area of Accounts and auditing as joint stock companies and joint venture companies
came into existence. Though significant improvement in Government and public sector auditing
was noticed after People Movement 2046 BS; Constitution of Nepal 2047 and Audit Act 2048 BS was
enacted. Further companies Act 2053 made compulsory audit of all companies and Audit report to be
presented in Annual General Meeting and submit the copy of same to Office of Company Registrar.
In 1984 AD, a group of Chartered Accountants gathered and formed an association called ‘The
Association of Chartered Accountants of Nepal’ and a joint association with Office of Auditor
General (OAGN), Government of Nepal (GON) enacted Nepal Chartered Accountants Act 1997
AD as an apex professional accounting body of Nepal. And now, Nepal Chartered Accountants
institute governs all the auditors (Chartered Accountants and Registered Auditors) and all other
audit related activities in private sector audits.
1.14 LATEST DEVELOPMENT IN AUDITING PROFESSION
a. Audit expectation gap

Auditing expectation gap or simply expectation gap is the term used to signify the difference
in expectations of users of financial statements and auditor’s expectation concerning audited
financial statements. Difference in expectation can arise on the performance i.e. the level of
performance what users expect from auditor and how auditor actually perform.
Expectation gap can also be explained as the difference between the effectiveness of audit
engagement what users believe and what auditor believes. Expectation gap in related to audit
can also be explained as the difference between expectation of user and auditor himself on the
responsibilities of the auditor. It can also be referred as difference in understanding regarding
nature of audit engagement i.e. what users believe audit is and what audit actually is.
Auditor is required to reduce audit risk to an acceptably low level to attain reasonable
assurance. But the precise definition and measurement of reasonable is different among
stakeholders and user of audit results, which is creating substantial expectation gap.
Gap is about what auditor expects and what others expect from the auditor. For last few years
this gap has been debated number of times at different forums and stakeholders have agreed
on reducing this gap as most of the time it has become basis of contention between client,
auditor and other users of financial statements. On careful analysis of this gap one of the
reasons that were critical in widening the gap is lack of understanding of different connected
factors. And this is not only a lacking on part of users of financial statements but also the
auditor sometimes. If efforts are invested in these areas then expectations can be bridged to
great extent.

One of the biggest reasons that have highlighted this gap is auditor’s responsibility to detect
fraud. When it comes to fraud, users require auditor to act as investigator and auditor is
expected to unearth even the most sophisticated fraud events. However, users do not agree
on explanation that auditor is not responsible to detect fraud it is management as they feel
auditor’s role is much more than just a confirmation of management’s assertions. This area is
still developing and audit as a profession is facing great challenges in this regard.
b. Quality Assurance Review

Quality Assurance Review means an examination and review of the systems and procedures
to determine whether they have been put in place by the practice unit for ensuring the quality
of attestation services as envisaged and implied/mandated by the Technical Standards and
whether these were effective or not during the period under review.
Peer review shall focus on:

 Compliance with Technical Standards.
 Quality of Reporting.
 Office systems and procedures with regard to compliance of attestation services systems
and procedures.
 Training Programs for staff (including Articled Trainees) concerned with attestation
functions, including appropriate infrastructure.
The Statement specifies the main objectives of peer review as under:
To ensure that members while performing attestation services comply with technical
standards laid down by the Institute;
- To ensure that such a member has in place proper system (including documentation
system) for maintaining the quality of attestation services performed by him;
- To ensure adherence to various statutory and other regulatory requirements; and
- To enhance the reliance placed by the users of financial statements for economic decision
making.
To conduct Quality Assurance review, ICAN has formed Quality Assurance Review Board,
which has already recruited a team of staff and developed review manual under Rule 103 of
ICAN Regulations 2061.
c. Quality audit
Quality audit is the process of systematic examination of a quality system carried out by an
internal or external quality auditor or an audit team. It is an important part of organization's
quality management system.

AUDIT AND ASSURANCE
Quality audits are typically performed at predefined time intervals and ensure that the
institution has clearly defined internal system monitoring procedures linked to effective
action. This can help determine if the organization complies with the defined quality system
processes and can involve procedural or results-based assessment criteria.
Audits are an essential management tool to be used for verifying objective evidence of
processes, to assess how successfully processes have been implemented, for judging the
effectiveness of achieving any defined target levels, to provide evidence concerning reduction
and elimination of problem areas. For the benefit of the organization, quality auditing should
not only report non-conformances and corrective actions, but also highlight areas of good
practice. In this way other departments may share information and amend their working
practices as a result, also contributing to continual improvement.
d. Relationship between Regulator and Auditor

Augmented business volume and complexity in Nepalese financial sector, regulator like
Nepal Rastra Bank and Insurance Boards has made concentrated, rigorous and powerful
supervision and regulation on financial sector. With increased role of regulator and growing
expectation of audit services, soothing relation between Auditor and regulator is the need of
today’s regulatory and auditing profession.
In many respects the regulator/supervisor and the auditor have complementary concerns
regarding the same matters though the focus of their concerns may be different. Nonetheless,
there are many areas where the work of the regulator and of the auditor can be useful to each
other. Management letters and long-form audit reports submitted by auditors can provide
supervisors with valuable insight into various aspects of operations. Also, auditors can obtain
helpful insights from information originating from the regulatory authority. Regulatory
authorities may also develop certain informal prudential ratios or guidelines which are made
available and which can be of assistance to auditors in performing analytical reviews.
There may be circumstances in which either the auditor or the regulator becomes aware of
information which an auditor believes is not available to, and which needs to be communicated
to, the other party. Such circumstances may, for example arise:
- Where the auditor becomes aware of facts which might endanger the existence of the
entity
- Where either the auditor or the regulator detects an indication of fraud at a senior level
- Where the auditor intends to resign in the course of an audit
- Where the auditor has an irreconcilable difference of view with management over a
material aspect of the financial statements, as a results of which an auditor is intending
to issue an audit opinion which is not unqualified

- Where the regulator has information which can materially affect the financial statements
or the auditor's report; and
- Where the auditor believes a matter should be communicated to the regulator/supervisor

and management has failed to make such communication when requested to do so.
Licensing conditions have been complied with
- The transactions which have come to the auditor's attention in the course of the audit are
in accordance with specified laws applicable
- The systems for maintenance of accounting and other records and/or the systems of
internal control are adequate
Cooperation among the supervisory authority, the external auditors and the internal auditors
as required by Basel committee on Banking Supervision (BCBS):
Principle 13
Bank supervisors should evaluate the work of the bank’s internal audit department and, if
satisfied, can rely on it to identify areas of potential risk.
Principle 16
Supervisory authorities should encourage consultation between internal and external auditors in order
to make their cooperation as efficient and effective as possible.
Principle 18
Cooperation among the supervisor, the external auditor and the internal auditor aims to make the work
of all concerned parties more efficient and effective. The cooperation may be based on periodic meetings
of the supervisor, the external auditor and internal auditor.
Some example of relationship of regulator and ICAN

- Joint meeting with ICAN/ASB regarding implementation of IFRS in banking sector
- A committee is formed by the ICAN to make fully convergent to the directive no 4

where; NRB senior representative is also a member. This committee is formed on request
of NRB.
- An interaction program on branch audit concept was jointly organized with ICAN and
NRB inviting Bankers at the premises of NRB.
- Organizing informal meeting with the auditors regarding the accounting issues.
e. Enron and Sarbanes-Oxley Act

The Sarbanes-Oxley Act 2002 is aimed primarily at public accounting firms who participate in
audits of corporations. It was passed in response to a number of corporate accounting scandals

AUDIT AND ASSURANCE
that occurred between 2000 /2002. This Act set new standards for public accounting firms,
corporate management, and corporate boards of directors. The intent of the SOX Act was to
protect investors, and really all stakeholders in a business firm, by improving the accuracy
and reliability of corporate disclosures, such as earnings reports, pursuant to securities laws
and regulations.
Purpose of Sarbanes-Oxley Act

The SOX Act holds listed company’s CEOs and CFOs responsible for the information
presented by their company in financial statements. Sarbanes-Oxley provides for increased
corporate governance and corporate accountability.
f. Financial crisis and the silence of the auditors

External audit is promoted as a trust engendering technology to persuade the public that
capitalist corporations and management are not corrupt and those companies and their
directors are made accountable. However, let’s take an example of Lehman Brothers, who
received an unqualified audit opinion on its annual accounts on 28 January 2008, followed by
a clean bill of health on its quarterly accounts on 10 July 2008. However, by early August it
was experiencing severe financial problems and filed for bankruptcy on 14 September 2008.
Bankruptcy of the bank led to the global financial crisis. In this regards, the silence of the
internal and external auditors was widely questioned. Also, in numbers of banks, within
certain days of receiving unqualified audit opinions they were found seeking financial
support from the state.
This financial crisis raises some old and new questions about auditing practices. It shows that
either auditors are reluctant to qualify bank accounts for fear of creating panic or jeopardizing
their liability position or unable to meet the standards as required. This financial crisis has
required the auditor to rethink about the services they have been offering.

Self-Evaluation Questions
Question 1 Distinguish between audit and assurance.
Question 2 Do you agree with the view that there are inherent limitations of Audit? If yes, what
are they?
Question 3 How is Auditing and Behavioral Science related to each other?
Question 4 Briefly explain the Elements of Assurance.
Question 5 The essence of investigation lies in going into the matter with some pre-conceived
notion suited to the objective. Explain.

AUDIT AND ASSURANCE

CHAPER 2 : REGULATORY AND ETHICAL ISSUES
CHAPTER 2
REGULATORY AND
ETHICAL ISSUES
To be able to:
 Explain the need for laws, regulations, standards and other

guidance relating to audit.
 Outline and explain the need for the legal and professional
framework for ethics
 Explain current developments in auditing standards.
 Discuss other current legal, ethical, other professional and

practical matters that affect accountants, auditors, their employers
and the profession.

AUDIT AND ASSURANCE
BACKGROUND
Accounting profession has a great role to play in promoting financial accountability which
ultimately contributes to good corporate governance. Auditing and assurance as widely practiced
wing of accounting profession, specially, has to gain credibility and be trustworthy towards
various stakeholders. To provide high quality audit, assurance and related services, the profession
needs to be regulated. Regulatory framework includes legal provision relating to audit and
independent regulatory body. In Nepal, various laws contain provisions relating to audit. The
Institute of Chartered Accountants of Nepal (ICAN) is established to regulate the profession under
a law of the parliament.
2.1 REGULATORY FRAMEWORK
Different industry and sector related laws contain provisions regarding accounts and audit.
In this chapter, we will discuss various provisions laid down in Company Act, 2063 and Bank
and Financial Institutions Act (BAFIA), 2073. Similarly, Local Government Operation Act, 2074,
Education Act, 2074 and regulations there under and Cooperative Act 2074 contain provisions
regarding audit of respective sector. However, they are not dealt in this chapter. Students may
refer relevant laws for further information.
Subject to the legal environment, accounting profession regulators issue financial reporting
standards, standards on auditing, assurance and related services. They further issue code of ethics
to be complied by their member in carrying out accounting profession.
1. COMPANIES ACT, 2063

Chapter 8 of Companies Act, 2063 deals with audit of books of accounts of companies which
have been explained in detail in Chapter 7 of this book.
Similalry, Chapter 18 of Companies Act, 2063 deals with Audit Committee which have been
explained in detail in Chapter 4 of this book.
2. BANKS AND FINANCIAL INSTITUTIONS ACT, 2073 [BAFIA 2073]

Requirement for preparation of Annual Accounts
A bank or a financial institution which has obtained the license to carry on financial
transactions pursuant to this act is called as licensed institution. Further, license means the
license issued by the Nepal Rastra Bank to a bank or financial institution to carry on financial
transactions, pursuant to this Act.
The provisions relating to preparation of financial statements are given in section 59 which
deals with preparation of balance sheet, profit and loss account and audit thereon. The
following are the sub-sections of the section 59:

(1) A licensed institution shall prepare its balance sheet, profit and loss account, cash flow
statement and other financial statements, as well, in such format and in accordance with
such procedure as may be prescribed by the Rastra Bank.
(2) A licensed institution shall, no later than five months after the expiry of a financial year,
prepare its balance sheet, profit and loss account, cash flow statement and other financial
statements, as well, in such format and in accordance with such procedure as may be
prescribed by the Rastra Bank and have them audited. Such financial statements shall be
signed by at least two directors, the chief executive and the auditor.
(3) If any licensed institution which has failed to have its accounts audited within the period
referred to in Sub-section (2) makes a request, accompanied by a reasonable reason, for
an extension of the period for audit, the Rastra Bank may extend a period of not more
than three months.
(4) The Rastra Bank may appoint an auditor to audit the accounts of a licensed institution
which fails to have its accounts audited even within the period referred to in Sub-section
(3).
(5) The auditor appointed pursuant to Sub-section (4) shall submit a report of audit
performed by him or her to the concerned licensed institution and the Rastra Bank.
(6) The auditor appointed pursuant to Sub-section (4) shall receive such remuneration as
prescribed by the Rastra Bank. It shall be the duty of the concerned licensed institution
to pay to the auditor so appointed the remuneration prescribed by the Rastra Bank.
Appointment of auditor:
Section 63 of the Act provides the following provisions regarding appointment and
appointment of auditor:-
(1) The general meeting of a bank or financial institution shall appoint an auditor.
(2) The General Meeting shall not appoint the same auditor for more than three consecutive
times.
(3) While appointing an auditor from amongst the auditors included in the list of auditors
approved by the Rastra Bank, the general meeting shall appoint a Chartered Accountant
in the case of a licensed institution of Class “A” or “B” or “C”, and a chartered accountant
or a registered auditor in the case of a licensed institution of Class “D”.
(4) The Rastra Bank shall appoint the auditor if the bank or financial institution did not or
could not appoint the auditor as pursuant to sub-section (1).
(5) In case the post of auditor remains vacant due to any reason, then for remaining period
the Board of Directors shall appoint another auditor.

AUDIT AND ASSURANCE
Disqualification for appointment as auditor [Section 64].

Any of the following persons or any firm, company or institution in which such person is a
promoter or partner shall not be eligible to be appointed as an auditor of a bank or financial
institution:
(a) A promoter, director, chief executive of a bank or financial institution or his\her family
member,
(b) An officer, employee or internal auditor of the bank or financial institution,
(c) A person working as a partner of director, chief executive or employee of the bank or
financial institution,
(d) A borrower, a person having significant ownership or associate person of the bank or
financial institution or person having financial interests,
(e) A person who has been declared insolvent in Nepal or abroad,
(f) A person, firm, company or institution having subscribed one percent or more shares of
the bank or financial institution,
(g) A person, who has been punished in any criminal offense by the court and a period of
five years has not been lapsed after he\she has served the punishment,
(h) A person, who is disqualified to be appointed as an auditor according to prevailing laws.
If any person appointed as auditor of bank or financial institution is found to be ineligible to

get appointment as auditor, his/her appointment shall be deemed to have been automatically
cancelled.
Returns to be submitted [Section 65]

A bank or financial institution shall, at all time, provide all such accounts, records, books,
ledgers and other related statements to such documents for auditing as demanded by the
auditor in the course of performing audit.
The officer, responsible for providing such returns or repliers as demanded, shall furnish
forthwith accurate returns and repliers to the queries made by the auditor.
Functions, duties and powers of auditor [Section 66]

The functions, duties and powers of the auditor shall be as follows:-
(a) To conduct audit of accounts and financial statements,
(b) To prepare and submit audit report including audited accounts, balance-sheet, and profit
and loss accounts to the Board of Directors of bank or financial institution,

(c) If it is found that there are irregularities in functions and activities of the bank or financial
institution or the functions are not being carried out in appropriate manner and such
matters could cause harm or loss to the bank or financial institution, to inform the same
to the Board of Directors,
(d) To inform the Rastra Bank, if there is probability of occurence of any of the following
situations:-
(1) Violation of the terms and conditions prescribed by the Rastra Bank during issuance
of the license or this Act or rules, byelaws, directives framed under this Act,
(2) To cause adverse effect on regular functions and activities of the bank or financial
institution,
(3) To prohibit the auditor to submit the audit report or force to submit false audit
report.
The auditor has authority to examine all documents and records concerning accounts
including ledger, books, account, voucher, at any time and the auditor can demand necessay
information and explanation from officer of a bank or financial institution on matters required
by him/her in the course of performing his/her duties and carrying out his/her functions in
appropriate manner.
The auditor shall have to include the following matters in his/her report clearly:-
(a) Whether or not replies to the queries as asked by him or her were given,
(b) Whether or not the balance sheet, off-balance sheet transactions, profit and loss account,
cash flow statement and other financial statements, as well, have been prepared in such
format and in accordance with such procedures as prescribed by the Rastra Bank, and
whether or not they coresspond to the accounts, records, books and ledgers maintained
by the bank and financial institution,
(c) Whether or not the accounts, records, books and ledgers have been maintained accurately
in accordance with the laws in force
(d) Whether or not any officer of the bank or financial institution has done any act contrary
to the laws in force or committed any irregularity or caused any loss or damage to the
bank or financial institution,
(e) Whether or not credits have been written off as per the Credit Write-off Byelaws or
directives of the Rastra Bank,
(f) Whether or not the transactions of the bank or financial institution have been carried on
in a satisfactory manner as prescribed by the Rastra Bank,
(g) Matters which should be made known to the shareholders,

AUDIT AND ASSURANCE
(h) Matters prescribed by the laws in force and other matters as prescribed by the Rastra
Bank as required to be mentioned in audit report by the auditor,
(i) Other suggestions, which the auditor deems necessary to be furnished.
Upon receipt of the audit report, the Rastra Bank may order the auditor of the bank or financial
institution to carry out the following additional functions:-
(a) To submit additional information as required by the Rastra Bank in regards to auditing,
(b) To expand the areas of auditing of transcations of the bank or financial institution or its
subsidiary company,
(c) To conduct other examinations as recommended to the bank or financial institution or

as required by the Rastra Bank in any particular subject.
Recommendation for taking actions against auditor [Section 67]

The Rastra Bank shall recommend the concerned regulating authority to remove name of an
auditor, who does not perform his/her duties as per this Act, from the panel of the auditors
such that to prohibit him/her to carry out audit of any bank or financial institution for one
year to three years.
In case of recommendation pursuant to sub-section (1), the concerned regulating body shall
take actions against such auditor as per the prevailing laws.
Auditor to certify [Section 68]

The auditor shall mark the accounts, records, books and ledgers audited by him/her by
affixing his /her signature thereon and also mentioning therein the date on which he/she has
audited them.
3. NEPAL FINANCIAL REPORTING STANDARDS (NFRS) AND INTERPRETATIONS

NFRS refers to Nepal Financial Reporting Standards. The Accounting Standards Board (ASB),
as a standards setting body of NFRS, develops a single set of high quality, understandable,
enforceable and globally accepted Nepal Financial Reporting Standards (NFRSs).
NFRSs set out recognition, measurement, presentation and disclosure requirements dealing
with transactions and events that are important in general purpose financial statements. They
may also set out such requirements for transactions and events that arise mainly in specific
industries. NFRSs are based on the Conceptual Framework, which addresses the concepts
underlying the information presented in general purpose financial statements.
NFRSs apply to all general purpose financial statements. Such financial statements are directed
towards the common information needs of a wide range of users, for example, shareholders,
creditors, employees and the public at large. The objective of financial statements is to

provide information about the financial position, performance and cash flows of an entity
that is useful to those users in making economic decisions.
The ASB is the independent standard-setting body of the NFRSs.
Benefits of NFRS
There are many benefits of implementing NFRS which can be broadly divided into 3 main
parts – Economy, Investors and the Industry.
Benefits to the Economy

As the market expands globally, the need for a global standard is also increasing.
Implementation of NFRS benefits the economy by increasing the growth of its international
business. It facilitates the maintenance of orderly and efficient capital markets and also helps
to increase the capital formation and thereby economic growth.
Benefits to the Investors

Investors who are willing to invest abroad want information which is more relevant, reliable,
timely and comparable across various jurisdictions. Financial statements prepared using
a common set of accounting standards help investors better understand the investment
opportunities as opposed to financial statements prepared using a different set of national
accounting standards.
For better understanding of financial statements, global investors have to incur more costs in
terms of the time and efforts to convert the financial statements so that they can confidently
compare opportunities. Investor’s confidence would be strong if the accounting standards
used are globally accepted. Convergence with NFRS contributes to investors understanding
and confidence in high quality financial statements.
Benefits to the Industry

A major push towards implementation of NFRS has been coming from the Industry. The
reason for the same is that the industry would be able to raise capital from foreign markets at
a lower cost if it can create confidence in the minds of the foreign investor that their financial
statements comply with globally accepted accounting standards.
With diversity in accounting standards from country to country, enterprises which operate
in different countries face a multitude of accounting requirements prevailing in different
countries. The burden of financial reporting is lessened with convergence of accounting
standards because it simplifies the process of preparing the individual and group financial
statements and thereby reduces the cost of preparing the financial statements.

AUDIT AND ASSURANCE
Audit and NFRS

Adoption or Convergence to NFRS is challenge to auditors as well as management. Following
are the consideration for auditors:
 Assessing the information needs of the entity
 Considering the mechanisms in place to prevent or detect fraud and error in the
restatement of comparative data, choices of accounting treatment and use of fair value
 Recording properly and accurate judgment applied and conclusion reached
 Timeliness and quality of transition process
 Communication of plan to enable discussion on conversion considerations with the

Board, Audit Committee and management
Assistance by auditors
Auditors can assist the management and the entity in the following ways:
 Assist with conversion/adoption project coordination
 Provide input into the client’s project team
 Provide insight on accounting policies
 Develop and deliver training
 Audit the adjustments required
 Practical experience with NFRS
 Access to wealth of global resources.
4. QUALITY CONTROL
A major challenge faced by practitioner is to consistently deliver high quality audit and
assurance and other services. The quality of work performed by the practitioner affects his
credibility and ultimately the reputation of the profession. Therefore, it is required to design
a system of quality control which is appropriate to the circumstances and which responds to
the risks to quality of the work. In this regards, the objective of the quality control policies to
be adopted by a practitioner firm should ordinarily consider the following:
(a) Professional Requirements: Personnel in the firm are to adhere to the principles of,
integrity, objectivity, confidentiality, professional competence and due care and
professional behavior.
(b) Skills and Competence: The firm is to be staffed by personnel who have attained and
maintained the technical standards and professional competence required enabling
them to fulfill their responsibilities with due care.

(c) Assignment: Audit work is to be assigned to personnel who have the degree of technical
training and proficiency required in the circumstances.
(d) Delegation: There is to be sufficient direction, supervision and review of work at all levels
to provide reasonable assurance that the work performed meets appropriate standards
of quality.
(e) Consultation: Whenever necessary, consultation within or outside the firm is to occur
with those who have appropriate expertise.
(f) Acceptance and Retention of Clients: An evaluation of prospective clients and a review,
on an ongoing basis, of existing clients is to be conducted.
The objective of quality control is to guide the firm and provide it with reasonable assurance
that:
(a) The firm and its personnel comply with professional standards and applicable legal and
regulatory requirements; and
(b) Reports issued by the firm or engagement partners are appropriate in the circumstances.
NSA 220 - Quality Control for Audits of Historical Financial Information provides that the
engagement team should implement quality control procedures that are applicable to the
individual audit engagement.
Firms Responsibility to establish a system of quality control

Under Nepal Standard on Quality Control (NSQC) 1, “Quality Control for Firms that Perform
Audits and Reviews of Historical Financial Information, and Other Assurance and Related
Services Engagements,” a firm has an obligation to 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 the auditors’ reports
issued by the firm or engagement partners are appropriate in the circumstances.
The system of quality control that includes policies and procedures that address each of
following elements: leadership responsibilities for quality within the firm, relevant ethical
requirements, acceptance and continuance of client relationships and specific engagements,
human resources, engagement performance and monitoring.
Leadership Responsibilities for Quality on Audits

The firm shall establish policies and procedures designed to promote an internal culture
recognizing that quality is essential in performing engagements. Such policies and procedures
shall require the firm’s chief executive officer (or equivalent) or, if appropriate, the firm’s
managing board of partners (or equivalent) to assume ultimate responsibility for the firm’s
system of quality control.

AUDIT AND ASSURANCE
The engagement partner should take responsibility for the overall quality on each audit
engagement to which that partner is assigned. The engagement partner sets an example
regarding audit quality to the other members of the engagement team through all stages
of the audit engagement. Ordinarily, this example is provided through the actions of the
engagement partner and through appropriate messages to the engagement team.
Relevant Ethical Requirements

The engagement partner should consider whether members of the engagement team have
complied with ethical requirements. The engagement partner remains alert for evidence of
non-compliance with ethical requirements. The Code of Ethics issued by the ICAN establishes
the fundamental principles of professional ethics, which include:
(a) Integrity;
(b) Objectivity;
(c) Professional competence and due care;
(d) Confidentiality; and
(e) Professional behavior.
Independence
The engagement partner should form a conclusion on compliance with independence
requirements that apply to the audit engagement. While ensuring this engagement partner
should:-
1) Obtain relevant information from the firm and, where applicable, network firms, to
identify and evaluate circumstances and relationships
2) Evaluate information on identified breaches, if any, of the firm’s independence policies

and procedures to determine whether they create a threat to independence for the audit
engagement;
3) Take appropriate action to eliminate such threats or reduce them to an acceptable level
by applying safeguards.
4) Document conclusions on independence and any relevant discussions with the firm that
support these conclusions.
Acceptance and Continuance of Client Relationships and Specific Engagements

The engagement partner should be satisfied that appropriate procedures regarding the
acceptance and continuance of client relationships have been followed and that conclusions
reached in this regard are appropriate and have been documented. Acceptance and
continuance of client relationships and specific audit engagements include considering:

a) The integrity of the principal owners, key management and those charged with
governance of the entity;
b) Whether the engagement team is competent to perform the audit engagement and has
the necessary time and resources; and
c) Whether the firm and the engagement team can comply with ethical requirements.
Where the engagement partner obtains information that would have caused the firm to
decline the audit engagement if that information had been available earlier, the engagement
partner should communicate that information promptly to the firm, so that the firm and the
engagement partner can take the necessary action.
Human Resources
The firm should establish policies and procedures designed to provide it with reasonable
assurance that it has sufficient personnel with the competence, capabilities, and commitment
to ethical principles necessary to perform engagements.
Assignment of Engagement Teams

The engagement partner should be satisfied that the engagement team collectively has the
appropriate capabilities, competence and time to perform the audit engagement in accordance
with professional standards and regulatory and legal requirements, and to enable an auditor’s
report that is appropriate in the circumstances to be issued.
The appropriate capabilities and competence expected of the engagement team as a whole
include the following:
• An understanding of, and practical experience with, audit engagements of a similar

nature and complexity through appropriate training and participation.
• An understanding of professional standards and regulatory and legal requirements.
• Appropriate technical knowledge, including knowledge of relevant information

technology.
• Knowledge of relevant industries in which the client operates.
• Ability to apply professional judgment.
• An understanding of the firm’s quality control policies and procedures.
Engagement Performance
The engagement partner should take responsibility for the direction, supervision and
performance of the audit engagement in compliance with professional standards and
regulatory and legal requirements, and for the auditor’s report that is issued to be appropriate
in the circumstances.

AUDIT AND ASSURANCE
The engagement partner directs the audit engagement by informing the members of the
engagement team of:
(a) Their responsibilities;
(b) The nature of the entity’s business;
(c) Risk-related issues;
(d) Problems that may arise; and
(e) The detailed approach to the performance of the engagement.
Partner ensures adequate supervision of the audit work by the following:
a) Tracking the progress of the audit engagement
b) Capabilities, competence of the staff and time allotted to them
c) Addressing significant issues arising during the audit engagement
d) Identifying matters for consultation or consideration by more experienced engagement

team members during the audit engagement
Before the auditor’s report is issued, the engagement partner, through review of the audit
documentation and discussion with the engagement team should be satisfied that sufficient
appropriate audit evidence has been obtained to support the conclusions reached and for the
auditor’s report to be issued.
The engagement partner conducts timely reviews at appropriate stages during the
engagement.
Consultation
The engagement partner should:
• Be responsible for the engagement team undertaking appropriate consultation on

difficult or contentious/controversial matters;
• Be satisfied that members of the engagement team have undertaken appropriate

consultation during the course of the engagement
• Be satisfied that the nature and scope of, and conclusions resulting from, such
consultations are documented and agreed with the party consulted; and
• Determine that conclusions resulting from consultations have been implemented.
Differences of Opinion
Where differences of opinion arise within the engagement team, with those consulted and,
where applicable, between the engagement partner and the engagement quality control

reviewer, the engagement team should follow the firm’s policies and procedures for dealing
with and resolving differences of opinion.
Engagement Quality Control Review

For audits of financial statements of listed entities, the engagement partner should:
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; and
c. Not issue the auditor’s report until the completion of the engagement quality control
review.
An engagement quality control review should include an objective evaluation of:
(a) The significant judgments made by the engagement team; and
(b) The conclusions reached in formulating the auditor’s report.
An engagement quality control review for audits of financial statements of listed entities
includes considering the following:
a) The engagement team’s evaluation of the firm’s independence in relation to the specific
audit engagement.
b) Significant risks identified during the engagement.
c) Judgments made, particularly with respect to materiality and significant risks.
d) Whether appropriate consultation has taken place on matters involving differences of

opinion or other difficult or contentious matters, and the conclusions arising from those
consultations.
e) The significance and disposition of corrected and uncorrected misstatements identified

during the audit.
f) The matters to be communicated to management and those charged with governance

and, where applicable, other parties such as regulatory bodies.
g) Whether audit documentation selected for review reflects the work performed in relation
to the significant judgments and supports the conclusions reached.
h) The appropriateness of the auditor’s report to be issued.

AUDIT AND ASSURANCE
5. SCOPE AND TERMS OF AN ASSURANCE ENGAGEMENT

Scope of an Assurance Engagement
Scope of assurance engagement in some cases may be regulated through legal provisions.
However, in some other cases it is regulated through agreed terms between parties. Where
engagement is regulated by the law, it should be done as required by the law, and in other
cases, care should be given to the responsible party's responsibility, practitioner's professional
standards and code of ethics and intended user's requirements. In particular, the practitioner
should comply, subject to the legal provisions, the professional pronouncements of ICAN;
Code of Ethics, and Professional Standards.
Terms of an Engagement
The legal requirement to get the accounts audited does not extend to all entities. Where law
governs the appointment of auditors and their duties, the responsibility is quite simple.
However, audit becomes matter of contract in case where audit is not specifically required
by laws. The client tells the auditor the nature of service he requires and the auditor, if he
is agreeable to undertake the assignment, specifies his terms. He must sign an agreement,
if he accepts the work in terms of the agreement subject to professional standards... It is
of the greatest importance, both for the auditor and client, that each party should be clear
about the nature of the engagement i.e., it must be reduced in writing and should exactly
specify the scope of the work. The audit engagement letter is sent by the auditor to his client
who documents the objective and scope of the audit, the extent of his responsibilities to the
client and the form of report. The ICAN has issued NSA 210 ‘Agreeing the terms of Audit
Engagements’ on this subject. It is in the interest of both the auditor and the client to issue
an engagement letter so that the possibility of misunderstanding is reduced to a great extent.
Audit Engagement Letters

Engagement letters are the letter of understanding between the auditor and client to avoid
any misunderstanding. NSA requires sending on engagement letter, preferably before
commencement of engagement. Thus, following points are relevant as given in NSA 210:
 The auditor and the client should agree on the terms of the engagement.
 The agreed terms would need to be recorded in an audit engagement letter/contract or

other suitable form of written agreement.
 It is to be signed preferably before the commencement of the engagement, to help in

avoiding misunderstandings with respect to the engagement.
Contents of engagement letter

Engagement letter generally include reference to:
 The objective of the audit of financial statements

 The responsibilities of the auditor
 Management's responsibility Identification of applicable financial reporting framework

for the preparation of the financial statements
 Scope of the audit, including reference to applicable legislation, regulations or

pronouncements of ICAN.
 The form of any reports or other communication of results of the engagement
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of any accounting and internal control system, there is an
unavoidable risk that even some material misstatement may remain undiscovered, even
though the audit is properly planned and performed in accordance with NSAa.
 Unrestricted access to whatever records, documentation and other information requested

in connection with the audit.
Following points may also be included in such letter/contract:-
 Arrangements regarding the planning and performance of audit, including the audit
team.
 Expectation that management will provide written representations.
 The agreement of management to make available to the auditor draft financial statements
and any accompanying other information in time to allow the auditor to complete the
audit in accordance with the proposed timetable.
 The agreement of management to inform the auditor of facts that may affect the financial
statements, of which management may become aware during the period from the date
of the auditor’s report to the date financial statements are issued.
 Request for the client to confirm the terms of the engagement by acknowledging receipt
of the engagement letter.
 Description of any other letters or reports the auditor expects to issue to the client.
 Basis on which fees are computed and any billing arrangement.
 Wherever relevant, the following points could also be incorporated:
 Arrangements concerning the involvement of other auditors and experts in some aspects
of the audit.
 Arrangements concerning the involvement of internal auditors and other client staff.
 Arrangements to be made with the predecessor auditor, if any, in the case of an initial
audit.

AUDIT AND ASSURANCE
 Any restriction of the auditor's liability when such possibility exists.
 A reference to any further agreements between the auditor and the client.
Audits of Components
When the auditor of a parent entity is also the auditor of its subsidiary, branch or division
(component), the factors that influence the decision whether to send a separate engagement
letter to the component include:
 Who appoints the auditor of the components
 Whether a separate audit report is to be issued on the component
 Legal requirements in relation to audit appointments
 Degree of ownership by parent; and
 Degree of independence of the component's management from the parent company.
Recurring Audits/Ongoing Audits

The auditor may decide not to send a new engagement letter each period. Auditor should
access the need whether circumstances require the terms of the engagement to be revised and
whether there is a need to remind the client of the existing terms of the engagement.
However, in case of the following it is appropriate to send a new letter:
a. Any indication that the client misunderstands the objective and scope of the audit
b. Any revised or special terms of the engagement
c. A recent change of senior management, board of directors or ownership
d. A significant change in nature or size of the client's business
e. A change in legal or regulatory requirements.
f. A change in the financial reporting framework adopted in preparation of financial

statements
g. A change in other reporting requirements.
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. A request from the entity to change the terms of audit
engagement may result from a change in circumstances affecting the need for the 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 other circumstances. The
auditor considers the justification given for such request, particularly the implications of a

restriction on the scope of the audit engagement. A change may not be considered reasonable
if it appears that the change relates to information that is incorrect, incomplete or otherwise
unsatisfactory.
 If, prior to completing the audit engagement, an auditor is requested to change terms
of the engagement to one which provides a lower level of assurance, the auditor shall
consider the appropriateness of doing so.
 Where it is changed the auditor and the client should agree on the new terms and record
the new terms in an engagement letter or other suitable form of written agreement.
When auditor is unable change and unable to continue with original terms of engagement
If the auditor is unable to agree to a change of the engagement and is not permitted to continue
the original engagement, the auditor should withdraw and consider whether there is any
obligation, either contractual or otherwise, to report to board of directors or shareholders, the
circumstances necessitating such withdrawal.
2.2 CODE OF ETHICS
a. Code of Ethics for Professional Accountants
The International Code of Ethics for Professional Accountants (including International

Independence Standards) (“the Code”) sets out fundamental principles of ethics for
professional accountants, reflecting the profession’s recognition of its public interest
responsibility. These principles establish the standard of behavior expected of a professional
accountant. The fundamental principles are: integrity, objectivity, professional competence
and due care, confidentiality, and professional behavior.
The Code provides a conceptual framework that professional accountants are to apply in order
to identify, evaluate and address threats to compliance with the fundamental principles. The
Code sets out requirements and application material on various topics to help accountants
apply the conceptual framework to those topics.
In the case of audits, reviews and other assurance engagements, the Code sets out International
Independence Standards, established by the application of the conceptual framework to
threats to independence in relation to these engagements.
ICAN, being member organisation of IFAC, adopts same principles and ICAN has issued
a Circular on Shrawan 01, 2076 for ‘Handbook of the code of Ethics for professional
Accountants, 2018’ being applicable from Shrawan 1, 2076. The 2018 edition of the handbook
is completely rewritten under a new structure and drafting convention that makes the Code
easier to navigate, use and enforce. The Code incorporates several substantive additions and
revisions.

AUDIT AND ASSURANCE
Structure of the Code

The code includes four parts. Part 1 deals with complying with the code, fundamental
principles and conceptual framework, Part 2 deals with codes applicable to professional
accountants in business, Part 3 deals with codes applicable to professional accountants in
public practice and Part 4 (Part 4A and 4B) deals with independence standards.
Objectives of code of ethics

The Code recognizes that the objectives of the accountancy profession are to work to the
highest standards of professionalism, to attain the highest levels of performance and generally
to meet the public interest requirement set out above. These objectives require four basic
needs to be met:
• Credibility: - In the whole society there is a need for credibility in information and
information systems.
• Professionalism: - There is a need for individuals who can be clearly identified by clients,
employers and other interested parties as professional persons in the accountancy field.
• Quality of Services: - There is a need for assurance that all services obtained from a
professional accountant are carried out to the highest standards of performance.
• Confidence: - Users of the services of professional accountants should be able to feel

confident that there exists a framework of professional ethics which governs the provision
of those services.
Note: Students are requested to download full text of Handbook of Code of Ethics for Professional
Accountants issued by the ICAN from www.ican.org.np and read it thoroughly.

GENERAL INTRODUCTION TO CODE OF ETHICS

( PART 1 – Complying With The Code, Fundamental Principles And Conceptual Framework )
COMPLYING WITH THE CODE [SECTION 100 ]

General
A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in
the public interest. A professional accountant’s responsibility is not exclusively to satisfy the needs
of an individual client or employing organization. Therefore, the Code contains requirements and
application material to enable professional accountants to meet their responsibility to act in the
public interest.
Breaches of the Code

A professional accountant who identifies a breach of any other provision of the Code shall
evaluate the significance of the breach and its impact on the accountant’s ability to comply with
the fundamental principles. The accountant shall also:
a) Take whatever actions might be available, as soon as possible, to address the consequences
of the breach satisfactorily; and
b) Determine whether to report the breach to the relevant parties.
THE FUNDAMENTAL PRINCIPLES [SECTION 110]

General
There are five fundamental principles of ethics for professional accountants:
(a) Integrity – to be straightforward and honest in all professional and business relationships.
(b) Objectivity – not to compromise professional or business judgments because of bias,

conflict of interest or undue influence of others.
(c) Professional Competence and Due Care – to:
(i) 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
(ii) Act diligently and in accordance with applicable technical and professional
standards.
(d) Confidentiality – to respect the confidentiality of information acquired as a result of

professional and business relationships.

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(e) Professional Behavior – to comply with relevant laws and regulations and avoid any
conduct that the professional accountant knows or should know might discredit the
profession.
A professional accountant shall comply with each of the fundamental principles.
The fundamental principles of ethics establish the standard of behavior expected of a professional
accountant. The conceptual framework establishes the approach which an accountant is required
to apply to assist in complying with those fundamental principles. Subsections 111 to 115 set out
requirements and application material related to each of the fundamental principles.
A professional accountant might face a situation in which complying with one fundamental
principle conflicts with complying with one or more other fundamental principles. In such a
situation, the accountant might consider consulting, on an anonymous basis if necessary, with:
• Others within the firm or employing organization.
• Those charged with governance.
• A professional body.
• A regulatory body.
• Legal counsel.
However, such consultation does not relieve the accountant from the responsibility to exercise
professional judgment to resolve the conflict or, if necessary, and unless prohibited by law or
regulation, disassociate from the matter creating the conflict.
The professional accountant is encouraged to document the substance of the issue, the details of
any discussions, the decisions made and the rationale for those decisions.
INTEGRITY [SUBSECTION 111]

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:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information provided recklessly; or
(c) Omits or obscures required information where such omission or obscurity would be
misleading.

When a professional accountant becomes aware of having been associated with information
described in paragraph R111.2, the accountant shall take steps to be disassociated from that
information.
OBJECTIVITY [SUBSECTION 112]

A professional accountant shall comply with the principle of objectivity, which requires an
accountant not to compromise professional or business judgment because of bias, conflict of
interest or undue influence of others.
A professional accountant shall not undertake a professional activity if a circumstance or

relationship unduly influences the accountant’s professional judgment regarding that activity.
PROFESSIONAL COMPETENCE AND DUE CARE [SUBSECTION 113]

A professional accountant shall comply with the principle of professional competence and due
care, which requires an accountant to:
(a) 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
(b) Act diligently and in accordance with applicable technical and professional standards.
Serving clients and employing organizations with professional competence requires the exercise
of sound judgment in applying professional knowledge and skill when undertaking professional
activities.
Maintaining professional competence requires a continuing awareness and an understanding of

relevant technical, professional and business developments. Continuing professional development
enables a professional accountant to develop and maintain the capabilities to perform competently
within the professional environment.
Diligence encompasses the responsibility to act in accordance with the requirements of an

assignment, carefully, thoroughly and on a timely basis.
In complying with the principle of professional competence and due care, a professional
accountant shall take reasonable steps to ensure that those working in a professional capacity
under the accountant’s authority have appropriate training and supervision.
Where appropriate, a professional accountant shall make clients, the employing organization, or
other users of the accountant’s professional services or activities, aware of the limitations inherent
in the services or activities.

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CONFIDENTIALITY [SUBSECTION 114]

A professional accountant shall comply with the principle of confidentiality, which requires an
accountant to respect the confidentiality of information acquired as a result of professional and
business relationships. An accountant shall:
(a) Be alert to the possibility of inadvertent disclosure, including in a social environment,

and particularly to a close business associate or an immediate or a close family member;
(b) Maintain confidentiality of information within the firm or employing organization;
(c) Maintain confidentiality of information disclosed by a prospective client or employing

organization;
(d) Not disclose confidential information acquired as a result of professional and business
relationships outside the firm or employing organization without proper and specific
authority, unless there is a legal or professional duty or right to disclose;
(e) Not use confidential information acquired as a result of professional and business
relationships for the personal advantage of the accountant or for the advantage of a third
party;
(f) Not use or disclose any confidential information, either acquired or received as a result
of a professional or business relationship, after that relationship has ended; and
(g) Take reasonable steps to ensure that personnel under the accountant’s control, and
individuals from whom advice and assistance are obtained, respect the accountant’s
duty of confidentiality.
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 in the knowledge
that the information will not be disclosed to a third party. Nevertheless, the following are
circumstances where professional accountants are or might be required to disclose confidential
information or when such disclosure might be appropriate:
a) Disclosure is required by law, for example:
i) Production of documents or other provision of evidence in the course of legal

proceedings; or
ii) Disclosure to the appropriate public authorities of infringements of the law that
come to light
b) Disclosure is permitted by law and is authorized by the client or the employing

organization and
c) There is professional duty or right to disclose, when not permitted by law:

i. To comply with the quality review of a professional body
ii. To respond to an inquiry or investigation by professional or regulatory body
iii. To protect the professional interests of a professional accountant in legal proceedings;

or
iv. To comply with technical and professional standards, including ethics requirements.
In deciding whether to disclose confidential information, factors to consider, depending on the

circumstances, include:
• Whether the interests of any parties, including third parties whose interests might
be affected, could be harmed if the client or employing organization consents to the
disclosure of information by the professional accountant.
• Whether all the relevant information is known and substantiated, to the extent practicable.
• The proposed type of communication, and to whom it is addressed.
• Whether the parties to whom the communication is addressed are appropriate recipients.
A professional accountant shall continue to comply with the principle of confidentiality even after
the end of the relationship between the accountant and a client or employing organization. When
changing employment or acquiring a new client, the accountant is entitled to use prior experience
but shall not use or disclose any confidential information acquired or received as a result of a
professional or business relationship.
PROFESSIONAL BEHAVIOR [SUBSECTION 115]

A professional accountant shall comply with the principle of professional behavior, which 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 business, 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.
Conduct that might discredit the profession includes conduct that a reasonable and informed third
party would be likely to conclude adversely affects the good reputation of the profession.
When undertaking marketing or promotional activities, a professional accountant shall not bring
the profession into disrepute. A professional accountant shall be honest and truthful and shall not
make:
(a) Exaggerated claims for the services offered by, or the qualifications or experience of, the
accountant; or
(b) Disparaging references or unsubstantiated comparisons to the work of others.

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If a professional accountant is in doubt about whether a form of advertising or marketing is

appropriate, the accountant is encouraged to consult with the relevant professional body.
THE CONCEPTUAL FRAMEWORK [SECTION 120]

a. Introduction
The circumstances in which professional accountants operate might create threats to compliance
with the fundamental principles. Section 120 sets out requirements and application material,
including a conceptual framework, to assist accountants in complying with the fundamental
principles and meeting their responsibility to act in the public interest. Such requirements and
application material accommodate the wide range of facts and circumstances, including the
various professional activities, interests and relationships, that create threats to compliance
with the fundamental principles. In addition, they deter accountants from concluding that a
situation is permitted solely because that situation is not specifically prohibited by the Code.
The conceptual framework specifies an approach for a professional accountant to:

(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the threats identified; and
(c) Address the threats by eliminating or reducing them to an acceptable level.
b. Requirements and Application Material

General
The professional accountant shall apply the conceptual framework to identify, evaluate and
address threats to compliance with the fundamental principles set out in Section 110.
Additional requirements and application material that are relevant to the application of the
conceptual framework are set out in:
(a) Part2- Professional Accountants in Business;
(b) Part3- Professional Accountants in Public Practice; and
(c) International Independence Standards, as follows:
(i) Part4A-Independence for Audit and Review Engagements; and
(ii) Part4B-Independence for Assurance Engagements Other than Audit and Review
Engagements
When dealing with an ethics issue, the professional accountant shall consider the context
in which the issue has arisen or might arise. Where an individual who is a professional
accountant in public practice is performing professional activities pursuant to the accountant’s
relationship with the firm, whether as a contractor, employee or owner, the individual shall
comply with the provisions in Part 2 that apply to these circumstances.

When applying the conceptual framework, the professional accountant shall:
(a) Exercise professional judgment;
(b) Remain alert for new information and to changes in facts and circumstances; and
(c) Use the reasonable and informed third party test described in paragraph 120.5 A4.
Exercise of Professional Judgment

Professional judgment involves the application of relevant training, professional knowledge,
skill and experience commensurate with the facts and circumstances, including the nature and
scope of the particular professional activities, and the interests and relationships involved.
In relation to undertaking professional activities, the exercise of professional judgment is
required when the professional accountant applies the conceptual framework in order to
make informed decisions about the courses of actions available, and to determine whether
such decisions are appropriate in the circumstances.
An understanding of known facts and circumstances is a prerequisite to the proper application

of the conceptual framework. Determining the actions necessary to obtain this understanding
and coming to a conclusion about whether the fundamental principles have been complied
with also require the exercise of professional judgment.
Reasonable and Informed Third Party

The reasonable and informed third party test is a consideration by the professional
accountant about whether the same conclusions would likely be reached by another party.
Such consideration is made from the perspective of a reasonable and informed third party,
who weighs all the relevant facts and circumstances that the accountant knows, or could
reasonably be expected to know, at the time the conclusions are made.
Identifying Threats
The professional accountant shall identify threats to compliance with the fundamental
principles. An understanding of the facts and circumstances, including any professional
activities, interests and relationships that might compromise compliance with the fundamental
principles, is a prerequisite to the professional accountant’s identification of threats to such
compliance. The existence of certain conditions, policies and procedures established by the
profession, legislation, regulation, the firm, or the employing organization that can enhance
the accountant acting ethically might also help identify threats to compliance with the
fundamental principles. Paragraph 120.8 A2 includes general examples of such conditions,
policies and procedures which are also factors that are relevant in evaluating the level of
threats.
Threats to compliance with the fundamental principles fall into one or more of the following
categories:

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(a) Self-interest threat – the threat that a financial or other interest will inappropriately
influence a professional accountant’s judgment or behavior;
(b) Self-review threat – the threat that a professional accountant will not appropriately
evaluate the results of a previous judgment made; or an activity performed by the
accountant, or by another individual within the accountant’s firm or employing
organization, on which the accountant will rely when forming a judgment as part of
performing a current activity;
(c) Advocacy threat – the threat that a professional accountant will promote a client’s or
employing organization’s position to the point that the accountant’s objectivity is
compromised;
(d) Familiarity threat – the threat that due to a long or close relationship with a client, or
employing organization, a professional accountant will be too sympathetic to their
interests or too accepting of their work; and
(e) Intimidation threat – the threat that a professional accountant will be deterred from
acting objectively because of actual or perceived pressures, including attempts to exercise
undue influence over the accountant.
A circumstance might create more than one threat, and a threat might affect compliance with
more than one fundamental principle.
Evaluating Threats
When the professional accountant identifies a threat to compliance with the fundamental
principles, the accountant shall evaluate whether such a threat is at an acceptable level.
Acceptable Level
An acceptable level is a level at which a professional accountant using the reasonable and
informed third party test would likely conclude that the accountant complies with the
fundamental principles.
Factors Relevant in Evaluating the Level of Threats

The consideration of qualitative as well as quantitative factors is relevant in the professional
accountant’s evaluation of threats, as is the combined effect of multiple threats, if applicable.
The existence of conditions, policies and procedures described in paragraph 120.6 A1

might also be factors that are relevant in evaluating the level of threats to compliance with
fundamental principles. Examples of such conditions, policies and procedures include:
• Corporate governance requirements.
• Educational, training and experience requirements for the profession.

• Effective complaint systems which enable the professional accountant and the general
public to draw attention to unethical behavior.
• An explicitly stated duty to report breaches of ethics requirements.
• Professional or regulatory monitoring and disciplinary procedures.
Consideration of New Information or Changes in Facts and Circumstances

If the professional accountant becomes aware of new information or changes in facts and
circumstances that might impact whether a threat has been eliminated or reduced to an
acceptable level, the accountant shall re-evaluate and address that threat accordingly.
Remaining alert throughout the professional activity assists the professional accountant in
determining whether new information has emerged or changes in facts and circumstances
have occurred that:
(a) Impact the level of a threat; or
(b) Affect the accountant’s conclusions about whether safeguards applied continue to be
appropriate to address identified threats.
Addressing Threats
If the professional accountant determines that the identified threats to compliance with the
fundamental principles are not at an acceptable level, the accountant shall address the threats
by eliminating them or reducing them to an acceptable level. The accountant shall do so by:
(a) Eliminating the circumstances, including interests or relationships, that are creating the
threats;
(b) Applying safeguards, where available and capable of being applied, to reduce the threats
to an acceptable level; or
(c) Declining or ending the specific professional activity.
Actions to Eliminate Threats

Depending on the facts and circumstances, a threat might be addressed by eliminating the
circumstance creating the threat. However, there are some situations in which threats can
only be addressed by declining or ending the specific professional activity. This is because the
circumstances that created the threats cannot be eliminated and safeguards are not capable of
being applied to reduce the threat to an acceptable level.
Safeguards
Safeguards are actions, individually or in combination, that the professional accountant takes
that effectively reduce threats to compliance with the fundamental principles to an acceptable
level.

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Consideration of Significant Judgments Made and Overall Conclusions Reached

The professional accountant shall form an overall conclusion about whether the actions
that the accountant takes, or intends to take, to address the threats created will eliminate
those threats or reduce them to an acceptable level. In forming the overall conclusion, the
accountant shall:
(a) Review any significant judgments made or conclusions reached; and
(b) Use the reasonable and informed third party test.
Considerations for Audits, Reviews and Other Assurance Engagements

Independence
Professional accountants in public practice are required by International Independence Standards to
be independent when performing audits, reviews, or other assurance engagements. Independence
is linked to the fundamental principles of objectivity and integrity. It comprises:
(a) Independence of mind – the state of mind that permits the expression of a conclusion
without being affected by influences that compromise professional judgment, thereby
allowing an individual to act with integrity, and exercise objectivity and professional
skepticism.
(b) Independence in appearance – the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party would be likely to conclude that
a firm’s or an audit or assurance team member’s integrity, objectivity or professional
skepticism has been compromised.
Professional Skepticism
Under auditing, review and other assurance standards, including those issued by the IAASB,
professional accountants in public practice are required to exercise professional skepticism
when planning and performing audits, reviews and other assurance engagements. Professional
skepticism and the fundamental principles that are described in Section 110 are inter-related
concepts.
In an audit of financial statements, compliance with the fundamental principles, individually and
collectively, supports the exercise of professional skepticism, as shown in the following examples:
• Integrity requires the professional accountant to be straightforward and honest. For

example, the accountant complies with the principle of integrity by:
(a) Being straightforward and honest when raising concerns about a position taken by
a client; and

(b) Pursuing inquiries about inconsistent information and seeking further audit
evidence to address concerns about statements that might be materially false or
misleading in order to make informed decisions about the appropriate course of
action in the circumstances.
In doing so, the accountant demonstrates the critical assessment of audit evidence that contributes
to the exercise of professional skepticism.
• Objectivity requires the professional accountant not to compromise professional or

business judgment because of bias, conflict of interest or the undue influence of others.
For example, the accountant complies with the principle of objectivity by:
(a) Recognizing circumstances or relationships such as familiarity with the client, that
might compromise the accountant’s professional or business judgment; and
(b) Considering the impact of such circumstances and relationships on the accountant’s
judgment when evaluating the sufficiency and appropriateness of audit evidence
related to a matter material to the client’s financial statements.
In doing so, the accountant behaves in a manner that contributes to the exercise of professional
skepticism.
• Professional competence and due care requires the professional accountant to have
professional knowledge and skill at the level required to ensure the provision of competent
professional service, and to act diligently in accordance with applicable standards, laws
and regulations. For example, the accountant complies with the principle of professional
competence and due care by:
(a) Applying knowledge that is relevant to a particular client’s industry and business
activities in order to properly identify risks of material misstatement;
(b) Designing and performing appropriate audit procedures; and
(c) Applying relevant knowledge when critically assessing whether audit evidence is
sufficient and appropriate in the circumstances.
In doing so, the accountant behaves in a manner that contributes to the exercise of professional
skepticism.

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PROVISION OF CODE OF ETHICS ON ICAN ACT 1997,
As mentioned on Section 34 of ICAN Act 1997, Members of ICAN should observe the following
code of conduct:
- Members and members holding Certificate of Practice shall fully abide this Act and the
Regulations framed under this Act.
- Auditing, either in partnership or in collusion in any manner with a person who has not
obtained the Certificate of Practice of one's class, is prohibited.
- One shall not share or distribute as profit the auditing fees or remuneration with any
person other than a member of the Institute; and shall not pay any commission, brokerage
etc. out of the professional fees earned to any person or member.
- One shall not, directly or indirectly, influence any person by way of fear, threat, terror or
enticement in order to secure any professional business.
- One shall not disclose or divulge any information and explanations acquired in the
course of professional service to any person other than the employer employing him and
the person whom he is compiled by the law to do so.
- Members holding Certificate of Practice shall not certify any financial statement or give
report of any type until they or their partner or employee checks and verifies it.
- Member holding Certificate of Practice shall, while certifying financial statements or

making report thereon of any corporate body in which he or his partner has interest,
clearly mention the extent of his or his partner's interest therein.
Provided that being merely a shareholder in a company shall not be deemed to have interest therein.
- Member holding Certificate of Practice shall, in order to truly present the financial
statement certified by him, clearly indicate all the material facts or any false statements
or explanations known to him or to the best of his knowledge.
- Members holding Certificate of Practice shall discharge their duties with due care in the
course of their profession and shall draw attention of all concerned to all material facts
which are or have taken place contrary to the prevailing law and do not comply with
generally accepted principles of auditing.
- Members holding Certificate of Practice shall not base their remuneration as a percentage
on the profit or on any other uncertain results.
- One shall not knowingly or recklessly mention any false matter in a notice, explanation
or statement required under the prevailing law to be provided to any office, department
of Nepal Government or any organization.

- One shall not perform audit of accounts of any organization where he has served until
the elapse of at least three years of his leaving the service.
- A member holding Certificate of Practice shall not accept his appointment as an auditor
of an organization without ascertaining that all required procedures for appointment as
the auditor under the prevailing law has been duly fulfilled.
- One should have obtained sufficient information prior to give audit opinion.
Other matters concerning the conduct to be observed by the members and members holding
Certificate of Practice shall be as prescribed
Process of filing complaints against member and members holding certificated of practice:
The concerned person may lodge complaint to the Institute of Chartered Accountants of Nepal
against any member or member holding Certificate of Practice for not upholding the conduct
mentioned in this Act or the Regulations framed under this Act or for violation of this Act or
Regulations framed under this Act. The person can give application showing all the available
evidence and paying a fee of Rs. 100. However, no fee is required if the complainant is any
Government agencies or other entity where council has waived such fee. The Executive Director
shall, if he finds convincing information that proves any member or member holding Certificate
of Practice is not observing the conduct, submit the proposal along with the related facts to the
Council for further action against such member or member holding Certificate of Practice.
The council if finds the complaints convincing, the complaint is placed in the disciplinary
committee for further discoveries and recommendation.
Disciplinary Committee
Pursuant to Section 14 of ICAN Act, a Disciplinary Committee, comprising of following 7 members,
shall be constituted to recommend the Council to take necessary actions after investigation upon
complaints lodged against any action, contrary to the Chartered Accountants Act or Regulations
or code of conduct framed under this Act, rendered by any member, or the Institute receives any
information of such kind -
A FCA member designated by council from amongst elected CA council members Chairman
Three persons nominated by the Council from amongst the Council members Member
Two persons nominated by the Council amongst the members Member
One person nominated by the Auditor General Member
The chairman or members shall not be allowed to attend any meeting that hears complaint against
the Chairman or member of the Disciplinary Committee for their actions contrary to this Act or the
Regulations, Byelaws or code of conduct framed under this Act. The Procedures of the meeting of
the Disciplinary Committee and the term of office of the chairman and members of the committee
shall be as prescribed.

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The Disciplinary committee shall have the authority, similar to a judicial court, in respect of
summoning concerned person and investigating evidences and witnesses.
The Disciplinary committee shall recommend to the Council, along with its opinion and finding,
for necessary action against a member, if found guilty, and the council may, considering such a
recommendation, impose any of the following punishment according to the degree of offence:
a. Reprimanding,
b. Removing from the membership for a period up to five years,
c. Prohibiting from carrying on the accounting profession for any particular period,
d. Cancellation of the Certificate of Practice (COP) or membership.
Any Council member against whom the Disciplinary Committee, after investigating upon the
complaint of his action contrary to the Act or Regulations, Bye –laws or code of conduct framed
under the Act, has decided to recommend the Council to take necessary action, shall not be allowed
to attend and to vote at the Council meeting where the Council is hearing at such recommendation.
Before imposing any punishment, the Council shall provide reasonable opportunity to the
concerned members to submit their clarification. The concerned member may, if he is not satisfied
with the decision, file an appeal in the Appellate Court.
c. Other Circulars Issued by ICAN

Notwithstanding anything contained herein before at different places, sections or points of
code of ethics of IESAB, the provisions of above mentioned laws, rules, regulations, directives,
and pronouncement of ICAN shall override the respective conflicting provisions of code of
ethics of IESAB which has been adopted by ICAN.
Cases or points for explanation:
 Regarding the Internal audit, the ICAN earlier decision prohibits the statutory auditor to
undertake such assignments.
 Likewise non-assurance engagements/assignments relating to provide other accounting

or professional services assuming the responsibility of the management shall be
prohibited.
 While offering services members are prohibited to participate in any tendering or

quoting lower fee for that professions/services than the fees/remuneration of their
previous auditor /professional accountants in public practice, without assigning and
communicating reasonable grounds for such reduction to those charged with governance.
 Regarding the rotation of audit, the provisions of company act 2063 is applicable whereby
auditors are not allowed to undertake any audit / assurance assignment of the public
limited company for more than 3 years.

i. Ceiling over the number of audit (Mandatory from 2067.04.01)

A member holding COP can audit the books of accounts of a maximum 100 clients only, in
a financial year. Out of these 100 clients, number of Public Companies shall not exceed 15.
The above limit is applicable for each member of a partnership firm. Provided, organizations
whose annual turnover is less than NRs. 2 lakhs, such as small Cooperatives, Religious
organizations, Social Organizations, Consumer Group, Different Committees, Trade
Unions, Professional Associations and other entities of similar nature are not included while
calculating the above limit.
ii. Engagement as an employee

The following provision is recommendatory from Shrawan 1, 2068.
To maintain the status and dignity of Chartered Accountants, all the Chartered Accountant
members of the Institute are advised not to accept appointment in a position lower than as
mentioned below:
 Government Entity and Corporations - Officer (2nd Class)
 Other Organizations - Managerial Level
However, where any person has entered into an agreement with an entity for an agreed
period to pursue his Chartered Accountancy Course, then this provision is not applicable to
him for the agreed period.
iii. Branch Audit (Recommendatory from financial year 2067/68)

Branch audit of Banks shall be conducted for the year beginning from financial year 2067/68.
Branch having 2% or more Deposit and/ or Credit of the bank should be audited every year
and other branch should be audited at least once in every three years. The audit committee of
the concerned bank may be entrusted to appoint independent branch auditors and fix their
remuneration.
iv. About Designation of members (Effective from 2067.01.29)

All the members of the Institute shall use the word CA or RA as the case may be before their
name in their professional documents. They may also use such designation before their name
in other documents.
v. Accounting profession by foreign citizen

Any foreign national who wants to do accounting professional and who has had all the
required qualification as mentioned in ICAN Act/rules may do so by entering in a partnership
with a Nepali citizen. The nature and extent and limit of the accounting profession for such
accounting firm shall be as decided by the Council.

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vi. Special Provision regarding Partnership

 Every partner of the firm must hold COP
 One firm can have a maximum 20 partners
 A member having his own proprietorship firm can be a partner in not more than
two accounting firms at a time. But he has to get approval of every partner to run his
proprietorship firm.
 Partnership of foreign accounting firm is not counted for this purpose
 Remaining partner must inform ICAN if there is any change in the composition of the
partner, within 35 days of such change.
 The member can use the word partner if he is one of the partners of the firm
vii. Name Plate and Sign Board

The professional accountant shall not use sign board/ hoarding board of a size greater than (2
feet X 3.5 feet). They shall not mention any words or symbols other than their name, certificate
number. Address, contact number and designation.
The professional accountant may keep a name plate disclosing his name and the professional
qualification in his residence. But sign board can be kept only at the office.
Professional accountant shall not use logo with special symbols on their own. They can
use name of the firm only, no additional symbol may be used. They may use logo/symbol
approved by the council.
viii. Special provision regarding Anti Money Laundering (AML) issued by Nepal Rastra Bank
Financial Information Unit (NRB-FIU)
Professional Accountant should conduct a Customer Due Diligence (CDD) as required by
Financial Action Task Force (FATF) in following situations:
Professional accountants – when they prepare for or carry out transactions for their client
concerning the following activities:
- buying and selling of real estate;
- managing of client money, securities or other assets;
- management of bank, savings or securities account;
- organization of contributions for the creation, operation or management of companies;
- Creation, operation or management of legal persons or arrangements, and buying and

selling of business entities.

Customer Due Diligence (CDD) includes following:
- Keeping and verifying identification document of the key persons (Directors/ owners/
senior management personnel)
- The address of the registered office, and, if different, a principal place of business
- Appointing a contact person in firm and communicating the details of the contact person
to Financial Information Unit (FIU) of NRB
- Make a suspicious transaction report (STR) to the financial intelligence unit (FIU)
However, accountants acting as independent legal professionals, are not required to report
suspicious transactions if the relevant information was obtained in circumstances where they
are subject to professional secrecy or legal professional privilege.
2.3 SOME DISCIPLINARY CASES
Given below are examples of some of the Disciplinary cases, where the council has decided to take
action against its members on recommendation of the Disciplinary Committee. Only facts of the
cases and decisions taken by the Council are given in brief.
Case 1:
The respondent, a registered auditor issued audit report without being legally appointed as
auditor and without verifying the books of accounts, knowing that the company has another
legally appointed statutory auditor. He pleaded that he issued the audit report on request for Visa
processing and that the report had not harmed anybody, and that it was his mistake and that he
will not repeat such mistakes in future.
The respondent was found compromising the provisions of Sec. 34(6) of the Nepal Chartered Accountants
Act,2053 which requires that members holding Certificate of Practice shall not certify any financial
statement or give report of any type until they or their partner or employee check and verify it. He was
also found compromising the provisions of Sec. 34 (9) of Nepal Chartered Accountants Act which requires
that members holding Certificate of Practice shall discharge their duties with due care in the course of
their profession and shall draw attention of all concerned to all material facts which are or have taken place
contrary to the prevailing law and do not comply with generally accepted principles of auditing. Further he
was found compromising the code of ethics.
On these grounds the Registered Auditor was held guilty of professional misconduct.
Case 2:
The respondent, a registered auditor issued three audit reports for same financial year on three
different dates and the figures in the financial statements are also different. One of the audit
reports was issued even before the date mentioned in the balance sheet.

AUDIT AND ASSURANCE
The auditor was found compromising seriously the code of ethics and the generally accepted
auditing principles and thus held guilty of professional misconduct.
Case 3:
The respondent, a Chartered Accountant issued audit report of a bank without any qualification
where, the bank while accepting the nonbanking assets,
a. did not charge the difference amount to the Income Statement as loss even though the
market value of the collateral was found lower than the principal amount, and
b. Charged the difference amount to the Income Statement as income where the market
value of the collateral was found higher than the total of loan and interest amount,
though the assets were not actually sold.
The auditor was found compromising the provisions of Sec.34(9) of the Nepal Chartered
Accountants Act 2053 which requires that members holding Certificate of Practice shall discharge
their duties with due care in the course of their profession and shall draw attention of all concerned
to all material facts which are or have taken place contrary to the prevailing law and do not comply
with generally accepted principles of auditing. The auditor was also found compromising the
provisions of clause 12 of the Code of Ethics 2060. Further, the auditor was found not complying the
Accounting Policy on Non-banking assets given in the Clause 2.5 of Part B “Principle Accounting
Policies” of the “NRB directives on the Accounting Policies and Format of Financial Statements”.
Thus, the Chartered Accountant was held guilty of professional misconduct by the Council.
Case 4:
The respondent, a Chartered Accountant issued audit report of a bank without any qualification
where, the bank has not set aside 20% of its net profit to the General Reserve as required by the
then Banking and Financial Institution Ordinance. The respondent pleaded that the profit was
very negligible and immaterial amount, so the transfer was not made.
The auditor was found compromising the provisions of Sec. 34(9) of the Nepal Chartered
Accountants Act 2053 which require that members holding Certificate of Practice shall discharge
their duties with due care in the course of their profession and shall draw attention of all concerned
to all material facts which are or have taken place contrary to the prevailing law and do not comply
with generally accepted principles of auditing.
He was found violating the mandatory provisions of Sec 44 of the then Banking Financial
Institutions Ordinance which required the transfer of 20% of the net profit to the General Reserve
every year unless the balance in the General Reserve becomes double than thepaid up capital.
On these grounds, the Chartered Accountant was held guilty of professional misconduct.

Case 5:
The respondent, a Registered Auditor after completing the statutory audit of two consecutive
years, issued audit report for further two years though he was not appointed as auditor for
those last two years. He signed the audit report of those last two years mentioning himself as the
representative of the statutory auditor.
The auditor was found violating the provisions of Sec. 34(13) of the Nepal Chartered Accountants
Act 2053 which requires that a member holding Certificate of Practice shall not accept his
appointment as an auditor of an organization without ascertaining that all required procedures
for appointment as the auditor under the prevailing law has been duly fulfilled.
Thus the Registered Auditor was held guilty of professional misconduct by the Council.
Case 6 :
The respondent, a Chartered Accountant issued audit reports for those financial years for which
audit was already completed by other auditors and Tax Returns were already filed based on
those reports. The figures in the two sets of reports were different. The respondent was also given
responsibility of preparing the Financial Statements for those financial years. The respondent
pleaded that the previous auditors gave false reports and board has not approved those
financial statements, his appointment as auditor was declared lawful by Company Law Board,
communication to previous auditors tried but not successful, he has not prepared the financial
statements, there was mistake in the appointment letter which includes preparation of financial
statements also and he informed to client about this.
The auditor was found compromising the provisions of Sec. 34 (13) of the Nepal Chartered Accountants Act,
2053 which requires that a member holding Certificate of Practice shall not accept his appointment as an
auditor of an organization without ascertaining that all required procedures for appointment as the auditor
under the prevailing law has been duly fulfilled. The auditor was also found compromising the provisions
of section 34 (9) of the Act which requires that members holding Certificate of Practice shall discharge their
duties with due care in the course of their profession and shall draw attention of all concerned to all material
facts which are or have taken place contrary to the prevailing law and do not comply with generally accepted
principles of auditing. Further, he was found not complying the clause 13(23) of the Code of Ethics 2060.
On these grounds, the Chartered Accountant was held guilty of professional misconduct by the Council.
Case 7:
The respondent, a Registered Auditor conducted the audit of a school for F/Y 2061/62, and issued
report, but in the Receipt and Payment account of the School for financial 2061/62, the receivable
amount of2060/61 was shown as receipt and the receivable amount of 2061/62 was shown as
payment, and thus the cash balance was understated. The auditor when informed about this
rejected to make any correction.

AUDIT AND ASSURANCE
The auditor was found compromising the provisions of section 34 (9) of the Nepal Chartered Accountants
Act which requires that members holding Certificate of Practice shall discharge their duties with due care in
the course of their profession and shall draw attention of all concerned to all material facts which are or have
taken place contrary to the prevailing law and do not comply with generally accepted principles of auditing.
Thus the Registered auditor was held guilty of professional misconduct.
Case 8:
The respondent, a registered auditor issued report on the financial statements of a school where
the financial statements were not approved by the management. He has not informed to the Board
about the audit. Also, he has not maintained proper documentation of his audit work as required
by the auditing standards.
The auditor was held guilty of professional misconduct.
Case 9:
The respondent, a registered auditor issued two different audit reports for same financial year of
a client for continuous three years.
The auditor was held guilty of professional misconduct.
Case 10:
A registered auditor member gave all the necessary documents together with the required fee to
renew his membership and COP to another registered auditor member. The other registered auditor
member did not renew his membership and COP in ICAN, but gave him false renewal certificates.
The other registered auditor member was found cheating another member and thus held guilty of professional
misconduct.
Case 11:
The respondent, a Chartered Accountant issued audit report of a company for financial year
2065/066 but he failed to comment on the compliance/noncompliance of the applicable Nepal
Accounting Standards. Also the Chartered Accountant could not show his working papers and
supporting documents sufficient to prove that he had carried out the audit in accordance with
Nepal Standards on Auditing.
The auditor was found compromising the provisions of Sec. 34 (9) of the Nepal Chartered Accountants Act
2053 which requires that members holding Certificate of Practice shall discharge their duties with due care in
the course of their profession and shall draw attention of all concerned to all material facts which are or have
taken place contrary to the prevailing law and do not comply with generally accepted principles of auditing.
Similarly the auditor was found compromising the provisions of clause 12 of the ICAN Code of Ethics 2060,
which requires that a Professional Accountant should carry out professional services in accordance with the

technical and professional standards and that Professional accountants have a duty to carry out with care
and skill the instructions of the client in so far as they are compatible with the requirements of integrity,
objectivity, and independence and that they should confirm with the technical and professional standards
promulgated by the Nepal Accounting Standards Board, Nepal Auditing Standards Board, ICAN or other
regulatory body, and relevant legislation.
On these grounds the auditor was held guilty of professional misconduct.
Case 12:
The respondent, a Registered Auditor issued audit report of a company for financial year 64-65.
But he failed to comment on the compliance/noncompliance of the applicable Nepal Accounting
Standards. Also the Auditor could not show his working papers and supporting documents
sufficient to prove that he had carried out the audit in accordance with Nepal Standards on
Auditing.
The auditor was found compromising the provisions of Section 34(9) of the Nepal Chartered Accountants
Act 2053 which requires that members holding Certificate of Practice shall discharge their duties with due
care in the course of their profession and shall draw attention of all concerned to all material facts which
are or have taken place contrary to the prevailing law and do not comply with generally accepted principles
of auditing. Similarly the auditor was found compromising the provisions of clause 12 of the ICAN Code
of Ethics 2060, which requires that a Professional Accountant should carry out professional services in
accordance with the technical and professional standards and that Professional accountants have a duty
to carry out with care and skill the instructions of the client in so far as they are compatible with the
requirements of integrity, objectivity, and independence and that they should confirm with the technical
and professional standards promulgated by the Nepal Accounting Standards Board, Nepal Standards on
Auditing Board, ICAN or other regulatory body, and relevant legislation.
On these grounds the auditor was held guilty of professional misconduct.
Case 13:
The Respondent, a Registered Auditor issued three audit reports of a Higher Secondary School for
same financial year on three different dates and the figures in the financial statements were also
different and, none of the previous audit reports were cancelled before issuing new reports.
The auditor was found compromising the code of ethics and the generally accepted auditing
principles and thus held guilty of professional misconduct.

AUDIT AND ASSURANCE
Question 1 In which situation auditor is appointed by company registrar?
Question 2 Explain the leadership responsibility of partner as given in NSQC.
Question 3 Describe about Scope and Terms of an Assurance Engagement?
Question 4 Explain the requirement of independence as given in Code of Ethics.

CHAPER 3 : PLANNING AN ASSURANCE ENGAGEMENT
CHAPTER 3
PLANNING AN ASSURANCE
ENGAGEMENT
To understand-
 The purpose of an audit planning
 Risk assessment-
 Business risks and
 Audit risks.
 Concept of materiality and sampling
 Internal control system and its limitations
 Audit in computerised environment

AUDIT AND ASSURANCE
3.1 UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT
The end product of audit of financial statements is an audit report indicating an opinion whether
or not the client’s financial statements are free of material misstatement. After accepting a client,
what should an auditor do to obtain the necessary (appropriate and sufficient) evidence to form
and support that opinion? The auditor must first obtain a thorough understanding of the entity
and its environment, including the entity’s internal control. The auditor must understand the
risks the client faces, how it is dealing with those risks, and what remaining risks are most likely
to result in a material misstatement in the financial statements. Armed with this understanding,
the auditor develops an audit strategy and an audit plan that will produce evidence helpful in
forming and supporting an opinion on the financial statements.
The auditor’s understanding of the entity and its environment should include a general knowledge
of the economy and the industry within which the entity operates and more particular knowledge
of how the entity operates.
Illustrative list of matters with regards to which the auditor would obtain knowledge are given
below:
a. Industry, regulatory, and other external factors, including the applicable financial reporting
framework
The auditor should obtain an understanding of relevant industry, regulatory, and other
external factors including the applicable financial reporting framework. These factors include
industry conditions such as the competitive environment, supplier and customer relationships,
and technological developments; the regulatory environment encompassing, among other
matters, the applicable financial reporting framework, the legal and political environment, and
environmental requirements affecting the industry and the entity; and other external factors
such as general economic conditions, interest rates and availability of financing and inflation.
The industry in which the entity operates may give rise to specific risks of material
misstatement arising from the nature of the business or the degree of regulation.
b. Nature of the entity, including the entity’s selection and application of accounting policies
The auditor should obtain an understanding of the entity’s selection and application of
accounting policies and consider whether they are appropriate for its business and consistent
with the applicable financial reporting framework and accounting polices used in the relevant
industry. The understanding encompasses the methods the entity uses to account for significant
and unusual transactions; the effect of significant accounting policies in controversial or
emerging areas for which there is a lack of authoritative guidance or consensus; and changes
in the entity’s accounting policies. Generally, matters which the auditor may consider when
obtaining knowledge of the nature of the entity are divided as follow:

• Ownership and governance structures
• Entity’s business operations such as nature of revenue sources, products or services,

markets, suppliers and distribution system, operation procedures, transcations with
related parties
• Investments and investment activities including planned or executed acquitions, capital

investments, investments in partnership, joint ventures and special purpose investments
• Financing and fiancial activities such as major subsidiaries and associated entties, debt
structure and leasing arrangements
• Financial performance, condition and profitability for previous period
• Financial Reporting environment and external influences which affect management in

preparation of financial statements such as accounting principles and industry specific
practices, accounting for unsual or complex transactions
• Applicable laws and legislations
c. Objectives and strategies and the related business risks that may result in a material
misstatement of the financial statements
The auditor should obtain an understanding of the entity’s objectives and strategies, and the
related business risks that may result in material misstatement of the financial statements.
Business risk is broader than the risk of material misstatement of the financial statements,
though it includes the latter. Business risk particularly may arise from change or complexity
for example industry developments, new products and services, expansion of business,
use of IT etc., though a failure to recognize the need for change may also give rise to
risk. An understanding of the business risks facing the enetity increases the likelihood of
identifying riks of material misstatement as most business risks will eventually have financial
consequences and thus an effect on the financial statements. However, the auditor does not
have responsibility to identify or assess all business risks since not all business risks give rise
to risks of material misstatements.
d. Measurement and review of the entity’s financial performance

The auditor should obtain an understanding of the measurement and review of the entity’s
financial performance. Performance measures and their review indicate to the auditor, aspects
of the entity’s performance that management and others consider to be important.
Performance measures, whether external or internal, create pressures on the entity that, in
turn, may motivate management to take action to improve the business performance or to
misstate the financial statements. Accordingly an understanding of the entity’s performance
measures assists the auditor in considering whether pressures to achieve the performance
targets may result in management actions that increase the risks of material misstatement
including those due to fraud.

AUDIT AND ASSURANCE
e. Internal control
Internal control is the process designed, implemented and maintained by those charged
with governance, management, and other personnel to provide reasonable assurance about
the achievement of the entity’s objectives with regards to reliability of financial reporting,
effectiveness and efficiency of operations and compliance with applicable laws and
regulations.
The auditor uses the understanding of internal control to identify types of potential
misstatements, consider factors that affect the risks of material misstatement, and design the
nature, timing, and extent of further audit procedures Although most controls relevant to
audit are likely to relate to the financial reporting, not all controls that relate of fincnaial
reporting are relevant to audit. It is a matter of professional judgment whether a control,
individually or in combination with others, is relevant to the audit.
f. Information System, Including the Related Business Processes, Relevant to Financial

Reporting, and Communication
The auditor should obtain an understanding of the information system, including the related
business processes, relevant to financial reporting, including the following areas:
- The classes of transactions in the entity’s operations that are significant to the financial
statements.
- The procedures, within both IT and manual systems, by which those transactions are
initiated, recorded, processed and reported in the financial statements.
- The related accounting records, whether electronic or manual, supporting information,

and specific accounts in the financial statements, in respect of initiating, recording,
processing and reporting transactions.
- How the information system captures events and conditions, other than classes of
transactions that are significant to the financial statements.
- The financial reporting process used to prepare the entity’s financial statements,
including significant accounting estimates and disclosures.
The auditor uses professional judgment to determine the extent of the understanding required
of the entity and its environment, including its internal control. The auditor’s primary
consideration is whether the understanding that has been obtained is sufficient to assess the
risks of material misstatement of the financial statements and to design and perform further
audit procedures. Understanding the business and using this information appropriately
assists the auditor in:
• Identifying and assessing risks,
• Identifying problems areas and pay attention to those,

• Developing appropriate audit response to assessed risks,
• Planning and performing the audit effectively and efficiently,
• Evaluating audit evidence,
• Providing better service to the client.
To make effective use of knowledge about the business, the auditor should consider how it
affects the financial statements taken as a whole and whether the assertions in the financial
statements are consistent with the auditor’s knowledge of the business. The auditor can
obtain such knowledge of the client business from:
(a) General economic factors and industry conditions affecting the entity’s business by
reviewing information obtained from external sources such as trade and economic
journals, reports by analysts, banks or rating agencies or regulatory or financial
publications.
(b) Important characteristics of the entity, its business, its financial performance and its
reporting requirements including changes since the date of the prior audit.
(c) The general level of competence of management.
(d) The client’s annual reports to shareholders.
(e) Minutes of meetings of shareholders, board of directors and important committees.
(f) Internal financial management reports for current and previous periods, including
budgets,
(g) The previous year’s audit working papers, and other relevant files.
(h) Firm personnel responsible for non-audit services to the client who may be able to
provide information on matters that may affect the audit.
(i) Discussions with client including inquiries directed towards those charged with
governance, of employees, inquiries with entity’s internal and external legal counsel or
of valuation experts that the entity has used,
(j) The client’s policies and procedures manual.
(k) Relevant publications of the Institute of Chartered Accountants of Nepal and other
professional bodies, industry publications, trade journals, magazines, newspapers or
textbooks.
(l) Consideration of the state of the economy and its effect on the client’s business, and
(m) Visits to the client’s premises and plant facilities.

AUDIT AND ASSURANCE
3.2 RISK ASSESSMENT PROCEDURES AND SOURCES OF

INFORMATION ABOUT THE ENTITY AND ITS ENVIRONMENT
Obtaining an understanding of the entity and its environment, including its internal control, is
a continuous, dynamic process of gathering, updating and analyzing information throughout
the audit. Audit procedures to obtain an understanding are referred to as “risk assessment
procedures” because some of the information obtained by performing such procedures may be
used by the auditor as audit evidence to support assessments of the risks of material misstatement.
In addition, in performing risk assessment procedures, the auditor may obtain audit evidence
about classes of transactions, account balances, or disclosures and related assertions and about
the operating effectiveness of controls, even though such audit procedures were not specifically
planned as substantive procedures or as tests of controls. The auditor also may choose to perform
substantive procedures or tests of controls concurrently with risk assessment procedures.
Risk Assessment Procedures

Risk assessment procedures provide a basis for the identification and assessment of risks of
material misstatement at financial statement and assertion levels. The auditor should perform the
following risk assessment procedures:
a) Inquiries of management, of appropriate individuals within internal audit function

(if exists), and of others within the entity who in the auditor’s judgment may have
information that is likely to assist in identifying risks of material misstatment due to
fraud or error;
b) Analytical procedures; and
c) Observation and inspection
Auditor should perform other audit procedures where the information obtained may be helpful
in identifying risks of material misstatement. For example, the auditor may consider making
inquiries of the entity’s external legal counsel or of valuation experts that the entity has used.
Reviewing information obtained from external sources such as reports by analysts, banks, or
rating agencies; trade and economic journals; or regulatory or financial publications may also be
useful in obtaining information about the entity.
Although much of the information the auditor obtains by inquiries can be obtained from
management and those responsible for financial reporting, inquiries of others within the entity,
such as production and internal audit personnel, and other employees with different levels of
authority, may be useful in providing the auditor with a different perspective in identifying risks of
material misstatement. In determining others within the entity to which inquiries may be directed,
and the extent of those inquiries, the auditor considers what information may be obtained that
helps the auditor in identifying risks of material misstatement. For example:

- Inquiries directed towards those charged with governance may help the auditor
understand the environment in which the financial statements are prepared.
- Inquiries directed towards internal audit personnel may relate to their activities
concerning the design and effectiveness of the entity’s internal control and whether
management has satisfactorily responded to any findings from these activities.
- Inquiries of employees involved in initiating, processing or recording complex or unusual

transactions may help the auditor in evaluating the appropriateness of the selection and
application of certain accounting policies.
- Inquiries directed towards in-house legal counsel may relate to such matters as litigation,
compliance with laws and regulations, knowledge of fraud or suspected fraud affecting
the entity, warranties, post-sales obligations, arrangements (such as joint ventures) with
business partners and the meaning of contract terms.
- Inquiries directed towards marketing or sales personnel may relate to changes in

the entity’s marketing strategies, sales trends, or contractual arrangements with its
customers.
- Inquiries directed to the risk management funcion (or those performing such roles) may
provide information about operational and regulatory risks that may affect financial
reporting.
- Inquiries directed to information systems personnel may provide information about

system changes, system or control failures or other information system related risks.
The members of the engagement team should discuss the susceptibility of the entity’s financial
statements to material misstatements. It provides an opportunity for more experienced engagement
team members, including the engagement partner, to share their insights based on their knowledge
of the entity, and for the team members to exchange information about the business risk to which
the entity is subject and about how and where the financial statements might be susceptible to
material misstatement.
Analytical procedures performed as risk assessment procedures may be helpful in identifying the
existence of unusual transactions or events, and amounts, ratios, and trends that might indicate
matters that have financial statement and audit implications. In performing analytical procedures
as risk assessment procedures, the auditor develops expectations about plausible relationships
that are reasonably expected to exist. When comparison of those expectations with recorded
amounts or ratios developed from recorded amounts yields unusual or unexpected relationships,
the auditor considers those results in identifying risks of material misstatement.
Observation and inspection may support inquiries of management and others, and also provide
information about the entity and its environment that includes:

AUDIT AND ASSURANCE
- Observation of entity activities and operations.
- Inspection of documents (such as business plans and strategies), records, and internal
control manuals.
- Reading reports prepared by management (such as quarterly management reports and

interim financial statements) and those charged with governance (such as minutes of
board of directors’ meetings).
- Visits to the entity’s premises and plant facilities.
- Tracing transactions through the information system relevant to financial reporting

(walk-through).
When the auditor intends to use information about the entity and its environment obtained in
prior periods, the auditor should determine whether changes have occurred that may affect
the relevance of such information in the current audit. For continuing engagements, previous
experience of the auditor with the entity contributes to the understanding of the entity and its
environment. For example, audit procedures performed in previous audits ordinarily provide
audit evidence about the entity's organizational structure, business, and controls, as well as
information about past misstatements and whether or not they were corrected on a timely basis,
which assists the auditor in assessing risks of material misstatement in the current audit. However,
such information may have been rendered irrelevant by changes in the entity or its environment.
The auditor should make inquiries and perform other appropriate audit procedures, such as walk-
throughs of systems, to determine whether changes have occurred that may affect the relevance
of such information.
Assessing the Risks of Material Misstatement

The auditor should identify and assess the risks of material misstatement at the financial statement
level, and at the assertion level for classes of transactions, account balances, and disclosures. For
this purpose, the auditor:
- Identifies risks throughout the process of obtaining an understanding of the entity and
its environment, including relevant controls that relate to the risks, and by considering
the classes of transactions, account balances, and disclosures in the financial statements;
- Relates the identified risks to what can go wrong at the assertion level;
- Considers whether the risks are of a magnitude that could result in a material misstatement
of the financial statements; and
- Considers the likelihood that the risks could result in a material misstatement of the

Significant Risks that Require Special Audit Consideration

The determination of significant risks, which arise on most audits, is a matter for the auditor’s
professional judgment. Significant risks are often derived from business risks that may result in
a material misstatement. In considering the nature of the risks, the auditor considers a number of
matters, including the following:
- Whether the risk is a risk of fraud.
- Whether the risk is related to recent significant economic, accounting or other

developments and, therefore, requires specific attention.
- The complexity of transactions.
- Whether the risk involves significant transactions with related parties.
- The degree of subjectivity in the measurement of financial information related to the risk
especially those involving a wide range of measurement uncertainty.
- Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual.
Risks of material misstatement may be greater for risks relating to significant non- routine
transactions arising from matters such as the following:
- Greater management intervention to specify the accounting treatment.
- Greater manual intervention for data collection and processing.
- Complex calculations or accounting principles.
- The nature of non-routine transactions, which may make it difficult for the entity to
implement effective controls over the risks.
3.3 BUSINESS RISK OF THE CLIENTS AND APPLICATION IN

AUDIT RISK ASSESSMENT PROCEDURE
The concept of business risk has risen up as a result of new audit methodologies development.
Business risk is defined as the risk that the entity’s objectives will not be achieved because of
internal or external factors. Professionally, auditing standards directed the auditors to obtain
understanding of the entity’s objectives and strategies and the related business risks that may
result in material misstatement of the financial statements. Auditors should consider business
risks when they assessed the risk of material misstatement during the planning phase of an audit.
The concept of business risk presents a broader vision of the range of risks that considered by
auditors. Increased emphasis on identifying and assessing business risk had been considered as
a major change to the conventional audit approach. More specifically, in an audit of the financial
statements, auditors obtain an understanding of internal control to assess the control risk.

AUDIT AND ASSURANCE
In today’s complex business environment, risk has become an inherent part of business and
public life. Dynamic market relations increase the uncertainty of the environment where business
and public organizations work. Maintaining high competitiveness needs organizations to start
initiatives that may have different outputs. The possibility of these outputs occurring determines
the risk in the organization’s activity. Organizations are exposed to various types and levels of risk
which may be classified in different ways. One approach is to classify risk on the basis of whether
all businesses are exposed to the same risks, often unavoidable (i.e. contextual, environmental or
systematic risks) as against those avoidable risks where the business elects to be exposed to the
risks in order to gain some strategic or competitive advantage (i.e. strategic or unsystematic risks),
potentially adding value for shareholders. As all business involves risk, one of the organisation’s
management functions is to assess the impact of potential risks to the business and to set in place
management controls that will minimize the impact of the identified risk. Management should be
aware of the nature of the underlying opportunities in order to identify and manage the associated
risk. Failure to do so can result in a failure to capture a fortunate opportunity and success. For
example, a sales campaign which generates unexpectedly high demand for a new product may
prove a disaster if that demand cannot be met and this stimulates a competitor to enter the market.
Business risk is defined generally as the risk that the entity’s business objectives will not be
attained as a result of the external and internal factors, pressure, and forces brought to bear on
the entity and ultimately, the risk associated with the entity’s survival and profitability. It refers to
introducing audit approach that focuses on the business risks in the organization whose financial
statements are being audited. In this concern, business risk arises from conditions and forces
within the entity’s internal environment, industry forces and macro-environmental forces. This
has been associated with changes in the extent of the planning and the process of assessing the risk
in the related evidence gathering procedures used by auditors. This approach has the potential to
enhance audit effectiveness, arguing that an in-depth understanding of a business, its environment
and the business processes through which value is created is the best way in which an auditor will
be able to recognize management fraud and business failure risks.
Business risk approach encourages the auditors to view the client in terms of key business
processes, and risks and controls within those processes, as opposed to a framework based on
financial statement balances and transaction streams. The rationale for this approach suggests that
if the auditor can identify the sources of business risk and ensure that the client has appropriate
systems to monitor and manage that risk, there is little value in extensive substantive testing. It has
also been suggested that obtaining such an insight on the business provides auditors with a better
basis for generating useful feedback for the client. Business risk audit approach emphasizes top-
down approach to the audit, starting from the business and its processes and working through the
financial statement instead of the opposite way that focusing on the financial statements. Business
risk approach was associated with the changes in the process of risk assessment, planning and
procedures of gathering evidence by auditors. This approach came to enhance the effectiveness of
external auditing, it also enhances the process of understanding of the auditor to the nature of the

client and the environment in which enabling a wider range to find out the risks facing activity,
and the expected fundamental misstatements.
The most important reasons for adopting the client’s business risk approach is that audit failures
may not stems mainly from the lack of efficiency and effectiveness of audit procedures to detect
material misstatement, but may be due to the problems faced by the entity under auditing as the
continuity problems (going concern) or manipulation arising from the audit environment. The
sources of business risk factors associated with the entity to external and internal factors. External
factors arise from outside the entity and include:
i. Change in Legislation;
ii. Interest Rates Change;
iii. Change in the Exchange Rate;
iv. Opinion or Attitude of the Public;
v. Competition;
vi. Untested Technology;
vii. Natural Threats (Such as Floods);
viii. Bad Debt;
ix. Judicial Matters;
x. Environmental Issues.
Any of the above factors could adversely affect the entity, and therefore the financial statements.
For example, when an entity manufactures a certain product exposed to intense competition
resulting from the import of the same product, the financial statements may be affected by the
value of equipment that may needs replacement and employees who may be laid off, and thus
continuity becomes questionable.
The risk arising from internal factors include:
i. Failure to update products, labour relations or marketing;
ii. Users in Organisations;
iii. Members of the board of directors;
iv. Failure to update products (failure to qualify for the ISO or the use of e-commerce);
v. Operations related to suppliers or customers;
vi. Excessive reliance on a single executive director;
vii. Cash flows;

AUDIT AND ASSURANCE
viii. The failure of electronic systems;
ix. Internal control;
x. Excessive reliance on a single supplier, a single client or a single product.
Business risk factors Level of business risk

Factor Lower Higher
The economy in which the company Healthy. Depressed; stagnant.
operates.
The industry in which the company Established; stable; Relatively new; unstable;
operates. relatively uninfluenced by greatly influenced by
external conditions. external conditions.
The company's management Conservative. Aggressive.
philosophy with regards to both
operational and accounting matters.
The company's control environment, Strong administrative Weak administrative
including the possibility of controls; control-conscious controls; management
management override. management; low isn't control conscious;
possibility of management high possibility of
override. management override.
The company's previous audit Unqualified opinions No prior audit
history. for previous audits; no history; qualified or
prior disagreements with adverse opinions for
auditors; few adjustments. previous audits; prior
disagreements with
auditors; numerous
adjustments.
Rate of turnover for top management Low. High.
and the board of directors.
The company's financial position and Strong. Weak.
operating performance.
The company's existing or potential Insignificant. Significant.
litigation.
The business reputation of the Good. Poor.
company's management and principal
owners.
The relevant experience of the High. Low.
company's management and principal
owners.
Ownership of the company. Nonpublic. Public.

Business risk factors Level of business risk

Factor Lower Higher
Client understanding of the auditor's Clear. Unclear.
responsibilities.
Conflicts of interest, regulatory Insignificant. Significant.
problems or auditor independence
problems.
The location of the company. Large city. Small community.
The level of business acuity or Low. High
sophistication within the community
in which the company operates.
3.4 AUDIT RISK
Audit risk means the risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated. Thus, it is the risk that the auditor may fail to express an
appropriate opinion in an audit assignment. An auditor may consider audit risk both at overall
financial statement level as well as at the level of individual account balances or classes of
transactions. This means that at overall level the auditor applies their professional judgment to
determine the extent of risk which he considers to be an acceptable level. At account balance level,
audit risk refers to the risk that error in monetary terms exists beyond a tolerable error limit in the
account balances or class of transaction which the auditor fails to defect. The auditor should obtain
an understanding of the accounting and internal control systems sufficient to plan the audit and
develop an effective audit approach. The auditor should use professional judgment to assess audit
risk and to design audit procedures to ensure it is reduced to an acceptably low level.
Audit risk may exist at overall level or while verifying various transactions and balance-sheet
items.
1. Audit risk at the financial statement level - Audit risk is considered at the financial statement
level during the audit planning process. At this time, the auditor should undertake an
overall audit risk assessment based on his knowledge of the client’s business, industry,
management, control environment and operations. Such an assessment provides
preliminary information about the general approach to the engagement, the auditor’s
staffing needs and the framework within which materiality and audit risk assessments
can be made at the individual account balance or class of transactions level. As part of
this overall risk assessment, the auditor should consider whether there is potential for
pervasive problems, for example, going concern problems.
2. Audit risk at the account balance and class of transactions level - The majority of audit
procedures are directed to and carried out at the account balance and class of transactions

AUDIT AND ASSURANCE
level. Accordingly, audit risk should be considered by the auditor at this level taking into
account the results of the overall audit risk assessment made at the financial statement
level.
Components of Audit Risk.
Inherent
Risks
Audit
Risks
Detection Control
Risks Risks
(a) Inherent risk

It is the susceptibility of an account balance or class of transactions to misstatement that could
be material, individually or when aggregated with misstatements in other balances or classes,
assuming that there were no related internal controls.
To assess inherent risk, the auditor uses professional judgment to evaluate numerous factors,
examples of which are:
(a) At the Financial Statement Level:

 The integrity of management.
 Management experience and knowledge and changes in management during the

period, for example, the inexperience of management may affect the preparation of
the financial statements of the entity.
 Unusual pressures on management, for example, circumstances that might

predispose management to misstate the financial statements, such as the industry
experiencing a large number of business failures or an entity that lacks sufficient
capital to continue operations.

 The nature of the entity’s business, for example, the potential for technological
obsolescence of its products and services, the complexity of its capital structure, the
significance of related parties and the number of locations and geographical spread
of its production facilities.
 Factors affecting the industry in which the entity operates, for example, economic
and competitive conditions as identified by financial trends and ratios, and changes
in technology, consumer demand and accounting practices common to the industry.
(b) At the Account Balance and Class of Transactions Level:

 Financial statement accounts likely to be susceptible to misstatement, for example,
accounts which required adjustment in the prior period, or which involve a high
degree of estimations.
 The complexity of underlying transactions and other events which might require
using the work of an expert.
 The degree of judgment involved in determining account balances.
 Susceptibility of assets to loss or misappropriation, for example, assets which are

highly desirable and movable such as cash.
 The completion of unusual and complex transactions, particularly at or near period end.
 Transactions not subjected to ordinary processing. Accounting and Internal Control

Systems.
(b) Control risk

It is the risk that a misstatement that could occur in an account balance or class of transactions
and that could be material individually or when aggregated with misstatements in other
balances or classes, will not be prevented or detected and corrected on a timely basis by the
accounting and internal control systems.
The preliminary assessment of control risk is the process of evaluating the effectiveness of
an entity’s accounting and internal control systems in preventing or detecting and correcting
material misstatements. There will always be some control risk because of the inherent
limitations of any accounting and internal control system. After obtaining an understanding
of the accounting and internal control systems, the auditor should make a preliminary
assessment of control risk, at the assertion level, for each material account balance or class
of transactions. The auditor ordinarily assesses control risk at a high level for some or all
assertions when:
i. The entity’s accounting and internal control systems are not effective; or
ii. Evaluating the effectiveness of the entity’s accounting and internal control systems
would not be efficient.

AUDIT AND ASSURANCE
The preliminary assessment of control risk for a financial statement assertion should be high
unless the auditor:
i. Is able to identify internal controls relevant to the assertion which are likely to prevent or
detect and correct a material misstatement; and
ii. Plans to perform tests of control to support the assessment. Documentation of

Understanding, identification and assessment of control risk.
The auditor should document in the audit working papers:
i. The understanding obtained of the entity’s accounting and internal control s y s t e m s ;

and
ii. The assessment of control risk. When control risk is assessed at less than high, the
auditor would also document the basis for the conclusions.
(c) Detection risk

It is the risk that an auditor’s substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material, individually or
when aggregated with misstatements in other balances or classes. The level of detection risk
relates directly to the auditor's substantive procedures. The auditor's control risk assessment,
together with the inherent risk assessment, influences the nature, timing and extent of
substantive procedures to be performed to reduce detection risk, and therefore audit risk, to
an acceptably low level.
Some detection risk would always be present even if an auditor were to examine 100 percent
of the account balance or class of transactions because, for example, most audit evidence is
persuasive rather than conclusive. The auditor should consider the assessed levels of inherent
and control risks in determining the nature, timing and extent of substantive procedures
required to reduce audit risk to an acceptably low level. In this regard the auditor would
consider:
i. The nature of substantive procedures, for example, using tests directed toward
independent parties outside the entity rather than tests directed toward parties or
documentation within the entity, or using tests of details for a particular audit objective
in addition to analytical procedures;
ii. The timing of substantive procedures, for example, performing them at period end rather
than at an earlier date; and
iii. The extent of substantive procedures, for example, using a larger sample size.

A comparison between the various components of Audit Risk

Inherent Risk Control Risk Detection Risk
Risk that material Risk that internal control Risk that auditor’s substantive
misstatement may occur fails to prevent, detect the procedure will not detect a
misstatement material misstatement
Arises at level of Arises at level of Arises at auditors’ level
management management
Auditor can only assess this Auditor can only assess this Auditor can frame this risk
risk risk
Risk of system of Risk of internal control Risk of auditor procedures
management system adopted by auditor
Relationship Between the Assessments of Inherent and Control Risks

Management often reacts to inherent risk situations by designing accounting and internal
control systems to prevent or detect and correct misstatements and therefore, in many cases,
inherent risk and control risk are highly interrelated. In such situations, if the auditor attempts
to assess inherent and control risks separately, there is a possibility of inappropriate risk
assessment. As a result, audit risk may be more appropriately determined in such situations
by making a combined assessment.
There is an inverse relationship between detection risk and the combined level of inherent
and control risks. For example, when inherent and control risks are high, acceptable detection
risk needs to be low to reduce audit risk to an acceptably low level. On the other hand, when
inherent and control risks are low, an auditor can accept a higher detection risk and still
reduce audit risk to an acceptably low level.
While tests of control and substantive procedures are distinguishable as to their purpose, the
results of either type of procedure may contribute to the purpose of the other. Misstatements
discovered in conducting substantive procedures may cause the auditor to modify the
previous assessment of control risk.
Mathematically Audit Risk (AR) can be expressed as a product of Inherent Risk (IR), Control
Risk (CR) and Detection Risk (DR), i.e. AR = IR x CR x DR.
Interrelationship of the Components of Audit Risk

The following table shows how the acceptable level of detection risk may vary based on
assessments of inherent and control risks.

AUDIT AND ASSURANCE
Auditor’s assessment of control risk is:

Inherent risk High Medium Low
Auditor’s assessment High
High Lowest Lower Medium
Lowest Lower Medium
Medium Lower Medium Higher
Low Medium Higher Highest
The shaded areas in this table relate to detection risk.
There is an inverse relationship between detection risk and the combined level of inherent
and control risks. For example, when inherent and control risks are high, acceptable levels
of detection risk need to be low to reduce audit risk to an acceptably low level. On the other
hand, when inherent and control risks are low, an auditor can accept a higher detection risk
and still reduce audit risk to an acceptably low level.
The assessed levels of inherent and control risks cannot be sufficiently low to eliminate the
need for the auditor to perform any substantive procedures. Regardless of the assessed levels
of inherent and control risks, the auditor should perform some substantive procedures for
material account balances and classes of transactions.
The auditor’s assessment of the components of audit risk may change during the course of
an audit, for example, information may come to the auditor’s attention when performing
substantive procedures that differs significantly from the information on which the auditor
originally assessed inherent and control risks. In such cases, the auditor would modify the
planned substantive procedures based on a revision of the assessed levels of inherent and
control risks.
The higher the assessment of inherent and control risk, the more audit evidence the auditor
should obtain from the performance of substantive procedures. When both inherent
and control risks are assessed as high, the auditor needs to consider whether substantive
procedures can provide sufficient appropriate audit evidence to reduce detection risk, and
therefore audit risk, to an acceptably low level. When the auditor determines that detection
risk regarding a financial statement assertion for a material account balance or class of
transactions cannot be reduced to an acceptable level, the auditor should express a qualified
opinion or a disclaimer of opinion.

3.5 ATTITUDE OF PROFESSIONAL SKEPTICISM
The term ‘professional skepticism’ is an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of
evidence.
NSA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance
with Nepal Standards on Auditing, contains more guidance on how and why the auditor should
act with an attitude of professional skepticism. NSA 200 contains a specific requirement in relation
to professional skepticism:
The auditor shall plan and perform an audit with professional skepticism recognizing 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 NSAs.
Essentially, NSA 200 requires the use of professional skepticism as a means of enhancing the
auditor’s ability to identify risks of material misstatement and to respond to the risks identified.
Professional skepticism is closely related to fundamental ethical considerations of auditor objectivity
and independence. Professional skepticism is also linked to the application of professional
judgment by the auditor. An audit performed without an attitude of professional skepticism is
not likely to be a high-quality audit. At its core, the application of professional skepticism should
help to ensure that the auditor does not neglect unusual circumstances, oversimplify the results
from audit procedures or adopt inappropriate assumptions when determining the audit response
required to address identified risks, all of which should improve audit quality.
How does the auditor apply professional skepticism?

The auditor is likely to apply professional skepticism at various stages from client acceptance and
at various points during the audit process, and some typical examples are given below:
• When assessing engagement acceptance – at this stage the auditor should consider
whether the management of the intended audit client acts with integrity and whether
there are any matters that may impact on the auditor being able to act with professional
skepticism if they accept the engagement, such as ethical threats to objectivity.

AUDIT AND ASSURANCE
• When performing risk assessment procedures – an auditor should be skeptical

when performing risk assessment procedures at the planning stage of the audit. For
example, when discussing the results of analytical procedures with management, the
auditor should not accept management’s explanations at face value and should obtain
corroboratory evidence for the explanations offered.
• When obtaining audit evidence – the auditor should be ready to challenge management,
especially on complex and subjective matters and matters that required a degree of
judgment to be exercised by management. The reliability and sufficiency of evidence
should be considered, especially where there are risks of fraud. There may also be specific
issues arising during an audit which impacts on professional skepticism – for example,
if management refuses the auditor’s request to obtain evidence from a third party.
The auditor will have to consider how much trust can be placed on evidence obtained
from management – for example, evidence in the form of enquiry with management or
written representations obtained from management. NSA 200 states that ‘a belief that
management and those charged with governance are honest and have integrity does not
relieve the auditor of the need to maintain professional skepticism or allow the auditor
to be satisfied with less than persuasive audit evidence when obtaining reasonable
assurance’.
• When evaluating evidence – the auditor should critically assess audit evidence and be
alert for contradictory evidence that may undermine the sufficiency and appropriateness
of evidence obtained.
The auditor should also apply professional skepticism when forming the auditor’s opinion, by
considering the overall sufficiency of evidence to support the audit opinion, and by evaluating
whether the financial statements depict fair presentation of underlying transactions and events.
Ultimately, the application of professional skepticism should reduce detection risk because it
enhances the effectiveness of applied audit procedures and reduces the possibility that the auditor
will reach an inappropriate conclusion when evaluating the results of audit procedures.
Specific Applications of Professional Skepticism

Fraud NSA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements, specifically refers to professional skepticism stating that ‘when obtaining reasonable
assurance, the auditor is responsible for maintaining professional skepticism throughout the audit,
considering the potential for management override of controls and recognizing the fact that audit
procedures that are effective for detecting error may not be effective in detecting fraud’.
NSA 240 goes on to state a specific requirement for the auditor: ‘The auditor shall maintain
professional skepticism throughout the audit, recognizing the possibility that a material
misstatement due to fraud could exist, notwithstanding the auditor’s past experience of the
honesty and integrity of the entity’s management and those charged with governance’.

NSA 240 emphasize the importance of assessing the reliability of the information to be used as
audit evidence and the controls over its preparation and maintenance. In addition, NSA 240 states
that ‘management is often in the best position to perpetrate fraud. Accordingly, when evaluating
management’s responses to inquiries with an attitude of professional skepticism, the auditor may
judge it necessary to corroborate responses to inquiries with other information’. This is significant
in that NSA 240 reminds the auditor that when management provides the auditor with audit
evidence – be that in the form of answers to enquiries, written representations or other forms of
documentary evidence – the auditor should carefully consider the integrity of that evidence and
whether additional corroboratory evidence should be obtained from a more reliable source.
Other aspects of an audit where professional skepticism may be important

• Accounting estimates – this include fair value accounting estimates, the use of significant
assumptions by management in developing accounting estimates, and reviewing the
judgments and decisions used by management for management bias in developing
accounting estimates.
• Going concern – the auditor should review management’s assessment of going concern
and feasibility of management’s plans, this being particularly important where there is a
significant doubt over the entity’s ability to continue as a going concern.
• Related party relationships and disclosures – it can be difficult to obtain information on

related parties, as knowledge may be confined to management meaning that the auditor
may have to rely on management to identify all related parties. The auditor should also
be skeptical when assessing the business rationale behind related party transactions.
• Consideration of laws and regulations – the auditor should be alert throughout the audit
for indications that there may have been a suspected non-compliance with laws and
regulations.
3.6 INFORMATION TECHNOLOGY IN THE RISK ANALYSIS
The auditor should obtain an understanding of the information system, including the related
business processes, relevant to financial reporting, including:
a. The classes of transactions in the company's operations that are significant to the financial
statements;
b. The procedures, within both automated and manual systems, by which those transactions
are initiated, authorized, processed, recorded, and reported;
c. The related accounting records, supporting information, and specific accounts in the
financial statements that are used to initiate, authorize, process, and record transactions;

AUDIT AND ASSURANCE
d. How the information system captures events and conditions, other than transactions, that
are significant to the financial statements; and
e. The period-end financial reporting process.
Further, the auditor also should obtain an understanding of how IT affects the company's flow of
transactions. The identification of risks and controls within IT is not a separate evaluation. Instead,
it is an integral part of the approach used to identify significant accounts and disclosures and their
relevant assertions and, when applicable, to select the controls to test, as well as to assess risk and
allocate audit effort.
A company might use automated procedures to initiate, record, process, and report transactions,
in which case records in electronic format would replace paper documents. When IT is used
to initiate, record, process, and report transactions, the IT systems and programs may include
controls related to the relevant assertions of significant accounts and disclosures or may be critical
to the effective functioning of manual controls that depend on IT.
The auditor should obtain an understanding of specific risks to a company's internal control over
financial reporting resulting from IT. Examples of such risks include:
• Reliance on systems or programs that are inaccurately processing data, processing

inaccurate data, or both;
• Unauthorized access to data that might result in destruction of data or improper

changes to data, including the recording of unauthorized or non-existent transactions
or inaccurate recording of transactions (particular risks might arise when multiple users
access a common database);
• The possibility of IT personnel gaining access privileges beyond those necessary to

perform their assigned duties, thereby breaking down segregation of duties;
• Unauthorized changes to data in master files;
• Unauthorized changes to systems or programs;
• Failure to make necessary changes to systems or programs;
• Inappropriate manual intervention; and
• Potential loss of data or inability to access data as required.
In obtaining an understanding of the company's control activities, the auditor should obtain an
understanding of how the company has responded to risks arising from IT.

3.7 PLANNING AN AUDIT
Planning an audit involves establishing the overall audit strategy for the engagement and
developing an audit plan. Adequate planning benefits the audit of financial statements in
several ways; helping the auditor to devote appropriate attention to important areas of the audit,
identify and resolve potential problems on a timely, properly organize and manage the audit
engagement so that it is performed in an effective and efficient manner basis, assisting in the
selection of engagement team members with appropriate levels of capabilities and competence to
respond to anticipated risks, and the proper assignment of work to them, facilitating the direction
and supervision of engagement team members and the review of their work, assisting, where
applicable, in coordination of work done by auditors of components and experts. So, planning an
audit refers to developing the overall strategy and a detailed approach for the expected nature,
extent and timing of the audit. The auditor should plan his work to enable him to conduct an
effective audit in an efficient and timely manner. The overall audit plan and the audit program
is the auditor’s responsibility. However, the auditor may wish to discuss elements of the overall
audit plan and certain audit procedures with the entity’s audit committee, management and staff.
Establishing an Overall Audit Strategy

Establish an overall audit strategy is an important activity that sets the scope, timing and direction
of the audit, and guides the development of the audit plan. In establishing the overall audit
strategy, the auditor should:
 Identify the characteristics of the engagement that define its scope;
 Ascertain the reporting objectives of the engagement to plan the timing of the audit and
the nature of the communications required;
 Consider the factors that, in the auditor’s professional judgment, are significant in
directing the engagement team’s efforts;
 Consider the results of preliminary engagement activities and, where applicable, whether
knowledge gained on other engagements performed by the engagement partner for the
entity is relevant; and
 Ascertain the nature, timing and extent of resources necessary to perform the engagement.
Audit Plan Coverage

Auditor should develop an Audit Plan that include a description of:
 The nature, timing and extent of planned risk assessment procedures,
 The nature, timing and extent of planned further audit procedures at the assertion level,

AUDIT AND ASSURANCE
 Other planned audit procedures that are required to be carried out so that the engagement
complies with NSAs.
Plans should be further developed and revised as necessary during the course of the audit. Audit
plan should also mention the planned nature, timing and extent of direction and supervision of
engagement team members and the review of their work.
The Audit Plan

The audit plan is more detailed than the overall audit strategy in that it includes the nature, timing
and extent of audit procedures to be performed by engagement team members. Planning for these
audit procedures takes place over the course of the audit as the audit plan for the engagement
develops. For example, planning of the auditor’s risk assessment procedures occurs early in the
audit process. However, planning the nature, timing and extent of specific further audit procedures
depends on the outcome of those risk assessment procedures. In addition, the auditor may begin
the execution of further audit procedures for some classes of transactions, account balances and
disclosures before planning all remaining further audit procedures.
The record of the overall audit plan will need to be sufficiently detailed to guide the development
of the audit program; its precise form and content will vary depending on the size of the entity, the
complexity of the audit and the specific methodology and technology used by the auditor. Matters
to be considered by the auditor in developing the overall audit plan includes:
a. Understanding of the Entity and Its Environment, Including the Entity’s Internal Control
Understanding of the entity and its environment, including the entity's internal control
requires that in performing an audit of financial statements, the auditor should have or obtain
understanding of the business, sufficient to enable the auditor to identify and understand the
events, transactions and practices that, in the auditor’s judgement, may have a significant
effect on the financial statements or on the examination or audit report. Such understanding
is used by the auditor in identifying and assessing audit risks and in determining the nature,
timing and extent of audit procedures. The auditor can obtain knowledge of the industry and
the entity from a number of sources. For example, previous experience with the entity and its
industry, discussion with people with the entity (for example, directors and senior operating
personnel), discussion with internal audit personnel and review of internal audit reports, etc.
Prior to accepting an engagement, the auditor would obtain a preliminary knowledge of the
industry and of the nature of ownership, management and operations of the entity to be
audited. Following acceptance of the engagement, further and more detailed information
would be obtained. The auditor would obtain the required knowledge at the start of the
engagement. As the audit progresses, that information would be assessed and updated, and
more information would be obtained. Obtaining the required knowledge of the business
is a continuous and cumulative process of gathering and assessing the information and

relating the resulting knowledge to audit evidences and information at all stages of audit.
For example, although information is gathered at the planning stage, it is ordinarily refined
and added to in later stages of the audit as the auditor and the member of his staff learn more
about the business.
b. Entity's Internal Control Systems

An understanding of internal control assists the auditor in identifying types of potential
misstatements and factors that affect the risks of material misstatement, and in designing the
nature, timing and extent of further audit procedures. While understanding entity's internal
control systems, auditor should consider the:
 General Nature and Characteristics of Internal Control.
 Controls Relevant to the Audit.
 Nature and Extent of the Understanding of Relevant Controls.
 Components of Internal Control.
c. Risk and Materiality

i. The expected assessments of audit risks and the identification of significant audit areas.
ii. The setting of materiality levels for audit purposes.
iii. The possibility of material misstatement, including the experience of past or fraud.
iv. The identification of complex accounting areas.
v. Nature, Extent and Timing (NET) of Procedures.
vi. Possible change of emphasis on specific audit areas.
vii. The effect of information technology on the audit and
viii. The work of internal auditing and its expected effect on external audit procedures.
d. Coordination, Direction, Supervision and Review

i. The involvement of other auditors in the audit of components.
ii. The involvement of experts.
iii. The number of locations and
iv. Staffing requirements.
e. Other Matters
i. The going concern assumption related questions.
ii. Conditions requiring special attention, such as the existence of related parties.

AUDIT AND ASSURANCE
iii. The terms of the engagement and any statutory responsibilities and
iv. The nature and timing of reports or other communication with the entity.
Audit Planning Memorandum

It is a document prepared by the auditor setting out those information obtained during the audit
planning process and those decision taken as a result of the audit planning efforts, which are
required by those audit staff who will be engaged on the audit assignment.
It is a written document, which set out the information obtained, and decision reached as a result
of audit planning effort. The nature of information contained in an audit-planning memorandum
will vary from one audit to the other, but generally may include:
• A summary of the terms of engagement to lay out the nature and scope of the work;
• Job timetable giving the provisional dates of the timing of the audit e.g. date of planned
commencement of the audit.
• Record of any changes in the client since the last audit e.g. changes in the nature of the
client’s business, change in management structure;
• Details of the planning decisions such as areas identified as having weak internal controls
requiring more detailed audit work, areas where the advice of an expert is needed etc;
• Extent of reliance expected on internal audit.
Generally Planning Memorandum includes following areas and the audit program will contain
the following material:
• Audit Objectives;
• Audit Scope;
• Details information of client, its key personnel;
• Information about nature of business, operation, accounting and IT control;
• Audit Methodology (including a sampling plan if some type of audit sampling is

proposed);
• Detailed audit plan;
• Audit Time budget;
• Milestone dates for completion of key elements of the audit program and preparation of
the discussion draft.

Reliance on other during Audit Planning

Auditor alone cannot wholly and completely perform all the auditing activities. They must rely
and get their work done by some other auditors, experts, valuators and other professionals. Further
with the concept of branch audit is under discussion, the frequency of using the work of other
personnel is indispensable. Also, mandatory use of actuarial valuation in insurance companies has
extended the use of work of other person. In this regards, professional auditor can consider the
work of other in following ways:
• Using the work of another auditor
• Considering the work of internal auditor
• Using the work of an expert
a. Using the Work of Another Auditor

When the principal auditor plan to uses the work of another auditor, the principal auditor
should determine how the work of the other auditor will affect the audit.
The auditor should consider whether the auditor’s own participation is sufficient to be able to
act as the principal auditor. For this purpose, the auditor would consider:
• the materiality of the portion of the financial information which the principal auditor
audits;
• the principal auditor’s degree of knowledge regarding the business of the components;
• the risk of material misstatements in the financial information of the components audited
by the other auditor;
• the performance of additional procedures regarding the components audited by other

auditor resulting in the principal auditor; and
• having significant participation in such audit.
When planning to use the work of another auditor, the principal auditor should consider the
professional competence of the other auditor in the context of specific assignment if the other
auditor is not a member of the Institute of Chartered Accountants of Nepal.
When using the work of another auditor, the principal auditor should ordinarily perform the
following procedures:
• advise the other auditor of the use that is to be made of the other auditor’s work and
report and make sufficient arrangements for co-ordination of their efforts at the planning
stage of the audit. The principal auditor would inform the other auditor of matters
such as areas requiring special consideration, procedures for the identification of inter-

AUDIT AND ASSURANCE
component transactions that may require disclosures and the timetable for completion of
audit; and
• advise the other auditor of the significant accounting, auditing and reporting requirements
and obtain representation as to compliance with them.
a. Considering the Work of the Internal Auditor

The scope and objectives of internal audit vary widely and are dependent upon the size and
structure of the entity and the requirements of its management.
Normally, however, internal audit operates in one or more of the following areas:
(i) Review of accounting system and related internal controls: The establishment of an
adequate accounting system and the related controls is the responsibility of management
which demands proper attention on a continuous basis. The internal audit function is
often assigned specific responsibility by management for reviewing the accounting
system and related internal controls, monitoring their operation and recommending
improvements thereto.
(ii) Examination for management of financial and operating information: This may include
review of the means used to identify measure, classify and report such information and
specific inquiry into individual items including detailed testing of transactions, balances
and procedures.
(iii) Examination of the economy, efficiency and effectiveness of operations including

non-financial controls of an organization: Generally, the external auditor is interested
in the results of such audit work only when it has an important bearing on the reliability
of the financial records.
(iv) Physical examination and verification: This would generally include examination and
verification of physical existence and condition of the tangible assets of the entity.
The external auditor should evaluate the internal audit function to the extent he/she considers
that it will be relevant in determining the nature, timing and extent of his compliance and
substantive procedures. Depending upon such evaluation, the external auditor may be able
to adopt less extensive procedures than would otherwise be required. By its very nature, the
internal audit function cannot be expected to have the same degree of independence as is
essential when the external auditor expresses his/her opinion on the financial information.
The report of the external auditor is his/her sole responsibility, and that responsibility is not
by any means reduced because of the reliance he/she places on the internal auditor’s work.
The external auditor’s general evaluation of the internal audit function will assist him/her in
determining the extent to which he can place reliance upon the work of the internal auditor.
The external auditor should document his/her evaluation and conclusions in this respect.
The important aspects to be considered in this context are:

a) Organizational Status: Whether internal audit is undertaken by an outside agency or by

an internal audit department within the entity itself, the internal auditor reports to the
management. In an ideal situation, he reports to the highest level of management and is
free of any other operating responsibility. Any constraints or restrictions placed upon his
work by management should be carefully evaluated. In particular, the internal auditor
should be free to communicate fully with the external auditor.
b) Scope of Function: The external auditor should ascertain the nature and depth of
coverage of the assignment which the internal auditor discharges for management. He
should also ascertain to what extent the management considers, and where appropriate,
acts upon internal audit recommendations.
c) Technical Competence: The external auditor should ascertain that internal audit work is
performed by persons having adequate technical training and proficiency. This may be
accomplished by reviewing the experience and professional qualifications of the persons
undertaking the internal audit work.
d) Due Professional Care: The external auditor should ascertain whether internal audit
work appears to be properly planned, supervised, reviewed and documented. An
example of the exercise of due professional care by the internal auditor is the existence of
adequate audit manuals, audit program, and working papers.
Having decided in principle that he intends to rely upon the work of the internal auditor, it
is desirable that the external auditor ascertains the internal auditor’s tentative plan for the
year and discusses it with him at as early a stage as possible to determine areas where he
considers that he could rely upon the internal auditor’s work. Where internal audit work is to
be a factor in determining the nature, timing and extent of the external auditor’s procedures,
it is desirable to plan in advance the timing of such work, the extent of audit coverage, test
levels and proposed methods of sample selection, documentation of the work performed, and
review and reporting procedures.
Coordination with the internal auditor is usually more effective when meetings are held at
appropriate intervals during the year. It is desirable that the external auditor is advised of,
and has access to, relevant internal audit reports and in addition is kept informed, along with
management, of any significants matter that come to the internal auditor’s attention and which
he believes may affect the work of the external auditor. Similarly, the external auditor should
ordinarily inform the internal auditor of any significant matters which may affect his work.
c. Using the Work of an Expert

The auditor’s education and experience enable him to be knowledgeable about business
matters in general, but he is not expected to have the expertise of a person trained for, or
qualified to engage in, the practice of another profession or occupation, such as an actuary or
engineer.

AUDIT AND ASSURANCE
An expert (or a specialist), is a person, firm or other association of persons possessing special
skill, knowledge and experience in a particular field other than accounting and auditing. An
“expert” may be:
• engaged by the client,
• engaged by the auditor,
• employed by the client, or
• employed by the auditor.
During the audit, the auditor may seek to obtain, in conjunction with the client or
independently, audit evidence in the form of reports, opinions, valuations and statements of
an expert. Examples are:
• Valuations of certain types of assets, for example, land and buildings, plant and
machinery, works of art, and precious stones.
• Determination of quantities or physical condition of assets, for example, minerals stored

in stockpiles, mineral and petroleum reserves, and the remaining useful life of plant and
machinery.
• Determination of amounts using specialized techniques or methods, for example, an

actuarial valuation,
• The measurement of work completed and to be completed on contracts in progress for

the purpose of revenue recognition,
• Legal opinions concerning interpretations of agreements, statutes, regulations,

notifications, circulars, etc.
When planning whether to use the work of an expert or not, the auditor should consider:
• The materiality of the item being examined in relation to the financial information as a
whole,
• The nature and complexity of the item including the risk of error therein, and
• The other audit evidence available with respect to the item.
Similarly, the auditor should satisfy himself as to the expert’s skills and competence by
considering the expert’s:
• Professional qualifications, license or membership in an appropriate professional body,

and
• Experience and reputation in the field in which the evidence is sought.

However, when the auditor uses the work of an expert employed by him, he will not need to
inquire into his skills and competence.
The auditor should also consider the objectivity of the expert. The risk that an expert’s
objectivity will be impaired increases when the expert is:
• Employed by the client, or
• Related in some other manner to the client.
In these circumstances, the auditor should consider performing more extensive procedures
than would otherwise have been planned, or might consider engaging another expert.
The audit evidence generated by the planned audit procedures should be sufficient and
appropriate to support and corroborate, or to contradict, the management’s assertions in
respect of specific classes of transactions, account balances or disclosures in the financial
statements.
In order for the auditor to obtain reliable audit evidence, information produced by the entity
that is used for performing audit procedures needs to be sufficiently complete and accurate.
For example, the effectiveness of auditing revenue by applying standard prices to records of
sales volume is affected by the accuracy of the price information and the completeness and
accuracy of the sales volume data. Similarly, if the auditor intends to test a population (for
example, payments) for a certain characteristic (for example, authorization), the results of
the test will be less reliable if the population from which items are selected for testing is not
complete.
Obtaining audit evidence about the accuracy and completeness of such information may be
performed concurrently with the actual audit procedure applied to the information when
obtaining such audit evidence is an integral part of the audit procedure itself. In other
situations, the auditor may have obtained audit evidence of the accuracy and completeness of
such information by testing controls over the preparation and maintenance of the information.
In some situations, however, the auditor may determine that additional audit procedures are
needed.
In some cases, the auditor may intend to use information produced by the entity for other
audit purposes. For example, the auditor may intend to make use of the entity’s performance
measures for the purpose of analytical procedures, or to make use of the entity’s information
produced for monitoring activities, such as internal auditor’s reports. In such cases, the
appropriateness of the audit evidence obtained is affected by whether the information is
sufficiently precise or detailed for the auditor’s purposes. For example, performance measures
used by management may not be precise enough to detect material misstatements.

AUDIT AND ASSURANCE
3.8 AUDIT PROGRAMME
Audit Programme is a list of examination and verification steps to be applied in a way that inter-
relationship of one step to another is clearly shown and designed. Audit programme helps to
complete the examination and verification process more easily. In another word, audit programme
is a detailed plan of applying the audit procedures in the given circumstances.
An audit programme consists of a series of verification procedures to be applied to the financial

statements and accounts of a given company for the purpose of obtaining sufficient evidence to
enable the auditor to express an informed opinion on such statements.
The role of audit programme in audit plan and performance:

The audit programme is helpful both in planning and performance stages of audit:
i. The audit programme lists down areas of audit before commencement.
ii. The audit timing is built there in, thereby it becomes a schedule of audit plan.
iii. The staff who are entrusted with the audit assignment is also specified. It is a plan of
resource allocation of the firm.
iv. It specifies the procedures to be checked during the audit.
v. As the audit work is split into various elements of procedures to be performed, the audit
programme acts as a guiding chart or check list during the performance of audit.
vi. Since the staff in charge of each work is specified and they sign the programme, it extracts
the responsibility from the audit assistants.
vii. The working papers of the audit staff can be reviewed against the audit programme
which helps a base of reference for evaluation of the performance before reporting on the
viii. It also helps in preparing a diary of the performance and plan and also base for billing
the clients for the time and manpower involved in the audit.
For the purpose of programme construction, the following points should be kept in view:
1. Stay within the scope and limitation of the assignment.
2. Determine the evidence reasonably available and identify the best evidence for deriving
the necessary satisfaction.
3. Apply only these steps and procedures which are useful in accomplishing the verification
purpose in the specific situation.

Advantages of Audit Program:

• Total and clear set of working is seen.
• A properly drawn audit program serves as evidence in the event of any charges of
negligence against the auditor.
• Helps in efficient utilization of assistants.
• Helps in controlling the progress of audit.
• It serves as guide for audit to be carried in succeeding period.
Disadvantages of Audit Program:

• More complexity in work.
• May bring rigidity in work and inflexibility to the changed situation.
• Inefficient assistants may take shelter behind the programme.
• Hard and fast audit program may kill the initiative and creativity of efficient assistants.
Methods of Work
Certain method should be adopted and carried out in a systematic and efficient manner to
accomplish the objective of audit. The following steps should be taken:
i. Work must be carried on regularly and record kept of time of arrival/departure of the
staff and also of the work done each day;
ii. As far as possible, a definite portion of the work should be completed each day so that
loose ends are not left over for being tied up at a later date;
iii. Entries should be made in the audit notebook and the audit programme initiated as a routine;
iv. Coloured pencils and different type of ticks must be employed to indicate the various
audit processes which have been applied and their significance must not be disclosed to
the client;
v. All the vouchers after examination must be immediately cancelled with an audit stamp;
vi. Staff members should refrain from discussing the client’s affairs amongst themselves
and with outsiders.
Co-ordination, Supervision and Monitoring of the work

The firm is required to establish policies and procedures designed to provide it with reasonable
assurance that engagements are performed in accordance with professional standards and
applicable legal and regulatory requirements, and that the firm or the engagement partner issue
reports that are appropriate in the circumstances. To ensure this, coordination, supervision and
monitoring responsibilities for each engagement should be clear. This may include;

AUDIT AND ASSURANCE
 Tracking the progress of the engagement;
 Considering the competence and capabilities of individual members of the engagement

team, whether they have sufficient time to carry out their work, whether they understand
their instructions and whether the work is being carried out in accordance with the
planned approach to the engagement;
 Addressing significant matters arising during the engagement considering their

significance and modifying the planned approach appropriately; and
 Identifying matters for consultation or consideration by more experienced engagement

team members during the engagement.
Coordination, supervision and monitoring is an overarching activity and it crosscuts each and
every process of audit.
Reliability of Information Produced by a Management’s Expert

The preparation of an entity’s financial statements may require expertise in a field other than
accounting or auditing, such as actuarial calculations, valuations, or engineering data. The
entity may employ or engage experts in these fields to obtain the needed expertise to prepare
the financial statements. Failure to do so when such expertise is necessary increases the risks of
material misstatement.
The nature, timing and extent of audit procedures for reliability of information produced by
Management experts may be affected by such matters as:
• The nature and complexity of the matter to which the management’s expert relates.
• The risks of material misstatement in the matter.
• The availability of alternative sources of audit evidence.
• The nature, scope and objectives of the management’s expert’s work.
• Whether the management’s expert is employed by the entity, or is a party engaged by it

to provide relevant services.
The probable number, timing, staffing and location of assurance visits

The nature and extent of planning activities of staff allocation may vary according to the size and
complexity of the entity, the key engagement team members' previous experience with the entity,
and changes in circumstances that occur during the audit engagement.
The involvement of the engagement partner and other key members of the engagement team in
planning the audit draws on their experience and insight, thereby enhancing the effectiveness and
efficiency of the planning process. The engagement partner may delegate portions of the planning
and supervision of the audit to other firm personnel.

The number, timing, staffing of the audit, and nature of communications and locations of the
assurances visits depends on following factors:
• The entity's timetable for reporting, including interim periods,
• The organization of meetings with management and those charged with governance to
discuss the nature, timing, and extent of the audit work,
• The discussion with management and those charged with governance regarding the
expected type and timing of reports to be issued and other communications, both written
and oral, including the auditor's report, management letters, and communications to
those charged with governance,
• The discussion with management regarding the expected communications on the status
of audit work throughout the engagement,
• Communication with auditors of components regarding the expected types and timing of
reports to be issued and other communications in connection with the audit of components,
• The expected nature and timing of communications among engagement team members,
including the nature and timing of team meetings and timing of the review of work performed,
• Whether there are any other expected communications with third parties, including any
statutory or contractual reporting responsibilities arising from the audit,
• The selection of the engagement team (including, when necessary, the engagement
quality control reviewer [as per NSA 220, Quality Control for an Audit of Financial
Statements] and the assignment of audit work to the team members, including the
assignment of appropriately experienced team members to areas in which there may be
higher risks of material misstatement,
• Engagement budgeting, including considering the appropriate amount of time to set

aside for areas in which there may be higher risks of material misstatement.
3.9 INTERNAL CONTROL SYSTEM
Internal control system is referred to as the policies and procedures established and implemented by
the entity to provide reasonable assurance that the management’s objective of ensuring the orderly
and efficient conduct of business including adherence to management policies, the safeguarding
of assets, the prevention and detection of fraud and error, the accuracy and completeness of the
accounting records and the timely preparation of reliable financial information are achieved.
The scope of internal controls extends beyond mere accounting controls and includes all
administrative controls concerned with the decision - making process leading to managements
authorization of transaction, such controls include, production method, time and motion study,
pricing policies, quality control, work standard, budgetary control, policy appraisal, quantitative

AUDIT AND ASSURANCE
controls etc. In an independent financial audit, the auditor is primarily concerned with those
policies and procedures having a bearing on the assertions underlying the financial statements.
These comprise primarily controls relating to safeguarding of assets, prevention and detection
of fraud and error, accuracy and completeness of accounting records and timely preparation of
reliable financial information. Administrative controls, on the other hand, have only a remote
relationship with financial records and the auditor may evaluate only those administrative controls
which have a bearing on the reliability of the financial records.
Objectives of Internal Control

The objectives of internal control systems are determined by the management, after considering
the nature of business, scale operations, the extent of professionalism of the management etc. The
objectives of internal controls relating to the accounting system are:
(i) Transactions are executed through general or specific management authorization.
(ii) All transactions are promptly recorded in an appropriate manner to permit the reparation
of financial information and to maintain accountability of assets.
(iii) Assets and records are safeguarded from unauthorized access, use or disposition.
(iv) Assets are verified at reasonable intervals and appropriate action is taken with regard to
the discrepancies.
Precisely, the control objectives ensure that the transactions processed are complete, valid
and accurate. The basic accounting control objectives which are sought to be achieved by any
accounting control system are:
i. whether all transactions are recorded;
ii. whether all recorded transactions are real;
iii. whether all recorded transactions are properly valued;
iv. whether all transactions are recorded timely;
v. whether all transactions are properly posted;
vi. whether all transactions are properly classified and disclosed;
vii. whether all transactions are properly summarized.
If the response to all the above answer is positive, the auditor would be justified in limiting his
account balance tests considerably. In case of excellent companies, it may also be possible to rely
on account balance with minimum of external tests, such as direct confirmation, management
representation etc. Where in a system a particular control is found to be deficient, audit attention
can be focused on the areas where basic accounting control objectives are not being adhered to. For
example, if it found that sales transactions are not being properly valued in accordance with the

price list determined by the management, the auditor would have to perform extensive searching
tests on sales invoices to assure him that the recoverable amounts are correctly posted. He may
also want to expand his confirmation request at the year end to cover a large majority of debtors.
Management’s role in designing the internal control system

The chief executive officer is ultimately responsible and should assume "ownership" of the system.
More than any other individual, the chief executive officer sets the organisational culture that
affects integrity and ethics and other factors of a positive control environment. In a large company,
the chief executive officer fulfills this duty by providing leadership and direction to senior
managers and reviewing the way they are controlling the business. Senior managers, in turn,
assign responsibility for establishment of more specific internal control policies and procedures
to personnel responsible for the unit's functions. In a smaller entity, the influence of the chief
executive officer, often an owner-manager, is usually more direct.
Management is accountable to the board of directors, which provides governance, guidance

and oversight. Effective board members are objective, capable and inquisitive. They also have
a knowledge of the entity's activities and environment and commit the time necessary to fulfill
their board responsibilities. Management may be in a position to override controls and ignore or
stifle communications from subordinates, enabling a dishonest management which intentionally
misrepresents results to cover its tracks. A strong, active board, particularly when coupled
with effective upward communications channels and capable financial, legal and internal audit
functions, is often best able to identify and correct such a problem.
Component of Internal Control

The control structure in an organization has the following components:
a. Control Environment - Control environment covers the effect of various factors like
management attitude; awareness and actions for establishing, enhancing or mitigating the
effectiveness of specific policies and procedures. The control environment encompasses the
elements of communication and enforcement of integrity and ethical values, commitment

AUDIT AND ASSURANCE
to competence, participation by those charged with governance, management’s philosophy

and operating style, organizational structure, assignment of authority and responsibility, and
human resource policies and practices. The resulting control environment has a pervasive
impact on the overall system of internal control.
Principles relating to the Control Environment component

 The organization demonstrates a commitment to integrity and ethical values.
 The board of directors demonstrates independence from management and exercises

oversight of the development and performance of internal control.
 Management establishes, with board oversight, structures, reporting lines, and

appropriate authorities and responsibilities in the pursuit of objectives.
 The organization demonstrates a commitment to attract, develop, and retain competent

individuals in alignment with objectives.
 The organization holds individuals accountable for their internal control responsibilities
in the pursuit of objectives.
b. The entity’s risk assessment process - The auditor should obtain an understanding of
whether the entity has a process for identifying business risks relevant to financial reporting
objectives, estimating the significance of the risks, assessing the likelihood of their occurrence;
and deciding about actions to address those risks.
Every entity faces a variety of risks from external and internal sources. Risk Assessment is
defined as the possibility that an event will occur and adversely affect the achievement of
objectives. Risk assessment involves a dynamic and iterative process for identifying and
assessing risks to the achievement of objectives. Risks to the achievement of these objectives
from across the entity are considered relative to established risk tolerances. Thus, risk
assessment forms the basis for determining how risks will be managed. A precondition to
risk assessment is the establishment of objectives, linked at different levels of the entity.
Management specifies objectives within categories relating to operations, reporting, and
compliance with sufficient clarity to be able to identify and analyze risks to those objectives.
Management also considers the suitability of the objectives for the entity. Risk assessment also
requires management to consider the impact of possible changes in the external environment
and within its own business model that may render internal control ineffective.
Principles relating to the Risk Assessment component

 The organization specifies objectives with sufficient clarity to enable the identification
and assessment of risks relating to objectives.
 The organization identifies risks to the achievement of its objectives across the entity and
analyzes risks as a basis for determining how the risks should be managed.

 The organization considers the potential for fraud in assessing risks to the achievement
of objectives.
 The organization identifies and assesses changes that could significantly impact the
system of internal control.
c. Control activities relevant to the audit - The auditor should obtain an understanding of control
activities relevant to the audit, being those the auditor judges it necessary to understand in
order to assess the risks of material misstatement at the assertion level and design further
audit procedures responsive to assessed risks.
Control activities are the actions established through policies and procedures that help ensure
that management’s directives to mitigate risks to the achievement of objectives are carried out.
Control activities are performed at all levels of the entity, at various stages within business
processes, and over the technology environment. They may be preventive or detective in
nature and may encompass a range of manual and automated activities such as authorizations
and approvals, verifications, reconciliations, and business performance reviews. Segregation
of duties is typically built into the selection and development of control activities. Where
segregation of duties is not practical, management selects and develops alternative control
activities.
Principles relating to the Control Activities component

 The organization selects and develops control activities that contribute to the mitigation
of risks to the achievement of objectives to acceptable levels.
 The organization selects and develops general control activities over technology to
support the achievement of objectives.
 The organization deploys control activities through policies that establish what is
expected and in procedures that put policies into action.
d. Information System, Including the Related Business Processes, Relevant to Financial

Reporting, and Communication – The auditor has to obtain understanding of entity's
information and communication systems. An information system consists of infrastructure
(physical and hardware components), software, people, procedures, and data. Many
information systems make extensive use of Information Technology (IT). The information
system relevant to financial reporting objectives, which includes the financial reporting
system, encompasses methods and records that identify and record all valid transactions,
describe on a timely basis the transactions in sufficient detail to permit proper classification
of transactions for financial reporting, measure the value of transactions in a manner that
permits recording their proper monetary value in the financial statements, determine the
time period in which transactions occurred to permit recording of transactions in the proper
accounting period, and present properly the transactions and related disclosures in the

AUDIT AND ASSURANCE
Communication, which involves providing an understanding of individual roles and

responsibilities pertaining to internal control over financial reporting, may take such forms as
policy manuals, accounting and financial reporting manuals, and memoranda. Communication
also can be made electronically, orally, and through the actions of management.
Information is necessary for the entity to carry out internal control responsibilities to support
the achievement of its objectives. Management obtains or generates and uses relevant and
quality information from both internal and external sources to support the functioning of
other components of internal control. Communication is the continual, iterative process of
providing, sharing, and obtaining necessary information. Internal communication is the
means by which information is disseminated throughout the organization, flowing up, down,
and across the entity. It enables personnel to receive a clear message from senior management
that control responsibilities must be taken seriously. External communication is twofold: it
enables inbound communication of relevant external information and provides information
to external parties in response to requirements and expectations.
Principles relating to the Information and Communication component

 The organization obtains or generates and uses relevant, quality information to support
the functioning of other components of internal control.
 The organization internally communicates information, including objectives and

responsibilities for internal control, necessary to support the functioning of other
components of internal control.
 The organization communicates with external parties regarding matters affecting the
functioning of other components of internal control.
e. Monitoring of controls - The auditor should obtain an understanding of the major activities
that the entity uses to monitor internal control relevant to financial reporting, including
those control activities relevant to the audit, and how the entity initiates remedial actions
to deficiencies in its controls. If the entity has an internal audit function, the auditor should
obtain an understanding of the nature of the internal audit function’s responsibilities, its
organizational status, and the activities performed, or to be performed.
Ongoing evaluations, separate evaluations, or some combination of the two are used to
ascertain whether each of the five components of internal control, including controls to affect
the principles within each component, is present and functioning. Ongoing evaluations, built
into business processes at different levels of the entity, provide timely information.
Separate evaluations, conducted periodically, will vary in scope and frequency depending
on assessment of risks, effectiveness of ongoing evaluations, and other management
considerations. Findings are evaluated against criteria established by regulators, standard-
setting bodies, or management and board of directors, and deficiencies are communicated to
management and the board of directors as appropriate.

Principles relating to the Monitoring Activities component

 The organization selects, develops, and performs ongoing and/or separate evaluations
to ascertain whether the components of internal control are present and functioning.
 The organization evaluates and communicates internal control deficiencies in a timely

manner to those parties responsible for taking corrective action, including senior
management and the board of directors, as appropriate.
The management is responsible for maintaining an adequate accounting system incorporating

various internal controls to the extent that they are appropriate to the size and nature of the
business. There should be reasonable assurance for the auditor that the accounting system
is adequate and that all the accounting information required to be recorded has in fact been
recorded. Internal controls normally contribute to such assurance. The auditor should gain an
understanding of the accounting system and related internal controls and should study and
evaluate the operation of those internal controls upon which he wishes to rely in determining
the nature, timing and extent of other audit procedures.
Internal control system means all the policies and procedures (internal controls) adopted by
the management of an entity to assist in achieving management’s objective of ensuring, as
far as practicable, the orderly and efficient conduct of its business, including adherence to
management policies, the safeguarding of assets, the prevention and detection of fraud and
error, the accuracy and completeness of the accounting records, and the timely preparation of
reliable financial information.
The system of internal control is also defined as the process designed, implemented and
maintained by those charged with governance, management and other personnel to provide
reasonable assurance about the achievement of an entity’s objectives with regards to reliability
of financial reporting, effectiveness and efficiency of operations, safeguarding of assets, and
compliance with applicable laws and regulations.
Limitations of Internal Control

An Internal Control system can provide only reasonable assurance that the management’s
objectives in establishing the system are achieved. That is, no internal control system can
provide absolute assurance that the control objectives are achieved. This is due to the fact that
any internal control system has certain internal limitations. The limitations may arise due to:
i. Management’s usual requirement that the cost of an internal control does not exceed the
expected benefits to be derived.
ii. Most internal controls tend to be directed at routine transactions rather than non-routine
transactions.

AUDIT AND ASSURANCE
iii. The potential for human error due to carelessness, distraction, mistakes of judgment and
the misunderstanding of instructions.
iv. The possibility of circumvention of internal controls through the collusion of a member
of management or an employee with parties outside or inside the entity.
v. The possibility that a person responsible for exercising an internal control could abuse
that responsibility, for example, a member of management overriding an internal control.
vi. The possibility that procedures may become inadequate due to changes in conditions,
and compliance with procedures may deteriorate. Controls have to be cost-effective.
The inherent limitation of internal control system requires the auditor to perform substantive
procedure to be able to express an opinion.
Evaluation of Internal Control

The auditor, in forming his opinion on financial information, needs reasonable assurance
that transactions are properly authorised and recorded in the accounting records and that
transactions have not been omitted. Internal controls, even if fairly simple, may contribute to
the reasonable assurance the auditor seeks. The auditor’s objective in studying and evaluating
internal controls is to establish the reliance he can place thereon in determining the nature,
timing and extent of his substantive auditing procedures. Compliance procedures are tests
designed to obtain reasonable assurance that those internal controls on which audit reliance
is to be placed are in effect. These procedures include tests requiring inspection of documents
supporting transactions to gain evidence that controls have operated properly (for example,
verifying that the document has been authorised) and enquiries about the observation of
controls which leave no audit trial (for example, determining who actually performs each
function trial not merely who is supposed to perform it). The auditor should review the
accounting system and related internal controls to gain an understanding of the flow of
transactions and the specific control procedures to be able to make a preliminary evaluation
and identification of those internal controls on which it might be effective and efficient to rely
in conducting his audit. The purpose of preliminary evaluation is to identify the particular
controls on which the auditor intends to rely and to test through compliance procedures. It
should be remembered that preliminary evaluation of the internal control is made on the
assumptions that the controls operates generally as described and that they function effectively
throughout the period of intended reliance. Compliance procedures should be conducted by
the auditor to gain evidence that those internal controls on which he intends to rely operate
generally as identified by him and that they function effectively throughout the period of
intended reliance. The concept of effective operation recognises that some deviations from
prescribed controls may have occurred. Deviations from prescribed controls may be caused
by such factors as changes in key personnel, significant seasonal fluctuations in volume of
transactions and human error. The auditor should make specific enquiries concerning these
matters, particularly as to the timing of staff changes in key control functions. He should

then ensure that his compliance procedures appropriately cover such a period of change or
fluctuation. Based on the results of his compliance procedures, the auditor should evaluate
whether the internal controls are adequate for his purposes. If based on the results of the
compliance procedures, the auditor concludes that it is not appropriate to rely on a particular
internal control to the degree previously contemplated, he should ascertain whether there is
another control which would satisfy his purpose and on which he might rely (after applying
appropriate compliance procedures). Alternatively, he may modify the nature, timing or
extent of his substantive audit procedures. The auditor’s compliance procedures normally
should be applied to transactions selected from those of the entire period under examination.
When, however, a shorter period is initially tested, the auditor needs to consider what is
necessary to provide reasonable assurance as to the reliability of the accounting records for
the whole period. The auditor’s judgement as to the nature, timing and extent of compliance
or substantive procedures to be applied to transactions occurring in the remaining period will
be affected by such factors as the following:
i. the results of the procedures already conducted;
ii. the responses to enquiries as to whether the internal control system is still operating in
the same manner as when studied and evaluated;
iii. the length of the remaining period;
iv. the nature and amount of transactions or balances involved;
v. the auditor’s evaluation of internal control environment, especially supervisory controls;

and
vi. the substantive procedures which the auditor intends to carry out irrespective of the
adequacy of internal controls.
The aforesaid study and discussion to give an overall idea of the control plan as it is and may
be considered as the first step of evaluation. This is followed by a process which enables the
auditor to know the specific control, its appropriateness and weakness of redundancy in the
context of the specific operation. This process is essentially a question and answer exercise.
For this, the auditor should have sufficient knowledge and experience about what should
be the appropriate and exact control in the given circumstances for the specific operation.
Accordingly, he frames questions for the answers to which will provide him insight into
the effectiveness or otherwise of the given controls. This question-answer exercise can be
undertaken either by framing a questionnaire or a check list.
Flow-Chart Technique for evaluation of Internal Control

This technique can be resorted for evaluation of the Internal Control System. It is a graphic
presentation of internal controls in the organisation and is normally drawn up to show the
controls in each section or sub-section. As distinct from a narrative form, it provides the

AUDIT AND ASSURANCE
most concise and comprehensive way for reviewing the internal controls and the evaluator’s
findings. In a flow chart, narratives are reduced to the minimum and by that process, it
can successfully bring the whole control structure, specially the essential parts thereof, in a
condensed but wholly meaningful manner. Every detail relevant from the control point of
view and the details about how an operation is performed can be included in the flow-chart.
Essentially, a flow chart is a diagram full of lines and symbols and if judicious use of them
can be made, it is probably an effective way of presenting the state of internal controls in the
client’s organisation. A properly drawn up flow chart can provide a neat visual picture of
the whole activities of the section or department involving flow of documents and activities.
More specifically it can show:
(a) at what point a document is raised internally or received from external sources;
(b) the number of copies in which a document is raised or received;
(c) the intermediate stages set sequentially through which the document and the activity
pass;
(d) distribution of the documents to various sections, department or operations;
(e) checking authorisation and matching at relevant stages;
(f) filing of the documents; and
(g) final disposal by sending out or destruction.
A flow chart is normally a horizontal one in which documents and activities are shown to
flow horizontally from section to section and concerned sections are shown as the vertical
column needs. These can be sales, purchase, wages, production etc. Purchases can be linked
with sundry creditors and payments, sales with sundry debtors and collections. By this
process, a flow chart will become self contained, complete and meaningful for evaluation of
internal controls. Generally, a questionnaire is also enclosed with a flow chart, incorporating
questions, the answers to which are to be looked into from the flow chart.
When developing the audit approach, the auditor considers the preliminary assessment of
control risk (in conjunction with the assessment of inherent risk) to determine the appropriate
detection risk to accept for the financial statement assertions and to determine the nature,
timing and extent of substantive procedures for such assertions. In developing the overall
audit plan, the auditor should assess inherent risk at the financial statement level. In
developing the audit program, the auditor should relate such assessment to material account
balances and classes of transactions at the assertion level or assume that inherent risk is high
for the assertion.

3.10 INTERNAL CONTROL AND THE COMPUTERISED ENVIRONMENT
The objective of audit is to ensure that the accounts on which the auditor is reporting to show
a true and fair view of the state of affairs at a given date and of the results for the period ended
on that date. The aforesaid objective and scope of an audit does not change in an Electronic Data
Processing (EDP) environment. However, the use of a computer changes the processing and
storage of financial information and may affect the organization and procedures employed by the
entity to achieve adequate internal control.
Accordingly, the procedures followed by the auditor in his study and evaluation of the accounting
system and related internal controls and nature, timing and extent of his other audit procedures
may be affected by an EDP environment. Audit in an EDP environment is different from normal
audit because of its reliability, nature of risk and the internal control and the characteristics of CIS
(Computerized Information System) environment.
 Nature of Risk, the internal control and the characteristics of CIS environment
• Lack of transaction trail

Although some system provide complete transaction trail, some of them (generally
in OLRT) does not provide the transaction trail
• Lack of segregation of function

Due to lack of segregation of function no person can be made responsible for error
and fraud
• Uniform processing of transaction

Because of uniform processing of all transaction there may be programming error.
• Automatic initiation or execution of transaction

Documents for automated transaction can’t be found
• Dependence of other controls over Computer processing

Manual works are also dependent on computer processing hence error and fraud in
computer processing may affect the manual procedure too.
• Potential for increased management supervision

By using tools and technology management can keep close watch to the operation
and processing.
• Potential for Human Errors

Although processing is done electronically, human effort is needed in input
controlling, development, maintenance and execution. In those stages chances of
human errors lies.

AUDIT AND ASSURANCE
• Potential for use of CAAT

Due to electronic form of data, CAAT may be easily applied and sometimes auditor
may be compelled to use them.
 Evaluating the reliability of CIS
The following are to be considered, to know the reliability of CIS whether it;
• Provides authorized, correct and complete data to processing centre;
• Provides for detection of errors on timely basis;
• Has data recovering arrangement so that incase of interruption due to power

mechanical or processing failures, the system restarts without loss of entries or
records;
• Ensure that output is correct and complete;
• Ensure that there is adequate data security against fire and other calamities, wrong
processing and fraud etc;
• Ensure that amendments to the programs are properly authorized; and
• Ensure safe custody of the application software and the data files.
Processing system in computerized environment

Data processing system in computerized environment is generally Batch Processing or On-
Line Real Time (OLRT) system which can be distinguished as under:
Batch Processing OnLine Real Time (OLRT) system

 Transactions are accumulated and processed in  Transactions are processed as on when
group. they occur.
 Two types of files are maintained; master file is  Only master file is maintained. It keeps
updated when batch processing is run. updating.
 Updating does not take place as quickly as in  Though updating takes place immediately
On-Line Real time system. the processing becomes complex.
 Not useful when instant and updated results are  Useful for immediate reporting system.
required.
 Generally, provides Audit trail .  Generally, does not provide audit trail
and hence requires more attention of
auditor.
Use of Computer in Auditing

Computer is more useful if the books of accounts are also in EDP environment. These are two
approaches of using Computer in Audit of computerized environment:

a) Audit around the computer

 It is also called Black Box approach.
 Computers are treated as mechanical device to complete the work fairly.
 The focus of audit is to take voluminous reports output and compare vouchers with
system of output to obtain assurance.
 Computer are considered only as a system to provide legible printouts of accounts

systematically and manually prepared.
 No regard is paid to the transaction of data that taken place inside the computer.
b) Audit through the computer

 It is also called White Box approach.
 Computer are treated as dynamic device to computer the task easily, correctly and in
good manner.
 The focus of audit is to check the accounting system and software used to ensure that
they provide audit assurance on various aspects of control.
 Computer are used to check, calculate, compare, logical operation, examination, analysis,
finding ratio by using computer software.
 CAAT and audit software tools are used to analyze the transformation of data.
Audit Trail
Audit trail means the situation where it is possible to relate the original input with final
output on one-to-one basis. Audit trail can’t be found generally on EDP environment and
especially in OLRT (On Line Real Time) system. The auditor needs to use computer assisted
audit techniques (CAAT) in such situation. There is no audit trail in EDP environment due
to the following:
• Direct data is entered in the system.
• Direct updation of master file as in OLRT system.
• No in-between reporting system, only direct final report is prepared.
Use of Computer Assisted Audit Techniques (CAAT); The audit trail to facilitate the audit
procedure remains low in case of computerized environment. This situation demands the use
of CAAT for effective audit. Thus, CAAT may be required because:
 The absence of input documents (e.g. order entry in on-line systems) or the generation of
accounting transactions by computer programs (e.g. automatic calculation of discounts)
may preclude the auditor from examining documentary evidence.

AUDIT AND ASSURANCE
 The lack of a visible audit trail will preclude the auditor from visually following
transactions through the computerized accounting system.
 The lack of visible output may necessitate access to data retained on files readable only
by the computer.
The timing of auditing procedures may be affected because data may not be retained in
computer files for a sufficient length of time for audit use, and the auditor may have to
make specific arrangements to have it retained or copied. The effectiveness and efficiency of
auditing procedures may be improved through the use of CAAT in obtaining and evaluating
audit evidence, for example:
(a) Some transactions may be tested more effectively for a similar level of cost by using the
computer to examine all or a greater number of transactions than would otherwise be
selected.
(b) In applying analytical review procedures, transactions or balance details may be

reviewed and reports printed of unusual items more efficiently by using the computer
than by manual methods.
Types of CAAT
a) Audit software (computer program used by auditor):
i. Package program – designed to perform data processing, reading file, selecting
information etc.
ii. Utility program – used by the organization to perform common data processing
function such as sorting, creating and printing eg. Excel.
iii. Purpose written program – computer program designed to perform audit task in
specific circumstances (visual basic oriented programs).
b) Test Data
Test data techniques are used in conducting audit procedures by entering data into
the computer system of the organization and comparing the results obtained with pre-
determined results.
Internal Controls in EDP Environment

There are two types of plan and policies adopted by the management to achieve the
management objectives in EDP environment.
A. Overall General EDP Controls

i. Organization and management controls
• Designing policies and procedure relating to control functions
• Segregation of incompatible functions

ii. System software Controls

• Restricted access of software to authorized personally
• Authorization, approval, testing and implementation of new system software
iii. Application system Development and Maintenance controls

• Restricted access to system documentation
• Changes to application system should be authorized
• Acquisition of application system from third parties should be carefully planned
• Testing and implementation of new system in proper ways
iv. Computer operation controls

• Use of only authorized programs on computer
• Only authorized personnel should use computer
• System should be used for authorized purpose
• Errors are detected on timely basis
v. Data entry and program controls

• Restricted access to data and program to authorized personal only
• Input should go through authorized process
B. Application Controls
i. Controls over Input
• Whether input is authorized and accurate
• Whether there is any alteration during input

AUDIT AND ASSURANCE
ii. Controls over processing and storage
• Whether processing errors are detected and corrected
• Whether each stages of processing are reviewed
iii. Controls over output
• Whether results are verified
• Whether confidentiality of results are maintained
3.11 COMMUNICATION OF DEFICIENCIES IN INTERNAL

CONTROL SYSTEM
As a result of obtaining an understanding of the accounting and internal control systems and
tests of control, the auditor may become aware of weaknesses in the systems.The auditor should
communicate to those charged with governance and management deficiencies in internal control
that the auditor has identified during the audit and that, in the auditor’s professional judgment are
of sufficient importance to merit their respective attentions. Deficiency in internal control exists
when a control is designed, implemented or operated in such a way that it is unable to prevent
or detect and correct, misstatements in the financial statements on a timely basis or a control
necessary to prevent or detect and correct misstatements in the financial statements on a timely
basis is missing. For example, if monthly age-wise analysis of debtors is not performed then it
may result in inadequate provisioning of bad debts for the fiscal year under audit. A deficiency
or combination of deficiencies in internal control that, in auditor’s professional judgment, is of
sufficient importance to merit the attention of those charged with governance. The communication
of significant deficiencies shall be in writing on timely basis. The auditor may communicate these
orally in the first instance to management and when appropriate to those charged with governance
to assist them in taking timely remedial action to minimize the risks of material misstatement.
Doing so, however, does not relieve the auditor of the responsibility to communicate the significant
deficiencies in writing. The auditor shall include in written communication of significant
deficiencies in internal control:
a) A description of the deficiencies and an explanation of their potential effects; and
b) Sufficient information to enable those charged with governance and management to

understand the context of the communication. In particular, the auditor shall explain
that:
i) The purpose of the audit for the auditor to express an opinion on the financial
statements
ii) The included consideration of internal control relevant to the preparation of the
financial statement sin order to design audit procedures that are appropriate in the

circumstances, but not for the purpose of expressing an opinion on the effectiveness
of internal control; and
iii) The matters being reported are limited to those deficiencies that the auditor has
identified during the audit and that the auditor has concluded are of sufficient
importance to merit being reported to those charged with governance.
This communication should be, preferably, in writing through a letter of weakness or management
letter. Important points with regard to such a letter are as follows:
(a) The letter lists down the area of weaknesses in the system and offers suggestions for
improvement.
(b) It should clearly indicate that it discusses only weaknesses which have come to the
attention of the auditor as a result of his audit and that his examination has not been
designed to determine the adequacy of internal control for management.
(c) This letter serves as a valuable reference document for management for the purpose of
revising the system and insisting on its strict implementation.
(d) The letter may also serve to minimize legal liability in the event of a major defalcation or
other loss resulting from a weakness in internal control.
It should be appreciated that by writing a letter to the management about the weaknesses in the
system, the auditor is not absolved from his duty to report the shortcomings in the accounts by way
of qualification where the defects have not been corrected to the auditor’s satisfaction weighing
the materiality of weaknesses and their impact, if considered necessary.
Communicating significant deficiencies in writing to those charged with governance reflects the
importance of these matters and assists those charged with governance in fulfulling their oversignt
responsibilities.
3.12 KNOWLEDGE OF COMMITTEE ON SPONSORING

ORGANIZATION (COSO)
In 1992 the Committee of Sponsoring Organizations (COSO) released its Internal Control—Integrated
Framework (the original framework). The original framework has gained broad acceptance and is
widely used around the world. It is recognized as a leading framework for designing, implementing,
and conducting internal control and assessing the effectiveness of internal control. In the twenty
years since the inception of the original framework, business and operating environments have
changed dramatically, becoming increasingly complex, technologically driven, and global. At the
same time, stakeholders are more engaged, seeking greater transparency and accountability for
the integrity of systems of internal control that support business decisions and governance of the
organization. COSO is pleased to present the updated Internal Control—Integrated Framework

AUDIT AND ASSURANCE
(Framework). COSO believes the Framework will enable organizations to effectively and efficiently
develop and maintain systems of internal control that can enhance the likelihood of achieving the
entity’s objectives and adapt to changes in the business and operating environments.
The purpose of this Internal Control-Integrated Framework (Framework) is to help management

better control the organization and to provide a board of directors with an added ability to
oversee internal control. A system of internal control allows management to stay focused on the
organization’s pursuit of its operations and financial performance goals, while operating within
the confines of relevant laws and minimizing surprises along the way. Internal control enables
an organization to deal more effectively with changing economic and competitive environments,
leadership, priorities, and evolving business models.
Understanding Internal Control

Internal control is defined as follows:
Internal control is a process, effected by an entity’s board of directors, management, and other personnel,
designed to provide reasonable assurance regarding the achievement of objectives relating to operations,
reporting, and compliance.
This definition emphasizes that internal control is:
• Geared to the achievement of objectives in one or more separate but overlapping categories.
• A process consisting of ongoing tasks and activities—it is a means to an end, not an end
in itself.
• Effected by people—it is not merely about policy and procedure manuals, systems, and
forms, but about people and the actions they take at every level of an organization to
effect internal control.
• Able to provide reasonable assurance, not absolute assurance, to an entity’s senior

management and board of directors.
• Adaptable to the entity structure—flexible in application for the entire entity or for a
particular subsidiary, division, operating unit, or business process.
This definition of internal control is intentionally broad for two reasons. First, it captures
important concepts that are fundamental to how organizations design, implement, and conduct
internal control and assess effectiveness of their system of internal control, providing a basis for
application across various types of organizations, industries, and geographic regions. Second, the
definition accommodates subsets of internal control.
Internal control is not one event or circumstance, but a dynamic and iterative process action that
permeate an entity’s activities and that are inherent in the way management runs the entity.

Embedded within this process are controls consisting of policies and procedures. These policies
reflect management or board statements of what should be done to effect internal control. Such
statements may be documented, explicitly stated in other management communications, or
implied through management actions and decisions.
Objectives, Components, and Principles

An organization adopts a mission and vision, sets strategies, establishes objectives it wants to
achieve, and formulates plans for achieving them. Objectives may be set for an entity as a whole
or be targeted to specific activities within the entity. Though many objectives are specific to a
particular entity, some are widely shared. For example, objectives common to most entities are
sustaining organizational success, reporting to stakeholders, recruiting and retaining motivated
and competent employees, achieving and maintaining a positive reputation, and complying with
laws and regulations.
Supporting the organization in its efforts to achieve objectives are five components of internal
control:
• Control Environment
• Risk Assessment
• Control Activities
• Information and Communication
• Monitoring Activities
Relationship of Objectives, Components, and the Entity

A direct relationship exists between objectives, which are what an entity strives to achieve,
components, which represent what is required to achieve the objectives, and entity structure (the
operating units, legal entities, and other structures). The relationship can be depicted in the form
of a cube:
• The three categories of objectives are represented by the columns.
• The five components are represented by the rows.
• The entity structure, which represents the overall entity, divisions, subsidiaries, operating
units, or functions, including business processes such as sales, purchasing, production,
and marketing and to which internal control relates, are depicted by the third dimension
of the cube.

AUDIT AND ASSURANCE
Objectives
Management, with board oversight, sets entity-level objectives that align with the entity’s mission,
vision, and strategies. These high-level objectives reflect choices made by management and
board of directors about how the organization seeks to create, preserve, and realize value for its
stakeholders. Such objectives may focus on the entity’s unique operations needs, or align with
laws, rules, regulations, and standards imposed by legislators, regulators, and standard setters, or
some combination of the two.
Setting objectives is a prerequisite to internal control and a key part of the management process
relating to strategic planning. Individuals who are part of the system of internal control need to
understand the overall strategies and objectives set by the organization. As part of internal control,
management specifies suitable objectives so that risks to the achievement of such objectives can be
identified and assessed. Specifying objectives relates to the articulation of specific, measurable or
observable, attainable, relevant, and time-bound objectives.
Categories of Objectives
The Framework groups entity objectives into the three categories of operations, reporting, and
compliance.
Operations Objectives
Operations objectives relate to the achievement of an entity’s basic mission and vision- the
fundamental reason for its existence. These objectives vary based on management’s choices
relating to the management operating model, industry considerations, and performance.
Entity-level objectives cascade into related sub-objectives for operations within divisions,

subsidiaries, operating units, and functions, directed at enhancing effectiveness and efficiency
in moving the entity toward its ultimate goal.
Reporting Objectives
Reporting objectives pertain to the preparation of reports for use by organizations and
stakeholders. Reporting objectives may relate to financial or non-financial reporting and to
internal or external reporting. Internal reporting objectives are driven by internal requirements
in response to a variety of potential needs such as the entity’s strategic directions, operating
plans, and performance metrics at various levels. External reporting objectives are driven
primarily by regulations and/or standards established by regulators, and standard-setting
bodies.
Compliance Objectives
Entities must conduct activities, and often take specific actions, in accordance with applicable
laws and regulations. As part of specifying compliance objectives, the organization needs to
understand which laws and regulations apply across the entity. Many laws and regulations
are generally well known, such as those relating to taxation and environmental compliance,
but others may be more obscure, such as those that apply to an entity conducting operations
in a remote foreign territory.
Limitations of Internal Control

Internal control, no matter how well designed, implemented and conducted, can provide only
reasonable assurance to management and the board of directors of the achievement of an entity’s
objectives. The likelihood of achievement is affected by limitations inherent in all systems of
internal control. These include the realities that human judgment in decision making can be faulty
and that breakdowns can occur because of human failures such as making errors. Additionally,
controls can be circumvented by two or more people colluding, and because management can
override the internal control system.
3.13 CONCEPT OF MATERIALITY
The concept of materiality is applied by the auditor both in planning and performing the audit, and
in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements,
if any, on the financial statements and in forming the opinion in the auditor’s report.
‘Framework for the Preparation and Presentation of Financial Statements’ states that information
is material if its omission or misstatement could influence the economic decisions of users taken
on the basis of the financial statements. Materiality depends on the size of the item or error judged
in the particular circumstances of its omission or misstatement. Thus, materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristic which information
must have if it is to be useful.

AUDIT AND ASSURANCE
Whether or not the knowledge of an item would influence the decisions of the users of the financial
statements is dependent on the particular facts and circumstances of each case. It is not possible
to lay down precisely either in terms of specific account or in terms of amounts the items which
could be considered as material in all circumstances. Materiality is a relative term and what may
be material in one circumstance may not be material in another. Therefore, the decision to judge
the materiality of the item whether in the aggregation of items, presentation or classification of
items shall depend upon the judgment of preparers of the account on the circumstances of the
particular case.
The key points of NSA 320 on Materiality in Planning and Performance of Audit are reproduced
here below:
1. When establishing the overall audit strategy, the auditor shall determine materiality for
the financial statements as a whole. If, in the specific circumstances of the entity, there is
one or more particular classes of transactions, account balances or disclosures for which
misstatements of lesser amounts than materiality for the financial statements as a whole could
reasonably be expected to influence the economic decisions of users taken on the basis of
the financial statements, the auditor shall also determine the materiality level or levels to
be applied to those particular classes of transactions, account balances or disclosures. The
auditor shall determine performance materiality for purposes of assessing the risks of material
misstatement and determining the nature, timing and extent of further audit procedures.
2. The auditor shall revise materiality for the financial statements as a whole (and, if applicable,
the materiality level or levels for particular classes of transactions, account balances or
disclosures) in the event of becoming aware of information during the audit that would
have caused the auditor to have determined a different amount (or amounts) initially. If the
auditor concludes that a lower materiality for the financial statements as a whole (and, if
applicable, materiality level or levels for particular classes of transactions, account balances or
disclosures) than that initially determined is appropriate, the auditor shall determine whether
it is necessary to revise performance materiality, and whether the nature, timing and extent of
the further audit procedures remain appropriate.
1. The auditor should consider materiality and its relationship with audit risk when
conducting an audit.
2. The objective of an audit of financial statements is to enable the auditor to express an

opinion whether the financial statements are prepared, in all material respects.
3. Quantification of materiality is a matter of professional judgment.
The auditor’s consideration of materiality on an audit is a matter of professional judgement.

Materiality is assessed in terms of the potential effect of a misstatement on decisions made
by a reasonable user of the financial statements. The auditor considers materiality at both
the overall financial statement level and in relation to individual account balances, classes of

transactions and disclosures. Materiality may be influenced by considerations such as legal

and regulatory requirements and considerations relating to individual financial statement
account balances and relationships. This process may result in different materiality levels
depending on the aspect of the financial statements being considered.
Factors that may affect the identification of an appropriate benchmark as a starting point in
determining materiality for the financial statements as a whole include the following:
• The elements of the financial statements (for example, assets, liabilities, equity, revenue,
expenses);
• Whether there are items on which the attention of the users of the particular entity’s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
• The nature of the entity, where the entity is in its life cycle, and the industry and economic
environment in which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is
financed solely by debt rather than equity, users may put more emphasis on assets, and
claims on them, than on the entity’s earnings); and
• The relative volatility of the benchmark.
The Relationship between Materiality and Audit Risk

There is an inverse relationship between materiality and the level of audit risk, that is, the higher
the materiality level, the lower the audit risk and vice versa.
When planning the audit, the auditor considers what would make the financial statements
materially misstated.
The auditor's assessment of materiality, related to specific account balances and classes of
transactions, helps the auditor decide such questions as what items to examine and whether to use
sampling and analytical procedures. This enables the auditor to select audit procedures that, in
combination, can be expected to reduce audit risk to an acceptably low level. Materiality and audit
risk are considered throughout the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures; and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial statements
and in forming the opinion in the auditor’s report.

AUDIT AND ASSURANCE
Evaluating the Effect of Misstatements

In evaluating the fair presentation of the financial statements, the auditor should assess whether
the aggregate of uncorrected misstatements that have been identified during the audit is material.
The aggregate of uncorrected misstatements comprises:
(a) specific misstatements identified by the auditor including the net effect of uncorrected
misstatements identified during the audit of previous periods; and
(b) the auditor's best estimate of other misstatements which cannot be specifically identified
(i.e., projected errors)
The auditor needs to consider whether the aggregate of uncorrected misstatements is material.
If the auditor concludes that the misstatements may be material, the auditor needs to consider
reducing audit risk by extending audit procedures or requesting management to adjust the
If management refuses to adjust the financial statements and the results of extended audit
procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements
is not material, the auditor should consider the appropriate modification to the auditor's report on
Tolerable Error and Materiality

Tolerable Error is the maximum error in a population (for example, the class of transactions or
account balance) that the auditor is willing to accept. Tolerable error is considered during the
planning stage and is related to the auditor's judgement about materiality. The smaller the tolerable
error, the larger is the sample size as a proportion of the population.
When assessing the risks of material misstatements and designing and performing further audit
procedures to respond to the assessed risks, the auditor should allow for the possibility that
some misstatements of lesser amounts than the materiality levels determined and could, in the
aggregate, result in a material misstatement of the financial statements. To do so, the auditor should
determine one or more levels of tolerable error that are normally lower than the materiality levels.
The auditor must perform the audit to obtain reasonable assurance of detecting misstatements that
the auditor believes could be large enough, individually or in the aggregate, to be quantitatively
material to the financial statements.
In the test of controls, the tolerable error is the maximum rate of deviation from a prescribed
control procedure that auditors are willing to accept in the population and still conclude that the
preliminary assessment of control risk is valid.

In substantive procedures, the tolerable error is the maximum monetary error in an account
balance or class of transactions that auditors are willing to accept so that when the results of all
audit procedures are considered they are able to conclude, with reasonable assurance, that the
financial statements are not materially misstated.
If auditors expect error to be present in the population, a larger sample than when no error is
expected generally has to be examined to conclude that the actual error in the population is not
greater that the planned tolerable error. The size and frequency of errors is important in assessing
the sample size. Larger sample sizes arise, for the same overall error, if there are a few large errors
compared to where there are many small ones. Smaller sample sizes result when the population is
expected to be error free. If the expected error rate is high, then sampling may not be appropriate.
In determining the expected error in a population, auditors consider such matters as the size and
frequency of errors identified in previous audits, changes in the entity's procedures and evidence
available form other procedures
3.14 GOING CONCERN ASSESSMENT AT PLANNING STAGE
The going concern assumption is a fundamental principle in the preparation of financial statements.
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for
the foreseeable future with neither the intention nor the necessity of liquidation. Accordingly,
assets and liabilities are recorded on the basis that the entity will be able to realise its assets and
discharge its liabilities in the normal course of business.
Nepal Accounting Standard (NAS) 01, “Presentation of Financial Statements” also requires
management to make an assessment of an enterprise’s ability to continue as a going concern.
Since the going concern assumption is a fundamental principle in the preparation of the financial
statements, management has a responsibility to assess the entity’s ability to continue as a going
concern even if the financial reporting framework does not include an explicit responsibility to do
so.
When there is a history of profitable operations and a ready access to financial resources,
management may make its assessment without detailed analysis.
Management’s assessment of the going concern assumption involves making a judgement, at a

particular point in time, about the future outcome of events or conditions which are inherently
uncertain.
When performing risk assessment procedures as required by NSA 315, the auditor shall consider
whether there are events or conditions that may cast significant doubt on the entity’s ability to
continue as a going concern. The auditor shall evaluate management’s assessment of the entity’s
ability to continue as going concern.

AUDIT AND ASSURANCE
The auditor’s evaluation of whether there is a substantial doubt about the entity’s ability to
continue as a going concern for a reasonable period of time (not to exceed one year beyond the
Statement of Financial Position date) is based on his or her knowledge of relevant conditions and
events that exist at, or occurred before, completion of fieldwork. It is not necessary for the auditor
to design audit procedures specifically to identify conditions and events that indicate a going
concern problem. Regular auditing procedures is sufficient to identify conditions and events that
indicate going concern problems which include the following:
1. Analytical procedures – Analytical procedures used as a substantive test or used in the

planning and overall review stages of the audit may indicate: a) Negative trends; b)
Slow-moving inventory; c) Receivable collectability problems; d) Liquidity and solvency
problems.
2. Review of subsequent events – Subsequent events, such as the bankruptcy of a major

customer, confirm adverse conditions that existed at the Statement of Financial Position
date. Other subsequent events that indicate a possible going concern problem include:
(a) collapse of the market price of the entity’s inventory; (b) withdrawal of line of credit
by bank; and (c) expropriation of entity’s assets.
3. Review of compliance with the terms of debt and loan agreements – Violation of debt
covenants results in debt default.
4. Reading of minutes – Minutes of meetings of stockholders, board of directors, and board

committees may indicate (a) potentially expensive litigation; (b) loss of lines of credit; (c)
loss of a major supplier; and (d) changes in the operation of the business that could result
in significant losses.
5. Inquiry of legal counsel – Responses to inquiries of the entity’s legal counsel about
litigation, claims, and assessments could indicate possible significant losses because of
product liability claims, copyright or patent infringement, contract violations, and illegal
acts.
6. Confirmations concerning financial support – Confirmation with related parties and

third parties of the details of arrangements to provide or maintain financial support
may indicate loss of bank lines of credit or loss of third-party guarantees of entity
indebtedness.
Regular audit procedures such as those described above may reveal conditions and events that
indicate there could be substantial doubt about the entity’s ability to continue as a going concern
for a reasonable period of time. Examples of these conditions and events (going concern warning
signs or ‘red flags’) are as follows:
1. Negative trends: (a) declining sales; (b) increasing costs; (c) recurring operating losses;
(d) working capital deficiencies; (e) negative cash flows from operations; and (f) adverse
key financial ratios.

2. Internal matters: (a) chaotic and inefficient accounting system; (b) loss of key
management or operations personnel; (c) work stoppages or other labor difficulties; (d)
substantial dependence on the success of a particular project; (e) uneconomic long-term
commitments; and (f) need to significantly revise operations.
3. External events that have occurred: (a) legal proceedings; (b) legislation or similar
matters that might jeopardize operating ability; (c) loss of a key franchise, license, or
patent; (d) loss of a principal customer or supplier; (e) uninsured catastrophes such as
drought, earthquake, or flood.
4. Other indications of possible financial difficulties are: (a) default on loan or similar
agreements; (b) arrearages in dividends; (c) denial of usual trade credit from suppliers;
(d) noncompliance with statutory capital requirements; (e) seeking new sources or
methods of financing.
Illustrative list of the events or conditions which may cast significant doubt about the going
concern assumption are as follow:
a) Financial
 Net liability or net current liability position.
 Fixed-term borrowings approaching maturity without realistic prospects of renewal or

repayment; or excessive reliance on short-term borrowings to finance long-term assets.
 Indications of withdrawal of financial support by debtors and other creditors.
 Negative operating cash flows indicated by historical or prospective financial statements.
 Adverse key financial ratios.
 Substantial operating losses or significant deterioration in the value of assets used to

generate cash flows.
 Arrears or discontinuance of dividends.
 Inability to pay creditors on due dates.
 Inability to comply with the terms of loan agreements.
 Change from credit to cash-on-delivery transactions with suppliers.
 Inability to obtain financing for essential new product development or other essential
investments.
b) Operating
 Management intentions to liquidate the entity or to cease operations
 Loss of key management without replacement.

AUDIT AND ASSURANCE
 Loss of a major market, franchise, license, or principal supplier.
 Labor difficulties or shortages of important supplies.
 Emergence of a highly successful competitor
c) Other
 Non-compliance with capital or other statutory requirements.
 Pending legal or regulatory proceedings against the entity that may, if successful, result
in claims that are unlikely to be satisfied.
 Changes in legislation or government policy expected to adversely affect the entity.
 Uninsured or underinsured catastrophes when they occur.
If, after considering the conditions and events described above, the auditor believes there is
substantial doubt about the entity’s ability to continue as a ‘going-concern’ for a reasonable
period of time, he or she should consider management’s plans for addressing these conditions
and events. Management’s plans may be classified as follows:
a. Plans to dispose of assets.
b. Plans to borrow money or restructure debt.
c. Plans to reduce or delay expenditures.
d. Plans to increase ownership equity.
The auditor’s responsibility is to consider the appropriateness of management’s use of the

going concern assumption in the preparation of the financial statements, and consider whether
there are material uncertainties about the entity’s ability to continue as a going concern that
need to be disclosed in the financial statements.
The auditor cannot predict future events or conditions that may cause an entity to cease to
continue as a going concern. Accordingly, the absence of any reference to going concern
uncertainty in an auditor’s report cannot be viewed as a guarantee as to the entity’s ability
to continue as a going concern. However, auditor should remain alert for evidence of events
or conditions which may cast significant doubt on the entity’s ability to continue as a going
concern throughout the audit. If such events or conditions are identified, the auditor should
perform the additional procedures and consider whether they affect the auditor’s assessments
of the components of audit risk.
The auditor should consider the same period as that used by management in making its
assessment under the financial reporting framework. If management’s assessment of the
entity’s ability to continue as a going concern covers less than twelve months from the
Statement of Financial Position date, the auditor should ask management to extend its
assessment period to twelve months from the Statement of Financial Position date.

The auditor should inquire of management as to its knowledge of events or conditions beyond
the period of assessment used by management that may cast significant doubt on the entity’s
ability to continue as a going concern.
Finally, substantial doubt may or may not exist on the entity financial statements:
1. Substantial Doubt Exists – If the auditor concludes after considering management’s

plans, that there is substantial doubt about the entity’s ability to continue as a going
concern for a reasonable period of time, he or she should consider possible effects on
the financial statements and the adequacy of the related disclosure. Disclosure might
• Conditions and events creating the doubt, such as recurring operating losses,
negative cash flows, working capital deficiency, and violation of debt covenants.
• Possible effect of conditions and events, such as a cutback in operations, a layoff of

employees, or a bankruptcy filing.
• Management’s evaluation of the significance of the conditions and events and any
mitigating factors.
• Whether operations may need to be discontinued.
• Management’s plans, including relevant prospective financial information (Note: It

is not intended that the prospective financial information should meet the minimum
presentation guidelines of ‘Statement on Standards for Accountants’ Services’ on
‘Prospective Financial Information’, ‘Financial Forecasts and Projections’. Also, the
inclusion of prospective financial information does not require procedures beyond
those required by Generally Accepted Auditing Standards)
• Information about recoverability or classification of recorded asset amounts or the

amounts or classification of liabilities.
2. Substantial Doubt Does Not Exist – After considering management’s plans, the auditor
may conclude that substantial doubt about the entity’s ability to continue as a going
concern for a reasonable period of time does not exist. In these circumstances, the auditor
should nonetheless consider the need to disclose the conditions and events responsible
for the initial doubt and any mitigating factors, including management’s plans.
Based on the audit evidence obtained, the auditor should determine if, in the auditor’s
judgement, a material uncertainty exists related to events or conditions that alone or in
aggregate, may cast significant doubt on the entity’s ability to continue as a going concern.
A material uncertainty exists when the magnitude of its potential impact is such that, in
the auditor’s judgement, clear disclosure of the nature and implications of the uncertainty
is necessary for the presentation of the financial statements not to be misleading.

AUDIT AND ASSURANCE
a. Going Concern Assumption Appropriate but a Material Uncertainty Exists

If the use of the going concern assumption is appropriate but a material uncertainty
exists, the auditor considers whether the financial statements:
i. adequately describe the principal events or conditions that give rise to the significant
doubt on the entity’s ability to continue in operation and management’s plans to
deal with these events or conditions; and
ii. state clearly that there is a material uncertainty related to events or conditions which
may cast significant doubt on the entity’s ability to continue as a going concern and,
therefore, that it may be unable to realise its assets and discharge its liabilities in the
normal course of business.
If adequate disclosure is made in the financial statements, the auditor should express an
unqualified opinion but modify the auditor’s report by adding an emphasis of matter
paragraph that highlights the existence of a material uncertainty relating to the event or
condition that may cast significant doubt on the entity’s ability to continue as a going
concern and draws attention to the note in the financial statements that discloses the
matters.
The following is an example of such a paragraph when the auditor is satisfied as to the
adequacy of the note disclosure:
“Without qualifying our opinion, we draw attention to Note X in the financial statements
which indicates that the Company incurred a net loss of Rs. ... during the year ended
Asadh 3X, 20XX and, as of that date, the Company’s current liabilities exceeded its
total assets by Rs. ... These conditions, along with other matters as set forth in Note X,
indicate the existence of a material uncertainty which may cast significant doubt about
the Company’s ability to continue as a going concern.”
If adequate disclosure is not made in the financial statements, the auditor should express
a qualified or adverse opinion, as appropriate. The report should include specific
reference to the fact that there is a material uncertainty that may cast significant doubt
about the entity’s ability to continue as a going concern.
The following is an example of the relevant paragraphs when a qualified opinion is to

be expressed:
“The Company’s financing arrangements expire and amounts outstanding are payable
on ... (specify date). The Company has been unable to re-negotiate or obtain replacement
financing. This situation indicates the existence of a material uncertainty which may
cast significant doubt on the Company’s ability to continue as a going concern and
therefore it may be unable to realise its assets and discharge its liabilities in the normal

course of business. The financial statements (and notes thereto) do not disclose this fact.
In our opinion, except for the omission of the information included in the preceding
paragraph, the financial statements give a true and fair view of (or are presented fairly,
in all material respects,) the financial position of the Company at Asadh 3X, 20XX and
the results of its operations and its cash flows for the year then ended in accordance with
Nepal Accounting Standards or relevant practices and comply with (Quote the relevant
statue or law)... (For example: Company Act, 2053/ Commercial Bank Act, 2031 etc.)”
The following is an example of the relevant paragraphs when an adverse opinion is to

be expressed:
“The Company’s financing arrangements expired, and the amount outstanding was
payable on ... (specify date). The Company has been unable to re-negotiate or obtain
replacement financing and is considering filing for liquidation. These events indicate
a material uncertainty which may cast significant doubt on the Company’s ability to
continue as a going concern and therefore it may be unable to realise its assets and
discharge its liabilities in the normal course of business. The financial statements
(and notes thereto) do not disclose this fact. In our opinion, because of the omission
of the information mentioned in the preceding paragraph, the financial statements
do not give a true and fair view of (or do not present fairly) the financial position
of the Company as at Ashad 3X, 20XX, and of its results of operations and its cash
flows for the year then ended in accordance with Nepal Accounting Standards or
relevant practices ..... (and do not comply with .....)......”
b. Going Concern Assumption Inappropriate

If, in the auditor’s judgement, the entity will not be able to continue as a going concern,
the auditor should express an adverse opinion if the financial statements have been
prepared on a going concern basis.
If, on the basis of the additional procedures carried out and the information obtained,
including the effect of management’s plans, the auditor’s judgement is that the entity will
not be able to continue as a going concern, the auditor concludes, regardless of whether or
not disclosure has been made, that the going concern assumption used in the preparation
of the financial statements is inappropriate and expresses an adverse opinion. When
the entity’s management has concluded that the going concern assumption used in the
preparation of the financial statements is not appropriate, the financial statements need
to be prepared on an alternative authoritative basis. If on the basis of the additional
procedures carried out and the information obtained the auditor determines the
alternative basis is appropriate, the auditor can issue an unqualified opinion if there is
adequate disclosure but may require an emphasis of matter in the auditor’s report to
draw the user’s attention to that basis.

AUDIT AND ASSURANCE
Management Unwilling to Make or Extend its Assessment

If management is unwilling to make or extend its assessment when requested to do so by the
auditor, the auditor should consider the need to modify the auditor’s report as a result of the
limitation on the scope of the auditor’s work.
When the auditor believes that it is necessary to ask management to make or extend its assessment.
If management is unwilling to do so, it is not the auditor’s responsibility to rectify the lack of
analysis by management, and a modified report may be appropriate because it may not be possible
for the auditor to obtain sufficient appropriate evidence regarding the use of the going concern
assumption in the preparation of the financial statements.
When there is significant delay in the signature or approval of the financial statements by
management after the Statement of Financial Position date, the auditor considers the reasons for
the delay. When the delay could be related to events or conditions relating to the going concern
assessment, the auditor considers the need to perform additional audit procedures as well as the
effect on the auditor’s conclusion regarding the existence of a material uncertainty.
The appropriateness of the use of the going concern assumption in the preparation of the financial
statements is generally not in question when auditing either the government or those public
sector entities having funding arrangements backed by the government. However, where such
arrangements do not exist, or where government funding of the entity may be withdrawn and the
existence of the entity may be at risk, reference to the Nepal Standard on Auditing - 570 “Going
Concern” will provide useful guidance. As government corporatize and privatize government
entities, going concern issues will become increasingly relevant to the public sector.
3.15 AUDIT WORKING PAPERS
The audit working papers constitute the link between the auditor’s report and the client’s records.
Working papers are considered as the property of the auditor. Audit Working papers provides for:
(i) means of controlling current audit work;
(ii) evidence of audit work performed;
(iii) schedules supporting or additional item in the accounts; and
(iv) information about the business being audited, including the recent history.
The relevant extracts of the NSA 230 ‘Documentation’ which covers the importance and relevance
of working paper is reproduced here below:
“Documentation" means the material (working papers) prepared / obtained / retained by auditor
in connection with the audit which may be in the form of data stored on paper, film, electronic
media or other media.

Working papers:
• Assist in the planning and performance of the audit,
• Assist in the supervision and review of the audit work and
• Provide evidence of the audit work performed.
Form and Content of Working Papers

All significant matters, which require the exercise of judgement, together with the auditor's
conclusion thereon, should be included in the working paper for providing overall understanding
of the audit. The audit plan, the nature, extent and timing (net) of auditing procedures performed
and the conclusions drawn from the evidence obtained should be recorded in working papers.
The form and content of working papers are affected by matters such as the:
Nature of the engagement,
• Form of the auditor's report,
• Nature and complexity of the client's business,
• Nature and condition of the client's records and internal control,
• Needs of direction, supervision and review of work performed by assistants and
• Specific audit methodology and technology used.
However, the extent of documentation is a matter of professional judgments.
Working papers normally include information relating to:
1. Legal and organizational structure of the client,
2. Legal documents, agreements and minutes,
3. Industry, economic environment and legislative environment information,
4. Evidence of the auditor's understanding,
5. Evidence of the auditor's evaluation of the work of internal auditing and conclusions,
6. Analyses of transactions and balances and significant ratios and trends,
7. Team members involved in audit procedures and date of such work,
8. Evidence that the work performed by assistants was supervised and reviewed,
9. Communications with other auditors, experts and other third parties,
10. Letters of representation,

AUDIT AND ASSURANCE
11. Conclusions on significant aspects of the audit, and
12. Financial statements and previous auditor's report.
In case of recurring audits, some working paper files may be classified as "permanent" audit files
as distinct from “current audit files.
Working papers are the property of the auditor. Although portions of or extracts from the working
papers may be made available to the client at the discretion of the auditor.
The auditor should adopt appropriate procedures for maintaining the confidentiality and safe
custody of the working papers and for retaining them for a period sufficient to meet the needs of
the practice and in accordance with legal and professional requirements of record retention.
Importance of Working Paper

• It provides guidance to the audit staff with regard to the manner of checking.
• The auditor is able to fix responsibility on the staff member who signs each schedule
checked by him.
• It acts as evidence in the court of law when a charge of negligence is brought against the
auditor.
• It acts as the process of planning for the auditor so that he can estimate the time that may
be required for checking the schedules

Changes in audit documentation in exceptional circumstances

When exceptional circumstances arise after the date of the auditor’s report that require the auditor
to perform new or additional audit procedures or that lead the auditor to reach new conclusions,
the auditor should document:
a. The circumstances encountered;
b. The new or additional audit procedures performed, audit evidence obtained, and
conclusions reached; and
c. When and by whom the resulting changes to audit documentation were made, and
(where applicable) reviewed.
Such exceptional circumstances include the discovery of facts regarding the audited financial
information that existed at the date of the auditor’s report that might have affected the auditor’s
report had the auditor then been aware of them.
3.16 AUDIT NOTE BOOK
An audit notebook is a book in which a large variety of matters observed during the course of
audit are recorded. It is thus a part of the permanent record of the auditor available for reference
later on, if required. The audit note book also provides a valuable help to the auditor in picking
up the links of work when the concerned assistant is away or the work is stopped temporarily
because in it are recorded along with observations, the various queries, explanations obtained and
evidence seen, while queries remaining undisposed of would be noted for follow up. It is more
satisfactory in some ways, however, to use loose sheets for entering queries and notes which,
subsequently, on being punched, may be filed in a special query file maintained for each client or
along with the clients’ accounts and papers, separately for each year.
Significant matters observed during the course of audit, a record of which should be kept in the
Audit Note Book such as:
(a) Audit queries not cleared immediately.
(b) The mistakes or irregularities observed during the course of audit.
(c) Unsatisfactory book-keeping arrangements, costing method, internal or financial

administration or organisation.
(d) Important information about the company which is not apparent from the accounts.
(e) Special points requiring consideration at the time of verification of final accounts.
(f) Important matters for future reference.

AUDIT AND ASSURANCE
The audit notes constitute important evidence of matters considered by the auditor during the
course of the audit. Audit notes can be an important defence for the auditor in the event of an
action for negligence in the discharge of his duties being subsequently brought against him.
3.17 TRANSACTION CYCLE
Typical accounting transactions follow a defined cycle for any organisation. For example, we tend
to view the transactions related to revenue to flow from an initial sale through to the collection
of the proceeds from the sale. The cycle concept helps the auditor visualize both the income,
expense and Statement of Financial Position accounts related to most day-to-day transactions
of the organization and thus provides a convenient way to organize accounting transactions
for audit testing and evaluation. Thus, the cycle concept presents a framework for viewing the
interrelationship between accounts affected by the same transaction or business activity. We use
the term cycle to refer to the processing of important transactions as these transactions update
all the related account balances associated with the transaction. The nature of transactions varies
with the organization, but most organizations process transactions that can be classified into the
following cycles:
• Revenue
• Purchase and payment of goods and services
• Payroll and related compensation
• Financing: debt and capital
• Capital Expenditure
Revenue cycle transactions include all the processes ranging from the initiation of a sales
transaction to distribution of a product, billing the customer, and collecting cash for the sale.
Sales transactions are always material to a company’s financial statements and often are subject
to manipulation. Many audit failures have been characterized by misstatement of sales. Because
sales are often subject to misstatement, special attention is paid to the control environment
and to management’s motivation to “stretch” accounting principles to achieve desired revenue
reporting. When examining sales transactions, the auditor also gathers evidence on proper credit
authorization and the proper valuation of the recorded transactions. Further, a review of sales
contracts provides evidence to analyze the adequacy of the client’s warranty expenses and related
liability. Revenue transactions often serve as a basis for computing commissions for sales staff.
Sales information is used for strategic long-term decision making and marketing analysis. Thus,
the accuracy of accounting in the revenue cycle is important for management decisions as well
as for the preparation of financial statements. The sales process differs with each client, but the
commonalities of the revenue cycle can be used to develop audit programs for most organizations.
For example, a sale of a consumable goods in a department store differs from a sale of construction
equipment, and both of these differ from a catalog sale of a lamp placed over the Internet. Some

organizations generate paper-based sales documentation; others maintain an audit trail only in
computerized form. The control concepts are similar, but the means to implement and document
the transactions differ. These control objectives of sales and debtors include:
a. Customers' orders should be authorized, controlled and recorded in order to execute

them promptly.
b. Goods shipped and work completed should be controlled to ensure that invoices are
issued and revenue recorded for all sales.
c. Goods returned and claims by customers (for example, in respect of damaged goods)
should be controlled in order to determine the liability for goods returned and claims
received.
d. Invoices and credits should be appropriately checked for accuracy and should be
authorized before being entered in the receivables' records.
e. Authorized customer transactions, and only those transactions, should be accurately

entered in the accounting records.
f. There should be procedures to ensure that sales invoices are subsequently paid by
customers and that doubtful amounts are identified in order to determine any provisions
or write offs required.
Purchases has a wide meaning in terms of the purchases cycle as purchases will include not
only inventory items but also all types of expense and the purchase of non-current assets. The
control objectives are to ensure that purchased goods/services are ordered under proper authority
and using proper procedures, Purchased goods/services are only ordered as necessary for the
proper conduct of the business operations and are ordered from suitable, approved suppliers,
goods/services received are inspected for quality, quantity and description, invoices and
related documentation are properly checked and approved as being valid before being entered
as trade creditors, all valid transactions relating to payables (suppliers' invoices, credit notes
and adjustments), and only those transactions, should be accurately recorded in the accounting
records. As with the sales system, there are a large number of controls that may be required in the
purchases cycle due to the importance of this area in any business
Most companies have processes related to payroll that identify and record transactions for staff
benefits and pensions. In this respect, the control objectives in respect of a wages and salaries
system are as follows:
a. Payment of wages and salaries should be made only in respect of the client's authorized
employees.
b. Payment should be made at authorized rates of pay.

AUDIT AND ASSURANCE
c. Wages and salaries payments should be in accordance with records of work performed,
e.g. time, output, commissions on sales.
d. Payroll and payroll deductions (tax and social security) should be calculated accurately.
e. Payment should be made to the correct employees.
f. Liabilities to the tax authorities for tax and social security should be properly recorded.
The control objectives for capital expenditure cycle are to ensure that:
i Capital expenditure are correctly recorded, adequately secured and properly maintained.
ii Acquisitions and disposals of non-current assets are properly authorized.
iii Acquisitions and disposals of non-current assets are for the most favorable price possible.
iv Non-current assets are properly recorded, appropriately depreciated, and written down
where necessary
The cycle approach is one way, but not the only way, to assist the auditor in focusing on all
important account balances surrounding a transaction to ensure that sufficient audit evidence is
gathered, evaluated, and used in reaching conclusions about the correctness of recorded balances.
The control objectives in the transaction cycle are the same as those developed in general operation
of organisation. The auditor should determine that the design of the system and the implemented
control procedures ensure that:
• All recorded transactions have occurred.
• All of the transactions that took place are recorded.
• The transactions have been recorded accurately.
• The transactions have been recorded in the correct accounting period.
• The transactions have been recorded in the proper accounts.

Self Evaluation Questions
Question 1 Knowledge of Business assists the auditor in assessing inherent and control risks
and in determining the nature, timing and extent of audit procedures. Explain.
Question 2 Explain analytical procedure and its types.
Question 3 Distinguish between audit plan and programme.
Question 4 Distinguish between audit risk and sampling risk.
Question 5 Explain the relationship between audit risk and materiality.

AUDIT AND ASSURANCE

CHAPER 4 : AUDIT EVIDENCE AND INTERNAL AUDIT
CHAPTER 4
AUDIT EVIDENCE
AND INTERNAL AUDIT
To understand-
 General principles of gathering audit evidence
 Sufficient and appropriate audit evidence
 The quality of audit evidence
 Procedures for generating audit evidence
 What if the audit evidence is not sufficient?
 Meaning and purposes of analytical procedures
 The knowledge of written representations from management

AUDIT AND ASSURANCE
4.1 EVALUATION OF AUDIT ASSERTIONS
Audit Assertions are the implicit or explicit claims and representations made by the management
responsible for the preparation of financial statements regarding the appropriateness of the various
elements of financial statements and disclosures. Audit Assertions are also known as Management
Assertions and Financial Statement Assertions.
In preparing financial statements, management is making implicit or explicit claims (i.e. assertions)
regarding the recognition, measurement and presentation of assets, liabilities, equity, income,
expenses and disclosures in accordance with the applicable financial reporting framework (e.g.
NFRS). For example, if a balance sheet of an entity shows buildings with carrying amount of Rs 10
million, the auditor shall assume that the management has claimed that:
• The buildings recognized in the balance sheet exist at the period end;
• The entity owns or controls those buildings;
• The buildings are valued accurately in accordance with the measurement basis;
• All buildings owned and controlled by the entity are included within the carrying
amount of Rs 10 million.
The auditor should consider the sufficiency and appropriateness of audit evidence to support
financial statement assertions. Financial statement assertions made by management can be
categorized as follows
a. Existence: An asset or a liability exists at a given date;
b. Rights and Obligations: An asset or a liability pertains to the entity at a given date;
c. Occurrence: A transaction or event took place which pertains to the entity during the
period;
d. Completeness: There are no unrecorded/undisclosed assets, liabilities, transactions or

events;
e. Valuation: An asset or liability is recorded at an appropriate carrying value;
f. Measurement: A transaction or event is recorded at the proper amount and for proper
period and
g. Presentation and Disclosure: An item is disclosed, classified, and described as per

requirement.
Types of Financial Statement Assertion: Financial Assertions may be classified into the following
types:

a. Audit Assertions relating to classes of Transactions-

Assertions Explanation Examples: Salaries & Wages Cost
Occurrence Transactions recognized in Salaries & wages expense have been
the financial statements have incurred during the period in respect of the
occurred and relate to the personnel employed by the entity. Salaries
entity. and wages expense do not include the
payroll cost of any unauthorized personnel.
Completeness All transactions that were Salaries and wages cost in respect of all
supposed to be recorded personnel have been fully accounted for.
have been recognized in the
Accuracy Transactions have been Salaries and wages cost have been
recorded accurately at their calculated accurately. Any adjustments
appropriate amounts. such as tax deduction at source have been
correctly reconciled and accounted for.
Cut-off Transactions have been Salaries and wages cost recognized during
recognized in the correct the period relates to the current accounting
accounting periods. period. Any accrued and prepaid expenses
have been accounted for correctly in the
Classification Transactions have been Salaries and wages cost have been fairly
classified and presented fairly allocated between:
in the financial statements. - Operating expenses incurred in
production activities;
- General and administrative expenses; and
- Cost of personnel relating to any self-
constructed assets other than inventory.
b. Audit Assertions relating to Assets, Liabilities and Equity Balance at the period end-
Assertions Explanation Examples: Inventory balance
Existence Assets, liabilities and equity Inventory recognized in the balance sheet
balances exist at the period end. exists at the period end.
Completeness All assets, liabilities and equity All inventory units that should have been
balances that were supposed recorded have been recognized in the
to be recorded have been financial statements. Any inventory held
recognized in the financial by a third party on behalf of the audit entity
statements. has been included in the inventory balance.

AUDIT AND ASSURANCE
Assertions Explanation Examples: Inventory balance

Rights & Entity has the right to Audit entity owns or controls the inventory
Obligations ownership or use of the recognized in the financial statements.
recognized assets, and the Any inventory held by the audit entity
liabilities recognized in the on account of another entity has not been
financial statements represent recognized as part of inventory of the audit
the obligations of the entity. entity.
Valuation Assets, liabilities and equity Inventory has been recognized at the
balances have been valued lower of cost and net realizable value in
appropriately. accordance with NAS 2 Inventories. Any
costs that could not be reasonably allocated
to the cost of production (e.g. general and
administrative costs) and any abnormal
wastage has been excluded from the cost
of inventory. An acceptable valuation basis
has been used to value inventory cost at the
period end (e.g. FIFO, AVCO, etc.)
c. Audit Assertions relating to Presentation and Disclosures-

Assertions Explanation Examples: Related Party Disclosures
Occurrence Transactions and events Transactions with related parties
disclosed in the financial disclosed in the notes of financial
statements have occurred and statements have occurred during the
relate to the entity. period and relate to the audit entity.
Completeness All transactions, balances, All related parties, related party
events and other matters that transactions and balances that should
should have been disclosed have been disclosed have been
have been disclosed in the disclosed in the notes of financial
financial statements. statements.
Classification & Disclosed events, The nature of related party transactions,
Understandability transactions, balances and balances and events has been clearly
other financial matters have disclosed in the notes of financial
been classified appropriately statements. Users of the financial
and presented clearly in statements can clearly determine the
a manner that promotes financial statement captions affected
the understandability of by the related party transactions and
information contained in the balances and can easily ascertain their
financial statements. financial effect.

Assertions Explanation Examples: Related Party Disclosures

Accuracy & Transactions, events, Related party transactions, balances
Valuation balances and other financial and events have been disclosed
matters have been disclosed accurately at their appropriate
accurately at their appropriate amounts.
amounts.
Use and Application

Auditors are required to obtain sufficient & appropriate audit evidence in respect of all material
financial statement assertions. The use of assertions therefore forms a critical element in the various
stages of a financial statement audit as described below-
Stage of Audit Application of Assertions

Audit Planning As part of the risk assessment procedures, auditors are required to understand
the entity and its environment including the assessment of the risk of material
misstatement (ROMM) due to fraud and error at the financial statement and
assertion level.
The assessment of ROMM at the financial statement and assertion level
provides the basis for determining the nature, timing and extent of audit
procedures that are necessary to obtain sufficient and appropriate audit
evidence in response to those assessed risks.
Performing Substantive tests are performed to identify material misstatements at the
Audit Procedures assertion level. In case of assertions whose ROMM has been assessed as
( Testing ) significant and no tests of control are planned to be performed, the substantive
procedures should include tests of detail (i.e. substantive analytical procedures
alone cannot be considered as sufficient and appropriate audit evidence for
assertions with a significant risk of material misstatement.
Tests of control (TOCs) are performed to assess the operating effectiveness
of controls at the financial statement and assertion level. TOCs are necessary
to validate the auditor's expectation of the operating effectiveness of controls
(as acquired from the risk assessment procedures performed at the planning
stage) and also in case where the performance of substantive procedures
alone cannot provide sufficient and appropriate audit evidence in respect of
a specific assertion.
Completion Auditor shall conclude whether sufficient and appropriate audit evidence
& Reporting has been obtained for all material financial statement assertions taking into
account any revisions in the assessment of ROMM at the assertion level.
Where an auditor is unable to obtain sufficient and appropriate audit evidence
in respect of a material financial statement assertion, he is required to modify
the audit report accordingly.

AUDIT AND ASSURANCE
Purpose & Importance

Assertions assist auditors in considering a wide range of issues that are relevant to the authenticity
of financial statements. The consideration of management assertions during the various stages of
audit helps to reduce the audit risk.
4.2 AUDIT EVIDENCE
Audit evidence refers to the information used by the auditor in arriving at the conclusions on
which the auditor’s opinion is based. Audit evidence includes both information contained in the
accounting records underlying the financial statements and other information. To obtain reasonable
assurance, the auditor should obtain sufficient appropriate audit evidence to reduce audit risk to
an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which
to base the auditor’s opinion. Sufficiency of audit evidence is the measure of the quantity of audit
evidence. The quantity of the audit evidence needed is affected by the auditor’s assessment of the
risks of material misstatement (the higher the assessed risks, the more audit evidence is likely to
be required) and also by the quality of such audit evidence (the higher the quality, the less may
be required). Obtaining more audit evidence, however, may not compensate for its poor quality.
Auditor’s judgment so as to sufficiency may be affected by factors such as materiality, risk of
material misstatement and size and characteristics of the population. Appropriateness of audit
evidence is the measure of the quality of audit evidence; that is, its relevance and its reliability
in providing support for the conclusions on which the auditor’s opinion is based. The reliability
of evidence is influenced by its source and by its nature, and is dependent on the individual
circumstances under which it is obtained. The sufficiency and appropriateness of audit evidence
are interrelated. When designing and performing audit procedures, the auditor should consider the
relevance and reliability of the information to be used as audit evidence. When using information
produced by the entity, the auditor should evaluate whether the information is sufficiently reliable
for the auditor’s purposes, including, as necessary in the circumstances, obtain audit evidence
about the accuracy and completeness of the information; and evaluate whether the information
is sufficiently precise and detailed for the auditor’s purposes. If information to be used as audit
evidence has been prepared using the work of a management’s expert, the auditor should, to the
extent necessary, have regard to the significance of that expert’s work for the auditor’s purposes,
evaluate the competence, capabilities and objectivity of that expert, obtain an understanding of the
work of that expert and evaluate the appropriateness of that expert’s work as audit evidence for
the relevant assertion.
Sources of Audit Evidence

Audit evidence is primarily obtained from audit procedures performed during the course of the
audit. It may, however, also include information obtained from other sources such as previous
audits (provided the auditor has determined whether changes have occurred since the previous
audit that may affect its relevance to the current audit) or a firm’s quality control procedures

for client acceptance and continuance. In addition to other sources inside and outside the entity,
the entity’s accounting records are an important source of audit evidence. Also, information
that may be used as audit evidence may have been prepared using the work of a management’s
expert. Audit evidence comprises both information that supports and corroborates management’s
assertions, and any information that contradicts such assertions.
Information from sources independent of the entity that the auditor may use as audit evidence
may include confirmations from third parties, analysts’ reports, and comparable data about
competitors (benchmarking data).
Audit Techniques
For collection and accumulation of audit evidence, certain methods and means are available and
these are known as audit techniques. Some of the techniques commonly adopted by the auditors
are the following:
i. Posting checking
ii. Casting checking
iii. Physical examination and count
iv. Confirmation
v. Inquiry
vi. Year-end scrutiny
vii. Re-computation
viii. Tracing in subsequent period
ix. Bank Reconciliation
4.3 AUDIT PROCEDURES TO OBTAIN AUDIT EVIDENCE
a) Auditor should obtain sufficient and appropriate audit evidences and test them before framing
an opinion about the assertions the financial statements reveal. Audit evidence to draw
reasonable conclusions on which to base the auditor’s opinion is obtained by performing:
Risk assessment procedures and
b) Further audit procedures which comprise:
• Compliance procedure/test of controls, when required by NSAs or when the auditor has
chosen to do so; and
• Substantial procedures, including test of details and substantive analytical procedures.

AUDIT AND ASSURANCE
The audit procedures inspection, observation, confirmation, recalculation, re-performance,

analytical procedures and inquiry may be used as risk assessment procedures, test of controls or
substantive procedures, depending on the context in which they are applied by the auditor.
The nature and timing of the audit procedures to be used may be affected but the fact that some
of the accounting data and other information may be available only in electronic form or only at
certain points or periods in time, For example, source documents, such as purchase orders and
invoices, may exist only in electronic form when an entity uses electronic commerce, or may be
discarded after scanning when an entity uses image processing systems to facilitate storage and
reference.
Certain electronic information may not be retrievable after a specified period of time, for example,
if files are changed and if backup files do not exist. Accordingly, the auditor may find it necessary
as a result of an entity’s data retention policies to request retention of some information for the
auditor’s review or to perform audit procedures at a time when the information is available.
As businesses have grown more complex and sophisticated, and the costs of labour have risen,
automated systems and processes have necessarily become much more prevalent. A well-run
business will have its own systems and controls in place to operate efficiently, safeguard its
assets, and to provide reasonable assurance that its transactions are properly reported and that
its financial statements are complete and accurate. The auditors assess the effectiveness of these
controls in preventing and mitigating the possible risk of material misstatement in those areas
where the auditor plans to use such controls to adjust the nature, timing and extent of their testing.
These compliance procedure/tests of controls are designed to obtain reasonable assurance that
those internal control on which audit reliance is to be placed are in effect. It seeks to test that
• there exists internal control,

• the existing internal control is effective and
• the internal control is in full force / continues during the period under review.
Test of control includes

• Inspection of documents supporting transactions and other events to gain audit evidence
that internal controls are operated properly, for example verifying that a transaction has
been authorized.
• Inquiries and observation of internal control which leaves no audit trials, for example,
determining who actually performs each function and not merely who are supposed to
perform it.
• Re-performance of the internal control for example, reconciliation of bank account, to

ensure they were correctly performed by the organisations and

• Testing of internal control operating on specific computerised applications or over the

overall information technology function, for example access or programme change
controls.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to
express opinion about the assertions the financial data in the form of balances and transactions.
These i.e. transactions and balances need to be tested. This is done by audit procedure called
substantial checking.
The level of substantive audit evidence needed to give an opinion may be reduced, if auditor
believe the controls are effective, and have tested that control operated reliably throughout the
year. These substantial procedures are designed to obtain audit evidence as to the completeness,
accuracy and validity of the data produced by the accounting system.
The substantial procedures involve

(a) Checking of transactions and balances and
(b) Analytical review. The checking of transaction and balances involves vouching of sales,
purchases, payments, receipts and scrutiny of ledgers. The analytical procedure involves
critically examining the accounts in an overall manner and it may entail computation of ratios,
trend analysis so as to dwell in length for examination of unusual or unexplained deviations.
In addition to testing controls, the auditor is required to perform further procedures to gather
evidence from substantive procedures (substantive audit evidence), which can include a
combination of the following:
• Physically observing or inspecting assets (such as inventory or property, plant and

equipment);
• Examining records to support balances and transactions;
• Obtaining confirmations from third parties the company does business with (such as its
suppliers, customers and in particular the banks it uses);
• Checking elements of the financial statements by comparison to relevant external

information and investigating any differences (for example, using an external market
index to check pricing and valuations); and
• Checking calculations.
Selection of the appropriate audit procedure is matter of experience and judgment of the auditor
in addition to the specific requirement, if any. There is no single procedure for the verification and
one procedure may not be practicable in all situations. The auditor has to think in advance that
which are suspected areas and may fetch the benefits to the actor. Generally extreme cases should
be investigated. While conducting audit; different techniques of auditing should be employed.
Audit evidence should be collected from various sources and needs to be corroborated.

AUDIT AND ASSURANCE
Audit procedures to obtain audit evidence can include:
Inspection of
Records or
Documents Inspection of
Analytical Tangible
Procedures Assets
Obtaining
Re- Audit
performance Evidence Observations
Recalculation
Inquiry
Confirmation
Inspection of Records or Documents:

Inspection consists of examining records or documents, whether internal or external, in paper
form, electronic form, or other media. Inspection of records and documents provides audit
evidence of varying degrees of reliability, depending on their nature and source and, in the case
of internal records and documents, on the effectiveness of the controls over their production.
An example of inspection used as a test of controls is inspection of records or documents for
evidence of authorization.
Inspection of Tangible Assets:

Inspection of tangible assets consists of physical examination of the assets. Inspection of tangible
assets may provide reliable audit evidence with respect to their existence, but not necessarily
about the entity’s rights and obligations or the valuation of the assets. Inspection of individual
inventory items ordinarily accompanies the observation of inventory counting.
Observation:
Observation consists of looking at a process or procedure being performed by others. Examples
include observation of the counting of inventories by the entity’s personnel and observation of the
performance of control activities. Observation provides audit evidence about the performance of
a process or procedure but is limited to the point in time at which the observation takes place and
by the fact that the act of being observed may affect how the process or procedure is performed.

It implies examination of a few selected transactions from the beginning to the end through the
entire flow of the transaction, i.e., from initiation to the completion of the transaction by receipt
of payment of cash and delivery or receipt of the goods. This examination consists of studying
the recording of transactions at the various stages through which they have passed. At each
stage, relevant records and authorities are examined; it is also judged whether the person who
has exercised the authority in relation to the transactions is fit to do so in terms of the prescribed
procedure. For example, if payment to a creditor is to be verified, auditing in depth technique will
be applied through following stages
 Examine the requisition note from the stores, ensuing that it has been signed by the
appropriate official.
 Examine the copy of the order placed by the purchasing department, ensuring that it was
properly executed on the official form, complied with all the client's regulations and was
authorised by the appropriate official.
 Examine the Goods Received Note and inspection certificate when out when goods were
received noting if it has been properly signed, if it indicates that the correct goods have
been received and if their quantity and condition have been checked.
 Examine the invoice and statements of accrual from the supplier and comparing it with
the copy of order.
 Check the entry in stock register showing the goods were received.
 Check the account department that the invoice from the supplier has been matched with
the copy of order and copy of the goods received note before being processed and that
the calculation has been checked.
 Check the appropriate entries in the accounting records and compare the cheque with
the invoice and supplier's statements.
From the above example, it can be seen that the auditor would trace the transaction right through
the system. He would not merely satisfy himself that the entries in the records were correct but
would ensure that the appropriate internal controls relating to authorization of transactions, the
checking of one document against another and physical inspection of goods has been properly
operated at the appropriate times. He would also ensure that a proper system was in force to claim
credits in respect of short deliveries or deliveries of defective goods.
Where the examination of successive stages in the depth test produces satisfactory results, it is
accepted practice that the auditor may progressively reduce the number of items to be examined
at subsequent stages. However, if the tests reveal an unacceptable number of errors, it will be
necessary for the auditor to increase the number of items examined in order to discover whether
the original sample was representative.

AUDIT AND ASSURANCE
Inquiry:
Inquiry consists of seeking information of knowledgeable persons, both financial and non-
financial, throughout the entity or outside the entity. Inquiry is an audit procedure that is
used extensively throughout the audit and often is complementary to performing other audit
procedures. Inquiries may range from formal written inquiries to informal oral inquiries.
Evaluating responses to inquiries is an integral part of the inquiry process.
Confirmation:
Confirmation, which is a specific type of inquiry, is the process of obtaining a representation
of information or of an existing condition directly from a third party. For example, the auditor
may seek direct confirmation of receivables by communication with debtors. Confirmations
are frequently used in relation to account balances and their components but need not be
restricted to these items. For example, the auditor may request confirmation of the terms of
agreements or transactions an entity has with third parties; the confirmation request is designed
to ask if any modifications have been made to the agreement and, if so, what the relevant details
are.
Recalculation:
Recalculation consists of checking the mathematical accuracy of documents or records.
Recalculation can be performed through the use of information technology, for example,
by obtaining an electronic file from the entity and using CAATs to check the accuracy of the
summarization of the file.
Re-performance:
Re-performance is the auditor’s independent execution of procedures or controls that were
originally performed as part of the entity’s internal control, either manually or through the use
of CAATs.
Analytical Procedures:
Analytical procedure involves evaluations of financial information through analysis of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass
such investigation as is necessary of identified fluctuations or relationships that are inconsistent
with other relevant information or that differ from expected values by a significant amount.
1. This includes the consideration of comparisons of the entity’s financial information with,
for example: Comparable information for prior periods.
2. Anticipated results of the entity, such as budgets or forecasts, or expectations of the

auditor, such as an estimation of depreciation.

3. Similar industry information, such as a comparison of the entity’s ratio of sales to

accounts receivable with industry averages or with other entities of comparable size in
the same industry.
• Analytical procedures also include consideration of relationships, for example:

Among elements of financial information that would be expected to conform
to a predictable pattern based on the entity’s experience, such as gross margin
percentages.
• Between financial information and relevant non-financial information, such as

payroll costs to number of employees.
Various methods may be used to perform analytical procedures. These methods range from
performing simple comparisons to performing complex analyses using advanced statistical
techniques. Analytical procedures may be applied to consolidated financial statements,
components and individual elements of information.
Analytical procedures also refers to the analysis of significant ratios and trends, including the
resulting investigation of fluctuations and relationships that are inconsistent with other relevant
information or which deviate from predicted amounts. The application of analytical procedures is
based on the expectation that relationships among data exist and continue in the absence of known
conditions to the contrary. The presence of these relationships provides audit evidence as to the
completeness, accuracy and validity of the data produced by the accounting system. However,
reliance on the results of analytical procedures will depend on the auditor’s assessment of the
risk that the analytical procedures may identify relationships as expected when, in fact, a material
misstatement exists.
The extent of reliance that the auditor places on the results of analytical procedures depends on
the various factors including:
i Materiality of the items involved, for example, when inventory balances are material, the
auditor does not rely only on analytical procedures in forming conclusions. However,
the auditor may rely solely on analytical procedures for certain income and expense
items when they are not individually material;
ii other audit procedures directed toward the same audit objectives, for example, other
procedures performed by the auditor in reviewing the collectability of accounts
receivable, such as the review of subsequent cash receipts, might confirm or dispel
questions raised from the application of analytical procedures to an ageing schedule of
customers’ accounts;
iii Accuracy with which the expected results of analytical procedures can be predicted. For
example, the auditor will ordinarily expect greater consistency in comparing gross profit
margins from one period to another than in comparing discretionary expenses, such as
research or advertising; and

AUDIT AND ASSURANCE
iv assessments of material misstatement, for example, if internal control over sales order
processing is weak and, therefore, control risk is high, more reliance on tests of details
of transactions and balances than on analytical procedures in drawing conclusions on
receivables may be required.
The auditor will need to consider testing the controls, if any, over the preparation of information
used in applying analytical procedures. When such controls are effective, the auditor will have
greater confidence in the reliability of the information and, therefore, in the results of analytical
procedures. For example, an entity in establishing recording of unit sales, the auditor could test
the controls over the recording of unit sales in conjunction with tests of the controls over the
processing of sales invoices.
Types of Analytical Procedure

Following are the basic types of analytical procedures.
(i) Ratio Analysis

Ratios are expressed as one financial statement data in relation to another. For example,
current ratio is calculated by dividing current assets with current liabilities. Auditors use
ratio analysis in their audit to compare ratios for the current year with ratios for a prior year,
budget or an industrial average. Any material differences in the ratios must be explained by
the auditors.
(ii) Trend Analysis

Trend analysis refers to the comparison of a current balance with a previous year's balance.
An auditor may choose to use either the diagnostic or casual approach. The diagnostic
approach is used to evaluate if a balance of a current account deviates significantly from the
trend established in the previous year's balances for that account. In the casual approach, the
auditor calculates a balance expected for the account then compared to the actual amount.
(iii) Reasonable Tests

Nonfinancial data for the current period is used to calculate an expected amount for the
account balance. This procedure does not use previous period events; rather, it uses operating
data for the period under consideration for the audit. These procedures are therefore more
applicable to income statements because data for current period may be easier to attain than
previous years' data. The calculated amount is then used to check for reasonableness in the
account balances under audit.
(iv) Model-Based Procedures

Model-based procedures use client-operating data and external data, such as industry and
economic information, to predict account balances for items under audit. These models also
use financial and nonfinancial data as well. The most commonly used procedure is regression

analysis, which is used for income statements using monthly data for the past three years. The
36 monthly observations are used to establish a relationship that is used to predict current
account balances.
Purposes of Analytical Procedures

Analytical procedures are used throughout the audit process and are conducted for three primary
purposes:
a. Preliminary analytical review – risk assessment

Preliminary analytical reviews are performed to obtain an understanding of the business and
its environment (e.g. financial performance relative to prior years and relevant industry and
comparison groups), to help assess the risk of material misstatement in order to determine
the nature, timing and extent of audit procedures, i.e. to help the auditor develop the audit
strategy and program.
b. Substantive analytical procedures

Analytical procedures are used as substantive procedures when the auditor considers that the
use of analytical procedures can be more effective or efficient than tests of details in reducing
the risk of material misstatements at the assertion level to an acceptably low level.
c. Final analytical review

Analytical procedures are performed as an overall review of the financial statements at the
end of the audit to assess whether they are consistent with the auditor’s understanding of
the entity. Final analytical procedures are not conducted to obtain additional substantive
assurance. If irregularities are found, risk assessment should be performed again to consider
any additional audit procedures are necessary.
Use of Substantive Analytical Procedures for gathering audit evidence
One of the objectives of NSA 520 is that relevant and reliable audit evidence is obtained when using
substantive analytical procedures. The primary purpose of substantive analytical procedures is to
obtain assurance, in combination with other audit testing (such as tests of controls and substantive
tests of details), with respect to financial statement assertions for one\ or more audit areas.
Substantive analytical procedures are generally more applicable to large volumes of transactions
that tend to be more predictable over time.
There are four elements that comprise\ distinct steps that are inherent in the process to using
substantial analytical procedures:

AUDIT AND ASSURANCE
a. Develop an independent expectation

The development of an appropriately precise, objective expectation is the most important
step in effectively using substantive analytical procedures. An expectation is a prediction of a
recorded amount or ratio. The prediction can be a specific number, a percentage, a direction
or an approximation, depending on the desired precision.
b. Define a significant difference

While designing and performing substantive analytical procedures the auditor should
consider the amount of difference from the expectation that can be accepted without further
investigation
The maximum acceptable difference is commonly called the ‘threshold’. Thresholds may be
defined either as numerical values or as percentages of the items being tested. Establishing
an appropriate threshold is particularly critical to the effective use of substantive analytical
procedures.
c. Compute difference
The third step is the comparison of the expected value with the recorded amounts and the
identification of significant differences, if any. This should be simply a mechanical calculation.
It is important to note that the computation of differences should be done after the
consideration of an expectation and threshold. In applying substantive analytical procedures,
it is not appropriate to first compute differences from prior period balances and then let the
results influence the ‘expected’ difference and the acceptable threshold.
d. Investigate significant differences and draw conclusions

The fourth step is the investigation of significant differences and formation of conclusions.
Differences indicate an increased likelihood of misstatements; the greater the degree of
precision, the greater the likelihood that the difference is a misstatement.
Explanations should be sought for the full amount of the difference, not just the part that
exceeds the threshold.
Analytical Procedures an example:

The auditor can adopt the following analytical procedures to verify the stock of inventories:
i Quantitative reconciliation of opening stocks, purchases, production, sales and closing

stocks;
ii Comparison of closing stock quantities and amounts with those of the previous year.
iii Comparison of the stock turnover ratios for the current year with that of the previous
year and with industry standards if available.

iv Comparison of the closing stock (Raw materials, closing work-in-progress and finished
goods are percentage of total stocks) with the corresponding figures of the previous year.
v Comparison of current year gross profit ratio of the previous year.
vi Comparison of actual stock, purchase and sales figures with the budgeted figures if
available.
vii Comparison of raw-material yield/wastage with previous year figures.
Above procedure often used in some combination, in addition to inquiry. Although inquiry
may provide important audit evidence, and may even produce evidence of a misstatement,
inquiry alone ordinarily does not provide sufficient audit evidence of the absence of a material
misstatement at the assertion level, nor of the operating effectiveness of controls.
4.4 QUALITY OF AUDIT EVIDENCE
The quality of all audit evidence is affected by the (a) relevance and (b) reliability of the information
upon which it is based.
a. Relevance
Relevance deals with the logical connection with, or bearing upon, the purpose of the audit
procedure and, where appropriate, the assertion under consideration. The relevance of
information to be used as audit evidence may be affected by the direction of testing. For
example, if the purpose of an audit procedure is to test for overstatement in the existence or
valuation of accounts payable, testing the recorded accounts payable may be a relevant audit
procedure. On the other hand, when testing for understatement in the existence or valuation
of accounts payable, testing the recorded accounts payable would not be relevant, but testing
such information as subsequent disbursements, unpaid invoices, suppliers’ statements, and
unmatched receiving reports may be relevant.
A given set of audit procedures may provide audit evidence that is relevant to certain assertions,
but not others. For example, inspection of documents related to the collection of receivables
after the period end may provide audit evidence regarding existence and valuation, but not
necessarily cutoff. Similarly, obtaining audit evidence regarding a particular assertion, for
example, the existence of inventory, is not a substitute for obtaining audit evidence regarding
another assertion, for example, the valuation of that inventory. On the other hand, audit
evidence from different sources or of a different nature may often be relevant to the same
assertion.
Tests of controls are designed to evaluate the operating effectiveness of controls in preventing,
or detecting and correcting, material misstatements at the assertion level. Designing tests of
controls to obtain relevant audit evidence includes identifying conditions (characteristics or

AUDIT AND ASSURANCE
attributes) that indicate performance of a control, and deviation conditions which indicate
departures from adequate performance. The presence or absence of those conditions can then
be tested by the auditor.
Substantive procedures are designed to detect material misstatements at the assertion level.
They comprise tests of details and substantive analytical procedures. Designing substantive
procedures includes identifying conditions relevant to the purpose of the test that constitute
a misstatement in the relevant assertion.
b. Reliability
The reliability of information to be used as audit evidence is influenced by its source and
its nature, and the circumstances under which it is obtained, including the controls over its
preparation and maintenance where relevant. While recognizing that exceptions may exist,
the following generalizations about the reliability of audit evidence may be useful:
 The reliability of audit evidence is increased when it is obtained from independent

sources outside the entity.
 The reliability of audit evidence that is generated internally is increased when the related
controls, including those over its preparation and maintenance, imposed by the entity
are effective.
 Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or by
inference (for example, inquiry about the application of a control).
 Audit evidence in documentary form, whether paper, electronic, or other medium, is

more reliable than evidence obtained orally (for example, a contemporaneously written
record of a meeting is more reliable than a subsequent oral representation of the matters
discussed).
 Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles, or documents that have been filmed, digitized or
otherwise transformed into electronic form, the reliability of which may depend on the
controls over their preparation and maintenance.
Sufficiency and Appropriateness of Evidence

Sufficiency is the measure of the quantity of evidence. Appropriateness is the measure of the
quality of evidence; that is, its relevance and its reliability. The quantity of evidence needed is
affected by the risk of the subject matter information being materially misstated (the greater the
risk, the more evidence is likely to be required) and also by the quality of such evidence (the higher
the quality, the less may be required).

Accordingly, the sufficiency and appropriateness of evidence are interrelated. However, merely
obtaining more evidence may not compensate for its poor quality.
The reliability of evidence is influenced by its source and by its nature and is dependent on the
individual circumstances under which it is obtained. Generalizations about the reliability of
various kinds of evidence can be made; however, such generalizations are subject to important
exceptions. Even when evidence is obtained from sources external to the entity, circumstances may
exist that could affect the reliability of the information obtained. For example, evidence obtained
from an independent external source may not be reliable if the source is not knowledgeable.
While recognizing that exceptions may exist, the following generalizations about the reliability of
evidence may be useful:
• Evidence is more reliable when it is obtained from independent sources outside the
entity.
• Evidence that is generated internally is more reliable when the related controls are
effective.
• Evidence obtained directly by the practitioner (for example, observation of the application
of a control) is more reliable than evidence obtained indirectly or by inference (for
example, enquiry about the application of a control).
• Evidence is more reliable when it exists in documentary form, whether paper, electronic,
or other media.
• Evidence provided by original documents is more reliable than evidence provided by

photocopies or facsimiles.
The practitioner ordinarily obtains more assurance from consistent evidence obtained
from different sources or of a different nature than from items of evidence considered
individually. In addition, obtaining evidence from different sources or of a different nature
may indicate that an individual item of evidence is not reliable. For example, corroborating
information obtained from a source independent of the entity may increase the assurance
the practitioner obtains from a representation from the responsible party. Conversely, when
evidence obtained from one source is inconsistent with that obtained from another, the
practitioner determines what additional evidence-gathering procedures are necessary to
resolve the inconsistency.

AUDIT AND ASSURANCE
4.5 QUALITY AND TIMELINESS OF AUDIT EVIDENCE
Certain types of audit evidence obtained by the auditor are more reliable than others. Ordinarily,
the auditor’s observation provides more reliable audit evidence than merely making inquiries,
for example, the auditor might obtain audit evidence about the proper segregation of duties by
observing the individual who applies a control procedure or by making inquiries of appropriate
personnel. However, audit evidence obtained by some tests of control, such as observation,
pertains only to the point in time at which the procedure was applied. The auditor may decide,
therefore, to supplement these procedures with other tests of control capable of providing audit
evidence about other periods of time.
In determining the appropriate audit evidence to support a conclusion about control risk, the
auditor may consider the audit evidence obtained in prior audits. In a continuing engagement,
the auditor will be aware of the accounting and internal control systems through work carried out
previously but will need to update the knowledge gained and consider the need to obtain further
audit evidence of any changes in control. Before relying on procedures performed in prior audits,
the auditor should obtain audit evidence which supports this reliance. The auditor would obtain
audit evidence as to the nature, timing and extent of any changes in the entity’s accounting and
internal control systems since such procedures were performed and assess their impact on the
auditor’s intended reliance. The longer the time elapsed since the performance of such procedures
the less assurance that may result.
The auditor should consider whether the internal controls were in use throughout the period. If
substantially different controls were used at different times during the period, the auditor would
consider each separately. A breakdown in internal controls for a specific portion of the period
requires separate consideration of the nature, timing and extent of the audit procedures to be
applied to the transactions and other events of that period.
The auditor may decide to perform some tests of control during an interim visit in advance of
the period end. However, the auditor cannot rely on the results of such tests without considering
the need to obtain further audit evidence relating to the remainder of the period. Factors to be
considered include:
 The results of the interim tests.
 The length of the remaining period.
 Whether any changes have occurred in the accounting and internal control systems
during the remaining period.
 The nature and amount of the transactions and other events and the balances involved.
 The control environment, especially supervisory controls.
 The substantive procedures which the auditor plans to carry out. Final Assessment of
Control Risk

Before the conclusion of the audit, based on the results of substantive procedures and other audit
evidence obtained by the auditor, the auditor should consider whether the assessment of control
risk is confirmed.
4.6 EXTERNAL CONFIRMATION
It is the process of obtaining and evaluating audit evidence through a direct communication
from a third party in response to a request for the information about a particular item affecting
assertions made by management in the financial statements. In deciding to what extent to use
external confirmations the auditor considers the characteristics of the environment in which the
entity being audited operates and the practice of potential respondents in dealing with requests
for direct confirmation.
External confirmations are frequently used in relation to account balances and their components but
need not be restricted to these items. For example, the auditor may request external confirmation
of the terms of agreements or transactions an entity has with third parties. The confirmation
request is designed to ask if any modifications have been made to the agreement, and if so, what
the relevant details are. Other examples of situations where external confirmations may be used
include the followings:
 bank balances and other information from bankers,
 accounts receivable balances,
 stocks held by third parties at bonded warehouses for processing or on consignment,
 property title deeds held by lawyers or financiers for safe custody or as security,
 investments purchased from stockbrokers but not delivered at the balance sheet date,
 loans from lenders, and
 Accounts payable balances.
The lower the assessed level of inherent and control risk, the less assurance the auditor needs
from substantive procedures to form a conclusion about a financial statement assertion. Unusual
or complex transactions may be associated with higher levels of inherent or control risk than
simple transactions. If the entity has entered into an unusual or complex transaction and the
level of inherent and control risk is assessed as high, the auditor considers confirming the terms
of the transaction with the other parties in addition to examining documentation held by the
entity.
Assertions embodied in financial statements as existence, rights and obligations, occurrence,

completeness, valuation, measurement, and presentation and disclosure. While external
confirmations may provide audit evidence regarding these assertions, the ability of an external

AUDIT AND ASSURANCE
confirmation to provide evidence relevant to a particular financial statement assertion varies.

External confirmation of an account receivable provides strong evidence regarding the existence
of the account as at a certain date. Confirmation also provides evidence regarding the operation
of cut-off procedures. However, such confirmation does not ordinarily provide all the necessary
audit evidence relating to the valuation assertion, since it is not practicable to ask the debtor to
confirm detailed information relating to its ability to pay the account.
The auditor should tailor external confirmation requests to the specific audit objective. When
designing the request, the auditor considers the assertions being addressed and the factors that
are likely to affect the reliability of the confirmations. Factors such as the form of the external
confirmation request, prior experience on the audit or similar engagements, the nature of the
information being confirmed, and the intended respondent, affect the design of the requests
because these factors have a direct effect on the reliability of the evidence obtained through
external confirmation procedures.
Types of External Confirmations

Confirmations may be of two types: positive and negative.
The auditor may use positive or negative external confirmation requests or a combination of both.
a. Positive Confirmation
A positive external confirmation request asks the respondent to reply to the auditor in all
cases either by indicating the respondent’s agreement with the given information, or by
asking the respondent to fill in information. A response to a positive confirmation request
is ordinarily expected to provide reliable audit evidence. There is a risk; however, that a
respondent may reply to the confirmation request without verifying that the information is
correct. The auditor is not ordinarily able to detect whether this has occurred. The auditor
may reduce this risk, however, by using positive confirmation requests that do not state
the amount (or other information) on the confirmation request but ask the respondent
to fill in the amount or furnish other information. On the other hand, use of this type of
“blank” confirmation request may result in lower response rates because additional effort
is required of the respondents.

Illustration
Shrawan 31, 2076
To,
ABC Corporation
Biratnagar, Nepal
Re- Figure Confirmation
Hi,
This request is being sent to you to enable our independent auditors to confirm the correctness of our
records. It is not a request for payment.
Our records on Ashad 31, 2076 showed an amount of Rs 32,82,216 receivable from you. Please confirm
whether this agrees with your records on that date by signing and returning this form directly to our
auditors, …… & Associates. An addressed envelope is enclosed for this purpose. If you find any
difference, please report details directly to our auditors in the space provided below.
Yours Faithfully
---------------
Accounts Head
XYZ Limited
Bhadra 01, 2076
To,
….. & Associates, Chartered Accountants
Kathmandu, Nepal
Re- Figure Confirmation
Hi,
The above amount is incorrect for and our books shows Rs. 31,82,216 as less by Rs 1,00,000
on account of our cheque not accounted but deposited on XYZ Limited’s bank account dated
31.03.2076.
Your faithfully
------------------
ABC Corporation
Biratnagar, Nepal

AUDIT AND ASSURANCE
b. Negative Confirmation
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response has
been received to a negative confirmation request, the auditor remains aware that there will be
no explicit evidence that intended third parties have received the confirmation requests and
verified that the information contained therein is correct. Accordingly, the use of negative
confirmation requests ordinarily provides less reliable evidence than the use of positive
confirmation requests, and the auditor considers performing other substantive procedures to
supplement the use of negative confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level when:
a. The assessed level of inherent and control risk is low;
b. A large number of small balances are involved;
c. A substantial number of errors is not expected; and
d. The auditor has no reason to believe that respondents will disregard these requests.
Illustration
Shrawan 21, 2076
ABC Corporation
Biratnagar
Nepal
This request is being sent to you to enable our independent auditors to confirm the correctness
of our records. It is not a request for payment
Our records on Ashad 31, 2076 showed an amount of Rs 32,82,216 receivable from you. If it
does NOT agree with your records, please report any exception directly to our auditors, XYZ
& Company. An addressed envelope is enclosed for this purpose
Yours Faithfully
---------------
PQR Pvt Ltd

XYZ & Company
P.O.BOX-7125
Kathmandu, Nepal

The above amount is incorrect for the following reason ..............
Your faithfully
------------------
PQR Pvt ltd
When the auditor seeks to confirm certain balances or other information, and management
requests the auditor not to do so, the auditor should consider whether there are valid grounds
for such a request and obtain evidence to support the validity of management’s requests. If the
auditor agrees to management’s request not to seek external confirmation regarding a particular
matter, the auditor should apply alternative procedures to obtain sufficient appropriate evidence
regarding that matter.
If the auditor does not accept the validity of management’s request and is prevented from carrying
out the confirmations, there has been a limitation on the scope of the auditor’s work and the
auditor should consider the possible impact on the auditor’s report.
The reliability of evidence provided by a confirmation is affected by the respondent’s competence,

independence, authority to respond, knowledge of the matter being confirmed, and objectivity.
For this reason, the auditor attempts to ensure, where practicable, that the confirmation request
is directed to an appropriate individual. When performing confirmation procedures, the auditor
should maintain control over the process of selecting those to whom a request will be sent, the
preparation and sending of confirmation requests, and the responses to those requests.
The auditor should perform alternative procedures where no response is received to a positive
external confirmation request. The alternative audit procedures should be such as to provide the
evidence about the financial statement assertions that the confirmation request was intended to
provide.
The auditor considers whether there is any indication that external confirmations received may not
be reliable. The auditor considers the response’s authenticity and performs procedures to dispel
any concern. The auditor may choose to verify the source and contents of a response in a telephone
call to the purported sender. When the auditor forms a conclusion that the confirmation process
and alternative procedures have not provided sufficient appropriate audit evidence regarding an
assertion, the auditor should undertake additional procedures to obtain sufficient appropriate
audit evidence.
The auditor should evaluate whether the results of the external confirmation process together with
the results from any other procedures performed, provide sufficient appropriate audit evidence
regarding the financial statement assertion being audited.
When the auditor uses confirmation as at a date prior to the balance sheet to obtain evidence to
support a financial statement assertion, the auditor obtains sufficient appropriate audit evidence

AUDIT AND ASSURANCE
that transactions relevant to the assertion in the intervening period have not been materially
misstated.
Bank Confirmations
As bank is the most liquid of all assets in general the auditor seeks direct receipt of a confirmation
from every bank or other financial institution with which the client does business. The importance
of bank confirmations extends beyond the verification of the actual cash balance. Generally, bank
confirmations (usually a standard format) request several specific items of information, namely:
• Full titles of all accounts in all currencies together with the account numbers and balances
thereon including nil balances, held at the year end. Confirmation of these details would
be sought on any account to which the client had title (including accounts held jointly or
in a trade name).
• Full titles and dates of closures of all accounts closed during the period being audited.
• Details of any interest or charges accrued but not charged or credited at year end.
• The amount of interest charged during the period being audited if not already disclosed
in the client’s bank statements.
• Details of overdraft and loans repayable on demand, other loans and other facilities.
• Details of any known client assets held as security, whether by a formal charge or
informal charge.
• Details of other client assets held, including share certificates, documents of title and
deed boxes.
• Details of any known contingent liabilities of the client at year end.
• A list of banks, other branches of the same bank or associated companies where a
relationship with the client had been established during the period being audited.
• Details of any personal guarantees or personal assets of the directors of the client, held
by the bank in connection with loans or facilities offered by the bank to the client.
If bank confirmations are not returned, they must be pursued until the auditor is satisfied as to
what the requested information is. After the bank confirmation has been received, the balance in
the bank account should be traced to the amount stated on the bank reconciliation. Likewise, all
other information should be traced to the relevant audit schedules. If the information is not in
agreement, an investigation must make of the difference.

Trade Payables/Receivable confirmation

A trade payables/receivable’ confirmation should be considered in the following situations:
• A substantial proportion of the company’s Suppliers/ Customer do not issue periodic

statements.
• Statements from suppliers / Customer with whom the company does substantial
business are unexpectedly unavailable for the last month of the year.
• Only fax or photocopies of statements are available whose authenticity is doubtful.
Contingent Liabilities confirmation

When the auditor assesses a risk of material misstatement regarding litigation or claims that have
been identified, or when the auditor believes that other litigation or claims may exist the auditor
shall seek direct communication with the entity’s legal counsel through a letter of general inquiry
or specific inquiry, prepared by management and sent by the auditor, requesting the entity’s legal
counsel to communicate directly with the auditor.
The client’s legal counsel is requested, in the letter of enquiry, to inform the auditor of any litigation
and claims of which they are aware, their likely outcome, and the expected financial implications
for the client. Where the auditor deems it likely that the legal counsel is not likely to respond in an
appropriate manner to a letter of general enquiry they will send a letter of specific enquiry. This
letter should contain:
• a list of litigation and claims;
• Management’s assessment of the outcome of each of the identified litigation and claims
and its estimate of the financial implications, including costs involved; and
• A request that the entity’s legal counsel confirm the reasonableness of management’s
assessments and provide the auditor with further information if the list is considered to
be incomplete or incorrect.
Other confirmations
• If inventory, which is material to the financial statement, is held under custody and
control of third party, the auditor should request confirmation from the third party as to
the quantities and condition of inventory held on behalf of the entity
• If investments are held by a third party, normally independent, reliable authorized

custodians, on behalf of the client direct confirmation from the third party should be
obtained
• If loans are made by client to third parties’ direct confirmation should be obtained from
the borrower

AUDIT AND ASSURANCE
• The auditor may also request confirmation of the terms of agreements or transactions a
client has with third parties; the confirmation is designed to ask if any amendments have
been made to the agreement and what the relevant details are.
4.7 AUDIT SAMPLING
It is the process of using auditing procedures to less than 100 percent of various items in a entity's
account balance such that each unit may have an equal opportunity of being selected.
As per NSA 530 on Audit Sampling, audit sampling involves the application of audit procedures
to less than 100% of items within an account balance or class of transactions such that all sampling
units have a chance of selection. This will enable the auditor to obtain and evaluate audit evidence
about some characteristic of the items selected in order to form or assist in forming a conclusion
concerning the population from which the sample is drawn. Audit sampling can use either a
statistical or a non-statistical approach.
The standard requires that when designing audit procedures, the auditor should determine
appropriate means for selecting items for testing so as to gather audit evidence to meet the
objectives of audit tests.
When designing audit procedures, the auditor should determine appropriate means of selecting
items for testing. The means available to the auditor are:
 selecting all items (100% examination);
 selecting specific items; and
 audit sampling.
The decision as to which approach to use will depend on the circumstances, and the application of
any one or combination of the above means may be appropriate in particular circumstances. While
the decision as to which means, or combination of means, to use is made on the basis of audit risk
and audit efficiency, the auditor needs to be satisfied that methods used are effective in providing
sufficient appropriate audit evidence to meet the objectives of the test.
The auditor may decide that it will be most appropriate to examine the entire population of items
that make up an account balance or class of transactions (or a stratum within that population).
100% examination is unlikely in the case of tests of control; however, it is more common for
substantive procedures. For example, 100% examination may be appropriate when the population
constitutes a small number of large value items, when both inherent and control risks are high and
other means do not provide sufficient appropriate audit evidence, or when the repetitive nature
of a calculation or other process performed by a computer information system makes a 100%
examination cost effective.

The auditor may decide to select specific items from a population based on such factors as
knowledge of the client's business, preliminary assessments of inherent and control risks, and the
characteristics of the population being tested. The judgmental selection of specific items is subject
to non-sampling risk. Specific items selected may include:
• High value or key items. The auditor may decide to select specific items within a
population because they are of high value, or exhibit some other characteristic, for
example items that are suspicious, unusual, particularly risk-prone or that have a history
of error.
• All items over a certain amount. The auditor may decide to examine items whose values
exceed a certain amount so as to verify a large proportion of the total amount of an
account balance or class of transactions.
• Items to obtain information. The auditor may examine items to obtain information
about matters such as the client's business, the nature of transactions, accounting and
internal control systems.
• Items to test procedures. The auditor may use judgement to select and examine specific
items to determine whether or not a particular procedure is being performed.
Statistical versus Non-Statistical Sampling Approaches

The decision whether to use a statistical or non-statistical sampling approach is a matter for the
auditor's judgement regarding the most efficient manner to obtain sufficient appropriate audit
evidence in the particular circumstances. For example, in the case of tests of control the auditor's
analysis of the nature and cause of errors will often be more important than the statistical analysis
of the mere presence or absence (that is, the count) of errors. In such a situation, non-statistical
sampling may be most appropriate.
When applying statistical sampling, the sample size can be determined using either probability
theory or professional judgement. Moreover, sample size is not a valid criterion to distinguish
between statistical and non-statistical approaches.
When designing an audit sample, the auditor should consider the objectives of the test and the
attributes of the population from which the sample will be drawn.
The auditor first considers the specific objectives to be achieved and the combination of audit
procedures which is likely to best achieve those objectives. Consideration of the nature of the
audit evidence sought and possible error conditions or other characteristics relating to that audit
evidence will assist the auditor in defining what constitutes an error and what population to use
for sampling.
The auditor considers what conditions constitute an error by reference to the objectives of the
test. A clear understanding of what constitutes an error is important to ensure that all, and only,

AUDIT AND ASSURANCE
those conditions that are relevant to the test objectives are included in the projection of errors.
For example, in a substantive procedure relating to the existence of accounts receivable, such as
confirmation, payments made by the customer before the confirmation date but received shortly
after that date by the client are not considered an error. Also, a mis posting between customer
accounts does not affect the total accounts receivable balance. Therefore, it is not appropriate to
consider this an error in evaluating the sample results of this particular procedure, even though it
may have an important effect on other areas of the audit, such as the assessment of the likelihood
of fraud or the adequacy of the allowance for doubtful accounts.
When performing tests of control, the auditor generally makes a preliminary assessment of the
rate of error the auditor expects to find in the population to be tested and the level of control
risk. This assessment is based on the auditor's prior knowledge or the examination of a small
number of items from the population. Similarly, for substantive tests, the auditor generally makes
a preliminary assessment of the amount of error in the population. These preliminary assessments
are useful for designing an audit sample and in determining sample size. For example, if the
expected rate of error is unacceptably high, tests of control will normally not be performed.
However, when performing substantive procedures, if the expected amount of error is high, 100%
examination or the use of a large sample size may be appropriate.
The auditor should select items for the sample with the expectation that all sampling units in the
population have a chance of selection. Students are requested to go through NSA 530 in detail in
this respect.
Sampling Risk
Sampling risk is one of the many types of risks an auditor may face when performing the necessary
procedure of audit sampling. Audit sampling exists because of the impractical and costly effects of
examining all or 100% of a client's records or books. As a result, sample of a client’s accounts are
examined. Due to the negative effects produced by sampling risk, an auditor may have to perform
additional procedures which in turn can impact the overall efficiency of the audit.
Sampling risk represents the possibility that an auditor's conclusion based on a sample is different
from that reached if the entire population were subject to audit procedure. The auditor may
conclude that material misstatements exist, in fact they do not; or material misstatements do not
exist but in fact they do exist. Auditor can lower the sampling risk by increasing the sampling size.
Although there are many types of risks associated with the audit process, each type primarily has
an effect on the overall audit engagement. The effects produced by sampling risk generally can
increase the risk of material misstatement which states that an entity's financial statements will
contain a material misstatement. Sampling risk can also increase detection risk which suggests the
possibility that an auditor will not find material misstatements relating to the financial statements
through substantive tests and analysis

Sample Selection
The aim of audit sampling is to form a conclusion about the population from which a sample is
obtained. It is, therefore, necessary to ensure that the method of sample selection can be expected
to produce a representative sample with each item in the population having a chance of being
selected.
The distinction between statistical and non-statistical sampling should be made clear before
considering the methods of selection.
i. Statistical sampling
Any approach to sampling that uses:
• random sample selection; and
• probability theory to:
(i) evaluate sample results (quantitatively); and
(ii) measure sampling risk.
The two main types of statistical sampling are Attribute sampling and Variables sampling.
Attribute sampling is concerned with testing items which can have only two possible values
(e.g., 0 or 1) or attributes (e.g., correct or incorrect). It is used to provide information about
rates of occurrence of events or characteristics. It is most widely used in tests of control (to
determine rates of non-compliance within control procedures) and Monetary Unit Sampling.
Variables sampling is concerned with testing items which can take any value within a
continuous range and is therefore used in substantive tests of details.
ii. Non-statistical sampling

Any approach to sampling which does not fulfill all the characteristics set out above for
statistical sampling. Such approaches are often referred to as judgement sampling. However,
as statistical sampling also requires judgment, the term non-statistical is preferred.
Methods of sample selection

The standards recognize three commonly used methods of obtaining representative samples for
audit sampling:
• Random Number Sampling;
• Systematic Sampling;
• Haphazard Sampling.

AUDIT AND ASSURANCE
a. Random number selection — every item in a population has the same statistical probability of
being selected as every other item. Random numbers are selected using a computer program
or random number tables.
b. Systematic selection — requires the calculation of a uniform sampling interval which is

obtained by dividing the population by the sample size. E.g., if 50 items are to be selected
from a population of 600 every 12th item will be selected from a randomly selected starting
point (within the sampling interval). This method is suitable for both tests of controls and
substantive tests and particularly useful for sampling from non-monetary populations.
However, care must be taken to ensure that the population is not structured in such a way
that the sampling interval corresponds to a pattern in the population. For example, if cash
book payments are written up by cheques in date order with all the bank statement entries
(direct debits, bank charges, etc.,) being recorded at each month end, a sample could be biased
towards a particular transaction type.
c. Haphazard selection — this method attempts to give all items in a population a chance
of selection by choosing items haphazardly. To avoid conscious bias, it is necessary to
avoid: favoring middle items, ignoring first and last items, selection of unusual items, etc.
Sometimes it is the only practical method (in terms of time and cost) of selecting a sample
from a population which cannot be accessed using a numerical sequence. Though sometimes
used for non-statistical sampling it is not sufficiently rigorous for statistical sampling.
Various Types of sample selection

a. Value weighted selection — this systematic selection method uses currency unit values,
rather than the items, as the sampling population. Each individual pound is given an equal
chance of selection. Since these cannot be examined, the item in which a pound selected
lies are tested. Using this method, high-value items have a greater chance of being selected.
Random number selection could be employed but usually the method involves cumulative
totaling of currency values (which can be time consuming unless computer-assisted).
Value weighted selection can also be used in non-statistical sampling. For example, by
stratifying the population and selecting more items from a particular stratum. An example of
this is the ‘two strata’ sampling method which combines 100% selection of high-value (key)
items with the sampling of items from two strata in the remaining population. The boundary
between the two strata may be calculated as (for example) twice the average population value.
The sample selected from the two strata is then weighted towards the higher value stratum
items.
b. Block sampling — consists of the selection ‘en bloc’ of adjacent transactions or items.
There are two major drawbacks:
a. a block selected may not be typical of the characteristics in the population as a whole;
and

b. relatively few blocks may be selected. It is, therefore, unlikely that a reasonable conclusion
can be drawn.
Nevertheless, significant cost savings in audit time can result and practical considerations
may dictate its use. For example, when conducting an audit over numerous branches, it may
be appropriate to select just one week’s payroll or one month’s postings to the general ledger
or all customer accounts beginning with the same letter.
The above points can be summarized as under:
• Not all selective testing constitutes audit sampling.
• Audit sampling is testing less than 100% of items that have a chance of selection.
• Sampling risk is the risk that a sample is not representative.
• Non-sampling risk arises from factors that cause the auditor to reach an incorrect
conclusion (for any reason unrelated to sample size).
• Four stages in audit sampling are design, selection, testing and evaluation.
• Statistical sampling requires random sample selection and use of probability theory.
• Three methods of selecting representative samples are random number, systematic and
haphazard.
• Results are evaluated qualitatively and quantitatively.
• Evaluation of sample results involves quantification, and this will be examinable.
c. Stratified Sampling: Stratified Sampling is one of the methods of Random Sampling. This
method involves dividing the whole population to be tested in a few groups called strata and
taking a sample from each of them. Each stratum is treated as if it were a separate population
and if proportionate items are selected from each of the stratum. The group into which the
whole population is divided is determined by the auditor on the basis of his judgement. E.g.
entire expense vouchers may be divided into:
(i) Vouchers above Rs.1,00,000
(ii) Vouchers between Rs.25,000 and Rs.1,00,000
(iii) Vouchers below Rs.25,000
The auditor can then decide to check all vouchers above Rs.1,00,000, 50% between 25,000 and
Rs.1,00,000 and 25% of those below Rs.25,000. The reasoning behind the stratified sampling
is that for a highly diversified population, weights should be allocated to reflect these
differences. This is achieved by selecting different proportions from each stratum. It can be
seen that the stratified sampling is simply an extension of simple random sampling.

AUDIT AND ASSURANCE
4.8 WRITTEN REPRESENTATIONS
This refers to a written statement by management provided to the auditor to confirm certain matters
or to support other audit evidence. Written representations in this context do not include financial
statements, the assertions therein, or supporting books and records. Written representations
are necessary information that the auditor requires in connection with the audit of the entity’s
financial statements. Accordingly, similar to responses to inquiries, written representations are
audit evidence.
Written Representations as Audit Evidence

Written Representations are an important source of audit evidence. If management modifies or
does not provide the requested written representations, it may alert the auditor to the possibility
that one or more significant issues may exist. Although written representations provide necessary
audit evidence, they do not provide sufficient appropriate audit evidence on their own about any
of the matters with which they deal. Furthermore, the fact that management has provided reliable
written representations does not affect the nature or extent of other audit evidence that the auditor
obtains about the fulfillment of management’s responsibilities, or about specific assertions.
Management from whom written representations requested

The auditor shall request written representations from management with appropriate
responsibilities for the financial statements and knowledge of the matters concerned. Those
individuals may vary depending on the governance structure of the entity, and the relevant law
or regulation; however, management (rather than those charged with governance) is often the
responsible party. Written representations may, therefore be requested from the entity’s chief
executive officer and chief financial officer, or other equivalent persons in entities that do not use
such titles. In some circumstances however, other parties, such as those charged with governance,
are also responsible for the preparation of financial statements.
Written Representations about management’s responsibilities include:

 Preparation of the Financial Statements: The auditor shall request management to provide
a written representations, that it has fulfilled its responsibility for the preparation of
financial statements in accordance with the applicable financial reporting framework,
including where required their fair presentation, as set out in the terms of the audit
engagement.
 Information Provided and Completeness of Transactions: the auditor shall request

management to provide a written representations that it has provided the auditor with
all relevant information and access as agreed in the terms of the audit engagement and
all transactions have been recorded and are reflected in the financial statements.
 Other responsibilities

NSA 580 Written Representations, governs the provisions about written representations from
management. Other NSAs also require the auditor to request written representations. If in addition
to such required representations, the auditor determines that it is necessary to obtain one or more
written representations to support other audit evidence relevant to the financial statements or
one or more specific assertions in the financial statements, the auditor shall request such other
written representations; such as written representations, that it has communicated to the auditor
all deficiencies in internal control of which management is aware.
Doubts as to reliability of written representations

If the auditor has concerns about the competence, integrity, ethical values or diligence of
management or about its commitment to or enforcement of those, the auditor shall determine
the effect of such concerns on the reliability of representations and audit evidence in general.
Particularly, if written representations are inconsistent with other audit evidence, the auditor
shall perform further audit procedures to resolve the matter and where it remains unresolved,
the auditor shall determine the effect of this on reliability of representations and audit evidence in
general. If the auditor concludes that the written representations are not reliable, the auditor shall
take appropriate actions including determining the possible effect on the opinion in the auditor’s
report. The auditor shall disclaim an opinion on the financial statements of auditor concludes that
there is sufficient doubt about the integrity of management.
These concerns may cause the auditor to conclude that the risk of management representation in
the financial statements is such that an audit cannot be conducted and thus auditor may consider
withdrawing from the engagement if possible under applicable law or regulation. In case of
identified inconsistencies between written representations and audit evidence, the auditor may
consider whether the risk assessment remains appropriate and, if not, revise the risk assessment
and determine the nature, timing and extent of further audit procedures to respond to the assessed
risks.
Written Representations not provided

If management does not provide one or more requested written representations, the auditor shall:
a) Discuss the matter with management
b) Reevaluate the integrity of management and evaluate the effect that this may have on the
reliability of representations (oral or written) and audit evidence in general; and
c) Take appropriate actions, including determining the possible effect on the opinion in the
auditor’s report

AUDIT AND ASSURANCE
Documentation of Representations by Management

The auditor would ordinarily include in audit working papers evidence of management’s
representations in the form of a summary of oral discussions with management or written
representations from management.
A written representation is better audit evidence than an oral representation and can take the form
of:
 A representation letter from management;
 A letter from the auditor outlining the auditor’s understanding of management’s

representations, duly acknowledged and confirmed by management; or
 Relevant minutes of meetings of the board of directors or similar body or a signed copy
of the financial statements.
Form of written representation

The written representation shall be in the form of a representation letter addressed to the auditor.
If the law or representation requires management to make written public statements about its
responsibilities, the auditor determines that such statements provide some or all of the required
representations, the relevant matters covered by such statements need to be included in the
representation letter. The date of the written representations shall be as near as practicable to, but
not after, the date of auditor’s report on the financial statements.
Example of a Representation Letter

The following letter is not intended to be a standard letter. Representations by management will
vary from one entity to another and from one period to the next. Although seeking representations
from management on a variety of matters may serve to focus management’s attention on those
matters, and thus cause management to specifically address those matters in more detail than
would otherwise be the case, the auditor needs to be cognizant of the limitations of management
representations as audit evidence as set out
(Entity Letterhead)
(To Auditor)
(Date)
Subject: Management Representation
This representation letter is provided in connection with your audit of the financial statements of ABC
Company for the year ended Ashad 3X, 20XX for the purpose of expressing an opinion as to whether
the financial statements give a true and fair view of (or 'are presented fairly, in all material respects,')
in accordance with with Nepal Financial Reporting Standards.

We confirm that (to the best of our knowledge and belief, having made such inquiries as we considered
necessary for the purpose of appropriately informing ourselves):
Financial Statements:
• We have fulfilled our responsibilities, as set out in the terms of audit engagement letter dated (XX/
XX/20XX) , for the preparation of the financial statements in accordance with Nepal Financial
Reporting Standards; in particular the financial statements are fairly presented (or give a true and
fair view) in accordance therewith.
• Significant assumptions used by us in making accounting estimates, including those measured at

fair value, are reasonable. (NSA 540)
• Related party relationships and transactions have been appropriately accounted for and disclosed
in accordance with the requirements of Nepal Financial Reporting Standards (NSA 550).
• All events subsequent to the date of the financial statements and for which Nepal Financial
Reporting Standards require adjustment or disclosure have been adjusted or disclosed.
• The effects of uncorrected misstatements are immaterial, both individually and in the aggregate,
to the financial statements as a whole. A list of the uncorrected misstatements is attached to the
representation letter. (NSA 450)
• (Any other matter that the auditor may consider appropriate)
Information Provided
• We have provided you with:
o Access to the information of which we are aware that is relevant to the preparation of the
financial statements, such as records, documentation and other matters;
o Additional information that you have requested from us for the purpose of the audit; and
o Unrestricted access to persons within the entity from whom you determined it necessary to
obtain audit evidence.
• All transactions have been recorded in the accounting records and are reflected in the financial
statements
• We have disclosed to you the results of our assessment of the risk and the financial statements may
be materially misstated as result of fraud. (NSA 540)
• We have disclosed to you all information in relation to fraud or suspected fraud that we are aware
of and that affects the entity and involves:
o Management
o Employees who have significant roles in internal control

AUDIT AND ASSURANCE
o Others where the fraud could have a material effect on the financial statements
• We have disclosed you all information in relation to allegations of fraud, or suspected fraud,
affecting the entity’s financial statements communicated by employees, former employees,
analysts, regulators or others. (NSA 240)
• We have disclosed to you all known instances of non compliance or suspected non-compliance
with laws and regulations whose effects should be considered when preparing financial statements
(NSA 250)
• We have disclosed to you the identity of the entity’s related parties and all the related party
relationships and transactions of which we are aware. (NSA 550)
• (Any other matters that the auditor may consider necessary)
----------------------------- (Senior Executive Officer)

-------------------------------- (Senior Financial Officer)
4.9 INTERNAL CHECK SYSTEM
The overall systems of inter control comprises of Administrative Control and Accounting Controls.
Internal Checks and Internal Audit are important constituents of Accounting Controls. Internal
check system implies organization of the overall system of book-keeping and arrangement of Staff
duties in such a way that no one person can carry through a transaction and record every aspect
thereof. It is a part of overall control system and operates basically as a built-in-device as far as
organization and job-allocation aspects of the controls are concerned. The system provides existence
of checks on the day to day transactions which operate continuously as part of the routine system
whereby the work of each person is either proved independently or is made complimentary to the
work of another. The following are the objectives of the internal check system:
i. To detect error and frauds with ease.
ii. To avoid and minimize the possibility of commission of errors and fraud by any staff.
iii. To increase the efficiency of the staff working within the organization.
iv. To locate the responsibility area or the stages where actual fraud and error occurs.
v. To protect the integrity of the business by ensuring that accounts are always subject to
proper scrutiny and check.
vi. To prevent and avoid the misappropriation or embezzlement of cash and falsification of
accounts.

The effectiveness of an efficient system of internal check depends on the following considerations
 Clarity of Responsibility -
The responsibility of different persons engaged in various operations of business

transactions should be properly identified. A well-integrated organizational chart
depicting the names of responsible persons associated with specific functions may help
to fix up responsibility.
 Division of Work –
The segregation of work should be made in such a manner that the free flow of work is not
interrupted and also helps to determine that the work of one person is complementary
to the other. Then, it is suggested that rotation of different employees through various
components of job should be effectively implemented.
 Standardization –
The entire process of accounting should be standardized by creating suitable policies

commensurate with the nature of the business, so as to strengthen the system of internal
check.
 Appraisal –
Periodic review should be made of the chain of operations and workflow. Such process
may be carried out by preparing an audit flow chart.
The general condition pertaining to the internal check system may be summarized as under -
i. No single person should have complete control over any important aspect of the business
operation. Every employee’s action should come under the review of another person.
ii. Staff duties should be rotated from time to time so that members do not perform the
same function for a considerable length of time.
iii. Every member of the staff should be encouraged to go on leave at least once a year.
iv. Persons having physical custody of assets must not be permitted to have access to the
books of accounts.
v. There should exist an accounting control in respect of each class of assets, in addition,
there should be periodical inspection so as to establish their physical condition.
vi. Mechanical devices should be used, wherever practicable to prevent loss or

misappropriation of cash.
vii. Budgetary control should be exercised, and wide deviations observed should be
reconciled.

AUDIT AND ASSURANCE
viii. For stock taking, at the close of the year, trading activities should, if possible be suspended,
and it should be done by staff belonging to several sections of the organization.
ix. The financial and administrative powers should be distributed very judiciously among
different officers and the manner in which those are actually exercised should be
reviewed periodically.
x. Procedures should be laid down for periodical verification and testing of different
sections of accounting records to ensure that they are accurate.
The scope of statutory audit is limited by both time and cost. Therefore, it is increasingly being
recognized that for an audit to be effective especially in case of large organization, the existence of
a system of internal check is essential.
4.10 INTERNAL AUDIT
Internal audit may be defined as, an independent appraisal function established within an
organization to examine and evaluate its activities as a service to the organization. The scope of the
internal audit is determined by the management. Internal auditing includes a series of processes
and techniques through which an organizations own employees ascertain for the management,
by means of on-the-job observation, whether established management controls are adequate,
and are effectively maintained; records and reports financial, accounting and otherwise reflect
actual operation and results accurately and properly; each division, department or other units are
carrying out the plans, policies and procedures for which they are responsible. The internal audit
and check can be distinguished in the following way:
Internal Check Internal Audit

i. It means the management of duties of staff in i It is independent examination of the
such a manner that the work of one person is data or procedure on behalf of the
automatically checked by other during the process management to assist them to discharge
of transaction their responsibilities
ii. Object is to minimize fraud & error ii Object is to detect fraud and error
iii. Integral part of regular operations iii Special work to fulfill its objectives
iv. Procedure oriented iv Control oriented
Review of the System of Internal Controls
The review of the internal control system enables the auditor -
(a) to formulate his opinion as to the reliance he may place on the system itself i.e. whether
the system is such as would enable the management to produce a true and fair set of
financial statements; and

(b) to locate the areas of weakness in the system so that the audit programme and the nature,
timing and extent of substantive and compliance audit procedures can be adjusted to
meet the situation.
For example, if the auditor is not satisfied with the control system as regards debtors, he may
decide to have a wider coverage for confirmation of debtor’s balances. Normally, investments
and cash are physically verified at the end of the period and this routine is known to the client
and his employees. In case the auditor comes across a weakness in the control either he may
provide in the programme for a surprise cash count or investment verification on a day preceding
or succeeding the routine verification. In such a case, a surprise check will be more useful if it
is undertaken after the routine verification is over. Similarly, if he is of the view that because of
weak controls the possibility of wrong billing to customers exists, be may extend the programme
for comparison of the invoices with the forwarding notes and for checking of the extensions and
castings of the invoices. Deciding the point of time appropriate for undertaking the review of the
internal controls is a matter for individual judgement of the auditor. This decision can be taken
on a consideration of the size and complexity of the client’s operations. If the auditor, because
of his continuing relationship with his client, is already aware of the features and efficacy of
internal controls, he may just review the changes that have taken place in the intervening period
because of changes in the operations of the client. However, a comprehensive review in such cases
must be made at an interval of, say, 3 years. Ordinarily, the review of internal controls should be
undertaken as a distinct phase of audit before finalisation of the audit programme. However, if
the size of operations is rather small, the review can be undertaken in conjunction with other audit
procedures and the programmes can be adjusted for any extension or elimination of checking.
When the auditor finds inadequacies or weaknesses in the internal control system, he should
advise his client about such inadequacies and weaknesses and the consequences that may follow.
It should be the duty of the auditor to see, in the course of his audit, how far the inadequacies and
weaknesses have been removed. He will take this into account in preparing his audit report. It is a
useful practice to note the following after each function, set out in the audit programme -
(a) Any change in the system of internal control from that record in the appropriate section
of the internal control questionnaire.
(b) Any further weakness noted in the internal control.
(c) Any instance where the prescribed system or procedure has not been followed.
These should be considered in deciding whether any further modification in the audit programme
is called for. Also, these should be communicated to the client and confirmation should be sought
as regards changes in the system. The review of internal control consists mainly of enquiries
of personnel at various organizational levels within the enterprise together with reference to
documentation such as procedures, manuals, job description and flow-charts, to gain knowledge
about the controls which the auditor has identified as significant to his audit. The auditor may
trace a few transactions through the accounting system to assist in understanding that system and

AUDIT AND ASSURANCE
it is related to internal controls. The auditor’s preliminary evaluation of internal controls should
be made on the assumption that the controls operate generally as described and that they function
effectively throughout the period of intended reliance. The purpose of the preliminary evaluation
is to identify the particular controls on which the auditor still intends to rely and to test through
compliance procedures. Different techniques are used to record information relating to an internal
control system. Selection of a particular technique is a matter for the auditor’s judgement.
Using the Work of Internal Auditors

The external auditor has sole responsibility for the audit opinion expressed and the responsibility is
not reduced by the use of the work of internal audit function. Although the internal audit function
may perform audit procedures similar to those performed by external auditor, neither the internal
audit function or the internal auditors are independent of the entity as is required of the external
auditor in an audit of financial statements. NSA 610 on “Using the work of Internal Auditor”
hints the statutory auditor can use the work of internal auditor provided statutory auditor obtains
a sufficient understanding of Internal Audit activities to identify and assess the risk of material
misstatements. Where the entity has an internal audit function and the external auditor expects to
use the work of the internal auditor to modify the nature or timing, or reduce the extent of audit
procedures to be performed directly by the external auditor, the external auditor need to whether
the work of the internal audit function can be used and if so in which areas and to what extent
whether the work is adequate for the purposes of the audit.
The external auditor shall determine the work of internal audit function can be used for the
purposes of the audit by evaluating the following:
a) The extent to which internal audit functions’ organizational status and relevant policies
and procedures support the objectivity of the internal auditors
b) The level of competence of the internal audit function and
c) Whether the internal audit function applies a systematic and disciplined approach,
including quality control.
The external audit shall not use the work of the internal auditor if the external auditor determines
that:
a) The internal audit function’s organizational status and relevant policies and procedures
do not adequately support the objectivity of the internal auditors;
b) The function lacks sufficient competence
c) The function does not apply a systematic and disciplined approach, including quality
control.
While determining the areas and extent to which the work of internal auditors can be used, the
external auditor shall consider the nature and scope of the work that has been performed or is

planned to perform by internal audit function and its relevance to the external auditor’s overall
audit strategy and audit plan.
If the external auditor plans to use the work of internal audit function, the external auditor shall
discuss the planned use of its work with internal auditor for coordinating their respecting activities
and shall read the reports of internal auditor relating to the works planned to use. The external
auditor shall perform sufficient audit procedures on the body of work of internal audit functions
as whole that is planned to be used as to determine its adequacy including evaluating whether the
work had been properly planned, performed, supervised, reviewed and documented, whether
sufficient audit evidence had been obtained and whether the conclusions reached are appropriate.
Hence it is said the Statutory Auditor may rely on Internal Auditor, provided he exercises due skill
and care and there is nothing to doubt.
4.10.1 Internal Audit and Corporate Governance

As defined on Nepal Standard on Auditing 610, Using the work of Internal Audit, “Internal Auditing”
means the appraisal activity established within an entity as a service to the entity. Its functions
include, amongst other things, monitoring internal control.
To elaborate, internal auditing is an independent, objective assurance and consulting activity

designed to add value and improve an organization's operations. It helps an organization
accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve
the effectiveness of risk management, control, and governance processes. Internal auditing is a
catalyst for improving an organization's governance, risk management and management controls
by providing insight and recommendations based on analyses and assessments of data and
business processes. With commitment to integrity and accountability, internal auditing provides
value to governing bodies and senior management as an objective source of independent advice.
Internal auditors provide an independent and objective assessment of the effectiveness and
efficiency of a company’s operations, specifically its internal control structure. The internal audit
function helps an organization accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control, and governance
processes. The scope of internal auditing is broad and may involve the efficiency of operations,
IT controls, the reliability of financial reporting, deterring and detecting fraud, and compliance
with laws and regulations. Internal Auditors may also conduct compliance and operational audits,
offering solutions for weaknesses in internal controls and verifying that all laws and regulations
are upheld.
Many entities establish internal audit functions as part of their internal control and governance
structures.

AUDIT AND ASSURANCE
Internal Audit Services as per IFAC code of ethics

As specified on Sub-Section 605, the scope and objectives of internal audit activities vary widely
and depend on the size and structure of the entity and the requirements of management and those
charged with governance. Internal audit activities may include:
 Monitoring of internal control.
 Examination of financial and operating function.
 Review of economy, efficiency and effectiveness of operations including non-financial
controls of the entity.
 Review of compliance with laws, regulation and other external requirements and with
management policies and directives and other internal requirements.
There is always a risk that the firm’s personnel assume a management responsibility when
providing internal audit services to an audit client and the threat created would be so significant
that no safeguards could reduce the threat to an acceptable level. So, a firm’s personnel shall not
assume a management responsibility when providing internal audit services to an audit client.
Examples of internal audit services that involve assuming management responsibilities include:
- Setting internal audit policies or the strategic direction of internal audit activities;
- Directing and taking responsibility for the actions of the entity’s internal audit employees;
- Deciding which recommendations resulting from internal audit activities shall be
implemented;
- Reporting the results of the internal audit activities to those charged with governance on
behalf of management;
- Performing procedures that form part of the internal control, such as reviewing and
approving changes to employee data access privileges;
- Taking responsibility for designing, implementing and maintaining internal control; and
- Performing outsourced internal audit services, comprising all or a substantial portion
of the internal audit function, where the firm is responsible for determining the scope of
the internal audit work and may have responsibility for one or more of the matters noted
stated above.
Following are the general provision governing ethics of the internal auditor:
i. Condition/Circumstances
A firm’s personnel providing internal audit services to an audit client.
Threats
Self-review threat

Safeguards/Measures to be taken
The threat would be so significant that no safeguards could reduce it to an acceptable level.
The firm shall provide internal audit services to an audit client only if it can avoid assuming
management responsibility, and it is satisfied that:
- The client designates an appropriate and competent resource, preferably within senior
management, to be responsible at all times for internal audit activities and to acknowledge
responsibility for designing, implementing, and maintaining internal control;
- The client’s management or those charged with governance reviews, assesses and
approves the scope, risk and frequency of the internal audit services;
- The client’s management evaluates the adequacy of the internal audit services and the
findings resulting from their performance;
- The client’s management evaluates and determines which recommendations resulting

from internal audit services to implement and manages the implementation process; and
- The client’s management reports to those charged with governance the significant
findings and recommendations resulting from the internal audit services.
ii. Condition/Circumstances
A firm accepts an engagement to provide internal audit services to an audit client, and the
results of those services will be used in conducting the external audit.
Threat
Self-review threat.
Safeguards/Measures to be taken
The significance of threat shall be evaluated, and safeguards applied when necessary to
eliminate the threat or reduce it to an acceptable level. The safeguards may be professionals
who are not members of the audit team shall be used to perform the internal audit service.
iii. Condition/Circumstances
In case of Audit clients that are public interest entities: Providing internal audit service.
Threat
Self-review threat
The firm shall not provide internal audit services that relate to:
- A significant part of the internal controls over financial reporting;

AUDIT AND ASSURANCE
- Financial accounting systems that generate information that is, separately or in the
aggregate, significant to the client’s accounting records or financial statements on which
the firm will express an opinion; or
- Amounts or disclosures that are, separately or in the aggregate, material to the financial
statements on which the firm will express an opinion.
4.10.2 Scope of Internal Audit Function

The scope of internal auditing within an organization is broad and may involve topics such as
an organization's governance, risk management and management controls over: efficiency/
effectiveness of operations (including safeguarding of assets), the reliability of financial and
management reporting, and compliance with laws and regulations. Internal auditing may also
involve conducting proactive fraud audits to identify potentially fraudulent acts; participating in
fraud investigations under the direction of fraud investigation professionals and conducting post
investigation fraud audits to identify control breakdowns and establish financial loss. Internal
auditors are not responsible for the execution of company activities; they advise management
and the Board of Directors (or similar oversight body) regarding how to better execute their
responsibilities.
Difference between Internal Audit and External Audit Services
Particulars Internal Audit External Audit

Appointing Management of the entity Owner of the entity
authority
Scope Defined by the appointing authority Defined by the law
To ensure adherence to management, To collect sufficient and reliable
safeguard of assets, completeness and audit evidence as to express,
Approach
accuracy of accounting records “true and fair” view on financial
statement
Independence Less independent Complete independent
Reporting To management or to Audit committee To shareholder of the owner
responsibility
Employee or outsourced consultancy Member holding Certificate of
Conducted by
firm practice
All categories of risk, their management, Financial reports, financial
Coverage
including reporting on them reporting risks.
Improvement is fundamental to the None, however, there is a duty to
purpose of internal auditing. But it report problems
Responsibility for
is done by advising, coaching and
improvement
facilitating in order to not undermine
the responsibility of management.

4.10.3 Internal Audit Reports

Internal auditors typically issue reports at the end of each audit that summarize their findings,
recommendations, and any responses or action plans from management. An audit report may
have an executive summary; a body that includes the specific issues or findings identified and
related recommendations or action plans; and appendix information such as detailed graphs and
charts or process information. Each audit finding within the body of the report may contain five
elements, sometimes called the "5 C's":
i. Condition: What is the particular problem identified?
ii. Criteria: What is the standard that was not met? The standard may be a company policy
or other benchmark.
iii. Cause: Why did the problem occur?
iv. Consequence: What is the risk/negative outcome (or opportunity foregone) because of
the finding?
v. Corrective action: What should management do about the finding? What have they
agreed to do and by when?
The recommendations in an internal audit report are designed to help the organization achieve
effective and efficient governance, risk and control processes associated with operations objectives,
financial and management reporting objectives; and legal/regulatory compliance objectives.
Audit findings and recommendations may also relate to particular assertions about transactions,
such as whether the transactions audited were valid or authorized, completely processed,
accurately valued, processed in the correct time period, and properly disclosed in financial or
operational reporting, among other elements.
Under the Institute of Internal Auditor standards, a critical component of the audit process is the
preparation of a balanced report that provides executives and the board with the opportunity to
evaluate and weigh the issues being reported in the proper context and perspective. In providing
perspective, analysis and workable recommendations for business improvements in critical areas,
auditors help the organization meet its objectives.
Quality of Internal Audit Report

• Objectivity - The comments and opinions expressed in the Report should be objective
and unbiased.
• Clarity - The language used should be simple and straightforward.
• Accuracy - The information contained in the report should be accurate.
• Brevity - The report should be concise.

AUDIT AND ASSURANCE
• Timeliness - The report should be released promptly immediately after the audit is
concluded, within a month.
4.10.4 Corporate Governance & Role of Internal Audit

Corporate governance broadly refers to the mechanisms, processes and relations by which
corporations are controlled and directed. A governance structure identifies the distribution of
rights and responsibilities among different participants in the corporation (such as the board of
directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and
includes the rules and procedures for making decisions in corporate affairs. Corporate governance
includes the processes through which corporations' objectives are set and pursued in the context of
the social, regulatory and market environment. Governance mechanisms include monitoring the
actions, policies and decisions of corporations and their agents.
Corporate governance became a pressing issue following the 2002 introduction of the Sarbanes-
Oxley Act in the U.S., which was ushered in to restore public confidence in companies and
markets after accounting fraud bankrupted high-profile companies such as Enron and WorldCom.
Both companies strive to have a high level of corporate governance. However, these days, it is
not enough for a company to merely be profitable; it also needs to demonstrate good corporate
citizenship through environmental awareness, ethical behavior and sound corporate governance
practices
Principles of Corporate governance

• Rights and equitable treatment of shareholders: Organizations should respect the
rights of shareholders and help shareholders to exercise those rights. They can help
shareholders exercise their rights by openly and effectively communicating information
and by encouraging shareholders to participate in general meetings.
• Interests of other stakeholders: Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders,
including employees, investors, creditors, suppliers, local communities, customers, and
policy makers.
• Role and responsibilities of the board: The board needs sufficient relevant skills and
understanding to review and challenge management performance. It also needs adequate
size and appropriate levels of independence and commitment.
• Integrity and ethical behavior: Integrity should be a fundamental requirement in

choosing corporate officers and board members. Organizations should develop a code of
conduct for their directors and executives that promotes ethical and responsible decision
making.
• Disclosure and transparency: Organizations should clarify and make publicly known
the roles and responsibilities of board and management to provide stakeholders with a

level of accountability. They should also implement procedures to independently verify

and safeguard the integrity of the company's financial reporting. Disclosure of material
matters concerning the organization should be timely and balanced to ensure that all
investors have access to clear, factual information.
Role of Internal Audit in Corporate Governance

Internal auditing activity as it relates to corporate governance has in the past been generally
informal, accomplished primarily through participation in meetings and discussions with members
of the Board of Directors. Corporate governance is the policies, processes and structures used by
the organization’s leadership to direct activities, achieve objectives, and protect the interests of
diverse stakeholder groups in a manner consistent with ethical standards. The internal auditor is
often considered one of the "four pillars" of corporate governance, the other pillars being the Board
of Directors, management, and the external auditor.
A primary focus area of internal auditing as it relates to corporate governance is helping the Audit
Committee of the Board of Directors (or equivalent) perform its responsibilities effectively. This
may include reporting critical management control issues, suggesting questions or topics for the
Audit Committee's meeting agendas, and coordinating with the external auditor and management
to ensure the Committee receives effective information. In recent years, the advocacy for assigning
internal auditor for formal evaluation of corporate governance, particularly in the areas of board
oversight of enterprise risk, corporate ethics, and fraud.
For managing inherent operational risk of bank and financial institution, NRB has made mandatory
provision for internal auditor to comment on the policies and operational procedure adopted by
bank and financial institution.
4.10.5 Function and Extent of Internal Audit in Entities

A typical internal audit assignment involves the following steps:
- Establish and communicate the scope and objectives for the audit to appropriate
management.
- Develop an understanding of the business area under review. This includes objectives,
measurements, and key transaction types. This involves review of documents and
interviews. Flowcharts and narratives may be created if necessary.
- Describe the key risks facing the business activities within the scope of the audit.
- Identify management practices in the five components of control used to ensure each key
risk is properly controlled and monitored. Internal Audit Checklist can be a helpful tool
to identify common risks and desired controls in the specific process or industry being
audited.

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- Develop and execute a risk-based sampling and testing approach to determine whether
the most important management controls are operating as intended.
- Report issues and challenges identified and negotiate action plans with management to
address the problems.
- Follow-up on reported findings at appropriate intervals. Internal audit departments

maintain a follow-up database for this purpose.
According to the institute of Internal auditors, internal audit establishes and functions as follows:
i. Formulating internal Audit charter and get approved by audit committee
ii. Understand industry specific benchmarking needs
iii. Hiring appropriate staff (internal or outsource)
iv. Review Policies and Procedures of the entity
v. Discuss and assess control issues
vi. Develop the "Audit Universe" (list of all auditable unit)
vii. Develop Risk Assessment of each unit
viii. Develop internal audit checklist
ix. Assign audit team member for each audit unit with appropriate working days considering
risk assessed as above.
x. Prepare the audit report on the observations/recommendation
xi. Obtain the management response
xii. Issue audit report
xiii. Present the audit report to Audit committee
xiv. Follow up on audit findings
General Evaluation of Internal Audit Function

The external auditor’s general evaluation of the internal audit function will assist him in
determining the extent to which he can place reliance upon the work of the internal auditor. The
external auditor should document his evaluation and conclusions in this respect. The important
aspects to be considered in this context are:
- Organizational Status: Whether internal audit is undertaken by an outside agency or by

management. In an ideal situation he reports to the highest level of management and is


- Scope of Function: The external auditor should ascertain the nature and depth of coverage
of the assignment which the internal auditor discharges for management. He should also
ascertain to what extent the management considers, and where appropriate, acts upon
internal audit recommendations.
- Technical Competence: The external auditor should ascertain that internal audit work is
- Due Professional Care: The external auditor should ascertain whether internal audit
4.10.6 Outsourcing in Internal Audit

While there is a clear need for internal audit, entity need to can create own internal audit function or
use the services of an external consultancy. The use of the external consultancy firm for managing
internal services is called outsourcing of internal audit.
For typical small and medium-sized enterprise there are clear benefits to outsourcing as it -
• Can focus attention on core business activities – the activities that make you money.
• Easier way to buy in the services of an expert than it is to recruit and employ an expert.
• Specialist consultancy firms can provide range of skills that may be costly on hiring staff.
• Employing a specialist create a reliance on that person. However, when that person
leaves, entity suffer disruption to business while replacing the expertise. This is not an
issue when outsourcing function is in place.
• Employing someone with the experience and qualifications to perform an internal audit
role is expensive. Recruiting cheaply will get poorly qualified person; this may cost you
in the future. There is a clear cost-benefit argument for outsourcing.
• Outsource ensure independence and objectivity.
• Monitoring of outsourced firm can be easily done with relationship through confidentiality
and service-level agreements.
For regulating outsourced internal audit of the Nepalese bank and financial institution, Nepal
Rastra Bank (NRB) has certain stipulated provision through NRB directive no 6, which states as
follows:

AUDIT AND ASSURANCE
- Bank and financial institution should assign one employee as liaison officer to
communicate with outsourced internal auditor
- At least quarterly, internal audit report should be placed on meeting of Audit committee
- The audit report should include the details of manpower involved and working man
days involved on carrying out audit
4.10.7 Initial Audit Engagement

For any auditor, opening balance of any financial statement is crucial for current year audit. And
it is of great importance when the financial statements are audited for the first time or when the
financial statements for the prior period were audited by another auditor. NSA 510 Initial Audit
Engagements—Opening Balances provides standards and provides guidance regarding opening
balances.
Opening Balance means those account balances which exist at the beginning of the period. Opening
balances are based upon the closing balances of the prior period and reflect the effects of:
• Transactions of prior periods;
• Accounting policies applied in the prior period.
In an initial audit engagement, the auditor will not have previously obtained audit evidence
supporting such opening balances.
Audit Procedures of the Initial Audit Engagement

For initial audit engagements, the auditor shall read the most recent financial statements, if any,
and the predecessor auditor’s report thereon, if any, for the information relevant to opening
balances including disclosures. The auditor shall obtain sufficient appropriate audit evidence
about whether the opening balances contain misstatements that materially affect the current
period’s financial statements by:
a. Determining whether the prior period’s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated; Determining whether
appropriate accounting policies are consistently applied or changes in accounting policies
have been properly accounted for and adequately disclosed; and Performing one or more of
the following:
i) Where prior year financial statements were audited, reviewing the predecessor auditor’s
working papers to obtain audit evidence regarding the opening balances;
ii) Evaluating whether audit procedures performed in the current period provide evidence
relevant to the opening balances;
iii) Performing specific audit procedures to obtain evidence regarding the opening balances.

The sufficiency and appropriateness of the audit evidence the auditor will need to obtain regarding
opening balances depends on such matters as:
 The accounting policies followed by the entity,
 Whether the prior period’s financial statements were audited, and if so whether the
auditor’s report was modified,
 The nature of the accounts balances, classes of transactions and disclosures and the risk
of misstatement in the current periods financial statements, and
 The significance of the opening balances relative to the current period’s financial
statements.
When the prior period’s financial statements were audited by another auditor, the current auditor
may be able to obtain sufficient appropriate audit evidence regarding opening balances by
reviewing the predecessor auditor’s working papers. In these circumstances, the current auditor
would also consider the professional competence and independence of the predecessor auditor. If
the prior period’s auditor’s report was modified, the auditor would pay particular attention in the
current period to the matter which resulted in the modification
Prior to communicating with the predecessor auditor, the current auditor will need to consider
the Code of Ethics for Professional Accountants issued by The Institute of Chartered Accountants
of Nepal.
For current assets and liabilities some audit evidence can ordinarily be obtained as part of the
current period’s audit procedures. For non-current assets and liabilities, such as property, plant
and equipment, investments and long-term debt, some audit evidence may be obtained by
examining the accounting records and other information underlying the opening balances.
If the auditor obtain audit evidence that the opening balances contain misstatements that could
materially affect the current period’s financial statements, the auditor shall perform such additional
audit procedures as are appropriate in the circumstances to determine the effect on the current
period’s financial statements. If the auditor concludes that such misstatements exist in the current
period’s financial statements, the auditor shall communicate the misstatements with appropriate
level of management and those charged with governance.
The auditor shall obtain sufficient appropriate audit evidence about whether the accounting
policies reflected in the opening balances have been consistently applied in the current period’s
financial statements, and whether changes in the accounting policies have been appropriately
accounted for and adequately presented and disclosed in accordance with the applicable financial
reporting framework.
If the prior period’s financial statements were audited by a predecessor auditor and there was
a modification to the opinion, the auditor shall evaluate the effect of the matter giving rise to

AUDIT AND ASSURANCE
the modification in assessing the risks of material misstatement in the current period’s financial
statements in accordance with NSA 315.
Audit Conclusions and Reporting

If, after performing procedures including those set out above, the auditor is unable to obtain
sufficient appropriate audit evidence concerning opening balances, the auditor’s report should
include:
(a) a qualified opinion,
(b) a disclaimer of opinion; or
(c) in those jurisdictions where it is permitted, an opinion which is qualified or disclaimed

regarding the results of operations and unqualified regarding financial position,
However, if a modification regarding the prior period’s financial statements remains relevant
and material to the current period’s financial statements, the auditor should modify the current
auditor’s report accordingly.
If the current period’s accounting policies have not been consistently applied in relation to opening
balances and if the change has not been properly accounted for and adequately disclosed, the
auditor should express a qualified opinion or an adverse opinion as appropriate.
4.10.8 USING THE WORK OF OTHERS1

Auditor alone cannot wholly and completely perform all the auditing activities. They must rely
and get their work done by some other auditor, experts, valuators and others professional. Further
with the concept of branch audit is under discussion, the frequency of using the work of other
personnel is indispensable. Also, mandatory use of actuarial valuation in insurance companies has
extended the use of work of other person.
When the auditor delegates work to assistants or uses work performed by other auditors and
experts, he will continue to be responsible for forming and expressing his opinion on the financial
information. However, he will be entitled to rely on work performed by others, provided he
exercises adequate skill and care and is not aware of any reason to believe that he should not have
so relied.
In this regards, professional accountant in public practice can use/consider the work of other in
following ways:
 Using the work of another auditor
 Considering the work of internal auditor
 Using the work of an expert

1 Related to NSA 600, NSA 610(Revised) and NSA 620

a. Using the work of another auditor

When the principal auditor uses the work of another auditor, the principal auditor should
determine how the work of the other auditor will affect the audit.
The principal auditor should perform procedures to obtain sufficient appropriate audit
evidence, that the work of the other auditor is adequate for the principal auditor’s purposes,
in the context of the specific assignment.
The principal auditor might discuss with the other auditor the audit procedures applied
or review a written summary of the other auditor’s procedures and findings which may be
in the form of a completed questionnaire or checklist. The principal auditor may also wish
to visit the other auditor. The nature, timing and extent of procedures will depend on the
circumstances of the engagement and the principal auditor’s knowledge of the professional
competence of the other auditor.
After considering above audit procedure, the principal auditor should consider the significant
findings of the other auditor. The principal auditor may consider it appropriate to discuss
with the other auditor and the management of the component, the audit findings or other
matters affecting the financial information of the components. He may also decide that
supplemental tests of the records or the financial statements of the component are necessary.
Such tests may, depending upon the circumstances, be performed by the principal auditor or
the other auditor.
The principal auditor should document in his working papers the components whose financial
information was audited by other auditors; their significance to the financial information of
the entity as a whole; the names of the other auditors; and any conclusions reached that
individual components are not material. The principal auditor should also document the
procedures performed and the conclusions reached.
When the principal auditor concludes, based on his procedures, that the work of the other
auditor cannot be used and the principal auditor has not been able to perform sufficient
additional procedures regarding the financial information of the component audited by the
other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion
because there is a limitation on the scope of audit. If the other auditor issues, or intends to
issue, a modified auditor’s report, the principal auditor should consider whether the subject
of the modification is of such nature and significance, in relation to the financial information
of the entity on which the principal auditor is reporting that it requires a modification of the
principal auditor’s report.
The principal auditor would not be responsible in respect of the work entrusted to the
other auditors, except in circumstances which should have aroused his suspicion about
the reliability of the work performed by the other auditor. When the principal auditor has

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

The external auditor’s general evaluation of the internal audit function will assist him in
determining the extent to which he can place reliance upon the work of the internal auditor.
The external auditor should document his evaluation and conclusions in this respect. The
important aspects to be considered in this context are:
I. Organizational Status: Whether internal audit is undertaken by an outside agency or by

management. In an ideal situation, he reports to the highest level of management and is
II. Scope of Function: The external auditor should ascertain the nature and depth of coverage
of the assignment which the internal auditor discharges for management. He should also
ascertain to what extent the management considers, and where appropriate, acts upon
internal audit recommendations.
III. Technical Competence: The external auditor should ascertain that internal audit work is
IV. Due Professional Care: The external auditor should ascertain whether internal audit
Where, following the general evaluation, the external auditor intends to rely upon specific
internal audit work as a basis for modifying the nature, timing and extent of his procedures,
he should review the internal auditor’s work, taking into account the following factors:
i. The scope of work and related audit program are adequate for the external auditor’s
purpose.
ii. The work was properly planned, and the work of assistants was properly supervised,
reviewed, and documented.

iii. Sufficient appropriate evidence was obtained to afford a reasonable basis for the
conclusions reached.
iv. Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of the work performed.
v. Any exceptions or unusual matters disclosed by the internal auditor’s procedures have
been properly resolved.
The external auditor should document his conclusions in respect of the specific work which he
has reviewed. The external auditor should also test the work of the internal auditor on which
he intends to rely. The nature, timing and extent of the external auditor’s tests will depend
upon his judgment as to the materiality of the area concerned to the financial statements taken
as a whole and the results of his evaluation of the internal audit function and of the specific
internal audit work. His tests may include examination of items already examined by the
internal auditor, examination of other similar items, and observation of the internal auditor’s
procedures.
c. Using the work of an expert

When the auditor intends to use the work of an expert, he should examine evidence to gain
knowledge regarding the terms of the expert’s engagement and such other matters as:
- the objectives and scope of the expert’s work,
- a general outline as to the specific items in the expert’s report,
- confidentiality of the expert’s work, including the possibility of its communication to

third parties,
- the expert’s relationship with the client, if any;
- confidentiality of the client’s information used by the expert.
The auditor should seek reasonable assurance that the expert’s work constitutes appropriate
audit evidence in support of the financial information, by considering:
- the source data used,
- the assumptions and methods used and, if appropriate, their consistency with the prior
period, and
- the results of the expert’s work in the light of the auditor’s overall knowledge of the
business and of the results of his audit procedures.
The auditor should also satisfy himself that the substance of the expert’s findings is properly
reflected in the financial information.

AUDIT AND ASSURANCE
The auditor should consider whether the expert has used source data which are appropriate in the
circumstances. The procedures to be applied by the auditor should include:
- making inquiries of the expert to determine how he has satisfied himself that the source
data are sufficient, relevant and reliable, and
- conducting audit procedures on the data provided by the client to the expert to obtain
reasonable assurance that the data are appropriate
Usually, after completion of above procedures auditor gains reasonable assurance that he has
obtained appropriate audit evidence in support of the financial information. In exceptional
cases where the work of an expert does not support the related representations in the financial
information, the auditor should attempt to resolve the inconsistency by discussions with the client
and the expert. Applying additional procedures, including possibly engaging another expert, may
also assist the auditor in resolving the inconsistency.
If, after performing these procedures, the auditor concludes that:
- the work of the expert is inconsistent with the information in the financial statements, or
that
- the work of the expert does not constitute sufficient appropriate audit evidence (e.g.,
where the work of the expert involves highly technical matters or where, on grounds of
confidentiality, the expert refuses to make available to the auditor the source data used
by him),
he should express a qualified opinion, a disclaimer of opinion or an adverse opinion, as may be

appropriate.
When expressing an unqualified opinion, the auditor should not refer to the work of an expert
in his report. If, as a result of the work of an expert, the auditor decides to express other than an
unqualified opinion, it may in some circumstances benefit the reader of his report if the auditor,
in explaining the nature of his reservation, refers to or describes the work of the expert. Where,
in doing so, the auditor considers it appropriate to disclose the identity of the expert, he should
obtain prior consent of the expert for such disclosure if such consent has not already been obtained.
4.10.9 Audit Committee and Relevant Legal Provision for Requirement of

Audit Committee
Requirement of Audit Committee:
Section 164 (1) of Companies Act 2063 provides that a listed company with paid up capital
of thirty million rupees [3 crore] or more or a company which is fully or partly owned by the
Government of Nepal shall form an audit committee consisting of a least three members under the
chairpersonship of a director who is not involved in the day-to –day operations of the company.

Formation
At least one member of the audit committee shall be an experienced person having obtained
professional certificate on accounting or a person having gained experience in accounting and
financial field after having obtained at least bachelor’s degree in accounts, commerce, management,
finance or economics [Section 164 (3)].
A person who is a close relative of the chief executive of a company shall not be eligible to be a
member of the audit committee formed pursuant to Sub-section (1) [Section 164 (2)].
The report of board of directors required to be prepared by a company shall set out a short
description of the activities of the audit committee, working policies adopted by the board of
directors to implement the suggestions, if any, given by the audit committee, the allowances or
facilities, if any, received by the members or the audit committee and the names of the members
of audit committee Section [164 (4)].
Power of Committee to call for meeting

The audit committee may, for inquiring into any matter, notify the managing director of the
company, chief executive or the company or other director, auditor, internal auditor and accounts
chief involved in the day-to-day operations of the company to attend its meeting; and it shall be
their duty to be present in the meeting of that committee if they are so notified [Section 164(5)].
Board to implement the suggestions given by the committee

The board of directors shall implement the suggestions given by the audit committee in respect
of the accounts and financial management the company; and where any suggestion cannot be
implemented, the board of directors shall also mention the reasons for the same in its report.
[Section 164(6)].
Procedure of the committee

The company shall arrange for such means and resources as may be adequate for the fulfillment
of responsibilities of the audit committee; and the audit committee may fix its internal rules of
procedures on its own. [Section 164(5)].
Quorum and Frequency of Meeting

• The chairperson of the audit committee shall be present in the annual general meeting of
the company [164(8)].
• The audit committee shall meet as per necessity [164(9)].

AUDIT AND ASSURANCE
The functions, duties and powers of the audit committee

Functions, duties and powers of audit committee as given in Section 165 shall be as follows:
(a) To review the accounts and financial statements of the company and ascertain the truth
of the facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system of the
company;
(c) To supervise and review the internal auditing activity or the company;
(d) To recommend the names of potential auditors for the appointment of the auditor of the
company, fix the remuneration and terms and conditions of appointment of the auditor
and present the same in the general meeting for the ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to the
prevailing law as required to be observed in the course of doing auditing work;
(f) Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the polices required to be observed by the
company in respect of the appointment and selection of the auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause to be
enforced, the same;
(h) Where any regulator body has provided for the long-term audit report to be set out in the
audit report of the company, to comply with the terms required to prepare such report;
(i) To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.

Self-evaluation Questions:
Question 1 What are the audit evidences?
Question 2 How do you obtain audit evidences?
Question 3 Write a short note on Audit Risk.
Question 4 Compare internal control, internal check and internal audit.
Question 5 Explain Internal Controls in EDP Environment
Question 6 Explain Internal Control in Service Bureau organisation.

AUDIT AND ASSURANCE

CHAPER 5 : VOUCHING
CHAPTER 5
VOUCHING
To learn to check whether -
 all the business transactions are properly recorded
 Transactions are free from error or fraud
 The documentary evidence is authenticated and relevant

AUDIT AND ASSURANCE
5.1 VOUCHING
Vouching refers to the act of examining vouchers in reference to certain transaction or event related
books of account. It is the practice followed in an audit, with the objective of establishing the
authenticity of the transaction recorded in the primary books of account. It essentially consists of
verifying a transaction recorded in the books of account with the relevant documentary evidence
and the authority on the basis of which the entry has been made; also confirming that the amount
mentioned in the voucher has been posted to an appropriate account which would disclose the
nature of transaction on its inclusion in the final statements of account.
Voucher is the documentary evidence for the support of a transaction in the books of account. It
may be bill, receipts, requisition form, agreement, decision, bank paying slip, or any other evidence
which supports for financial transaction or an event.
Vouching is a technical term which refers to the examination by the auditor of documentary
evidence supporting and substantiating a transaction or an event. Simply stated, vouching means
a careful examination of all original evidence i.e. invoices, statements, receipts, correspondence,
minutes and contracts etc. with a view to ascertain the accuracy of the entries in the books of
accounts and also to find out, as far as possible, that no entries have been omitted in the books of
accounts. Therefore, vouching is the act of testing the truth of entries appearing in the primary
books of accounts.
Main objective of vouching is to test the regularity of transactions or an event, frauds and errors.
Regularity means maintaining record and performing the work in compliance with the rules,
regulation and law.
After examination, each voucher is usually marked in a manner to ensure that it may not be
presented again in support of another entry. The following points need careful consideration
while examining a voucher:
(i) that the date of the voucher falls within the accounting period;
(ii) that the voucher is made out in the client’s name;
(iii) that the voucher is duly authorised;
(iv) that the voucher comprised all the relevant documents which could be expected to have
been received or brought into existence on the transactions having been entered into, i.e.,
the voucher is complete in all respects; and
(v) that the account in which the amount of the voucher is adjusted is the one that would
clearly disclose the character of the receipts or payments posted thereto on its inclusion
in the final accounts.

CHAPER 5 : VOUCHING
5.2 PRINCIPLE OF CUT-OFF ARRANGEMENT
Accounting is a continuous process because the business never comes to halt. It is, therefore,
necessary that transactions of one period would be separated from those in the ensuing period so
that the results of the working of each period can be correctly ascertained. The arrangement that
is made for this purpose is technically known as “cut-off arrangement”. It essentially forms part
of the internal control system of an organisation. So, it refers to separating the transaction of one
period from those in the next period so that the working results of each period can be correctly
ascertained.
This arrangement is generally applied to sales, purchase and inventory (stock) which are usually
affected by the continuity of the business. The auditor satisfies by examination and test check that
the cut-off arrangements adequately ensure that:
(i) Goods purchased have in fact been included in the inventories and liability have been
provided for credit purchases and
(ii) Goods sold have been excluded from the inventories and credit has been taken for the
sales and concerned party has been debited if the value of sale is yet to be received.
The auditor may examine a sample of documents, evidencing the movement of stock into and out
of stores, including documents pertaining to period shortly before and after the cut-off date and
check whether stocks represented by those documents were included or excluded as appropriate
during stock taking for perfect and correct presentation in the financial statements.
5.3 SPECIFIC CASES OF VOUCHING
a. Audit of Purchase
While auditing purchases, the auditor shall see that:
i. All purchases are made economically and in accordance with rules or direction, if any ;
ii. Quotations must have been called for all purchases exceeding amount specified by
the byelaws of the organization. A wide publicity is made for calling the quotation. At
least three quotations from different suppliers must have been presented in every case.
Specific design and brand required must be mentioned in the publicity inviting such
quotation;
iii. The purchase has been made from the lowest quotation unless there are recorded reasons
to the contrary;
iv. Rate paid is that of the rate shown in the quotation approved.

AUDIT AND ASSURANCE
v. Certificate of quality and quantity are furnished by the store in-charge and verified by
the accountant before any payment is made;
vi. In case of immovable property documents such as title deed, sale deed, registration and
mutation papers etc., are properly secured;
vii. Cash purchases should be verified by reference to cash memos or received invoices by
suppliers. Payments made against credit purchases should be vouched with the receipts
issued by the suppliers and the credit to their accounts on the basis of invoices entered
in the purchase book. There must be evidence of goods having been received through an
entry in the Goods Inward Books or Store Ledger;
viii. Where advance is given to the suppliers for supplies to be made in future, it is necessary
to make distinction between payment for goods and an advance so given. In case of
advances given auditors have to confirm whether it is as per normal trade practice and
check ceiling of advance given, its settlement at final settlement of the purchases. For the
purchases made at year end, auditors have to check whether cut-off arrangement has
been made;
ix. In particular, invoice number, date, purchase order number, vendor signature/stamp
quantity, amount per unit and applicable taxes should be examined.
In case of purchase returns, apply following procedures:
i. Examine debit note issued to the supplier which in turn may be confirmed by
corresponding credit note issued by the supplier acknowledging the same. The relevant
correspondence may also be examined;
ii. Verify by reference to relevant corresponding record in good outward book or the stores
records. Further, the figures in these documentary evidence should be compared with
the supplier’s original invoices for rates and other charges and calculation should also be
checked;
iii. Examine in depth to eliminate the possibility of fictitious purchase returns for covering
bogus purchases recorded earlier when such returns outwards are in substantial figure
either at the beginning or end of the accounting year;
iv. Cross-check with reference to original invoices any rebates in price or allowances if any
given by suppliers on strength of their Credit Notes.
b. Audit of Sales
The sales and collections cycle in a business refers to the set of processes that begin when a
customer makes a request for the purchase of goods or services and ends when the company
receives complete payment for the sales. As part of the audit of a company's financial
statements, auditor should test sales transactions and the internal controls over those

CHAPER 5 : VOUCHING
transactions to ensure that the company is not materially misstating its revenues from sales
or accounts receivable. The overall objective in the audit of sales and collection cycle is to
evaluate whether the account balances affected by the cycle are fairly presented in accordance
with relevant accounting standards. It should be noted that there are various accounts that
are involved in the sales and collection cycle of a business. The name given to the various
types of accounts in the sale and collection cycle vary from business to business.
For example, the name given to sales in a retail business will be Sales Revenue while in an
insurance business it would be Premium Income. Though the names differ, it is important
to note that the key concepts and principles are the same. Debtors and Advance payment
form significant part of the assets of most companies. While sales figure is key to determining
the overall result and performance of a business. It is therefore important that the auditor
carries out appropriate audit procedures to verify the accounts in the financial statements of
a company being audited.
When reviewing the Internal Control Procedures put in place by management to achieve the
sales system objectives, the relevant aspects to examine are:
• Organizational Controls
• Segregation of duties
• Physical Controls
• Authorization
• Arithmetic and Accounting Controls
Procedure to test the sales transactions are given below:
b.1 Regular Sales

i. Obtain the client’s sales journal and review for unusual transactions and amounts;
ii. Check new accounts and credit limits are properly authorized and credit procedures
are operating;
iii. Check that sales invoices are supported by customer orders, and signed delivery
notes or evidence of work performance and review for the sequence of dispatch/
shipping documents;
iv. Check for prices, arithmetic and calculations of invoices;
v. Check that invoices are correctly coded with customer codes;
vi. Test numerical sequences of invoices and enquire into missing invoices, sales orders,
delivery notes and goods returned notes;

AUDIT AND ASSURANCE
vii. Check goods returned are supported by goods returned notes, evidence of
correspondence with customers and credit note authorized;
viii. Observe whether monthly statements are sent to customers;
ix. Observe whether accountant compares subsidiary ledger total with control totals;
x. Trace selected dispatch documents to sales journal to be sure that each one has been
included;
xi. Trace selected sales invoice numbers from the sales journals to the accounts
receivable ledger;
xii. Sample selected sales invoices and check supporting documents for internal
verification;
xiii. Test selected invoices with customer order checking for customer name, product
description, quantity, date, contracts and credit approval;
xiv. Obtain prelisting of cash receipts and trace amounts to the cash receipt journal
testing for names, amounts, dates and internal verification;
xv. Trace cash receipt entries to bank statement;
xvi. Trace selected entries from the cash receipt journal to entries in the customer
subsidiary ledger;
xvii. Conduct the analytical procedures when carrying out the audit of sales as given
below
a. Prepare summary of the following for the present year, budgeted years and
previous two years –
• Sales
• Cost of Sales
• Gross Profit
• Gross Profit Ratio
• Stock at Statement of Financial Position date
• Trade Debtors
b. Explain material fluctuations in above,
c. Compare Sales returns and allowance as a percentage of sales with prior year,
d. Compare sales patterns and gross profit rates with industry averages,
e. Explain any significant changes in type of business carried on, method of

operating source of earning, etc.

CHAPER 5 : VOUCHING
If the sales or account receivable are materially inflated, the application of analytical
procedures should reveal abnormal sales patterns or reduced account receivable turnover
or both. Moreover, if sales were inflated by holding the sales record open after year end,
sales cutoff procedures should assist the auditor in detecting the misrepresentation.
b.2 Credit Sales

i. Ensure that the internal control system is efficient in respect of credit procedure of
organisation;
ii. Compare the date of the copy of the invoice with the date in the Sales Books;
iii. Ensure that the sales are not omitted from being entered in the sale book. If it is
done, it is possible that when the customer sends cash or cheque in payment of
the goods sold, such an amount may the misappropriated. The fraud will not be
detected because no entry was made when the goods were sold and therefore , if
no entry is made when the payment is received, it will not affect the accounts at all
where cash has been misappropriated. Fraud can be detected in such a case when
comparison is made with original records, e.g. copies of invoices, order received
book, goods outward book, gatekeeper’s outward books, delivery note duly signed
by the purchaser , receipts issued by the transport company;
iv. Ensure that the sales of the asset are not treated as ordinary sales, otherwise profit
will be inflated. If an old asset has been sold, purchaser’s account should be debited
and particular asset account should be credited;
v. With the permission of the client, the auditor should send statement of account to
the customer to confirm the accuracy of the balance. This method will prove the
accuracy of the credit sales as well as the receipts from debtors and is very effective
to check frauds;
vi. Check the sales book for the last days or weeks of the financial period and the
returns inward books for a few day or weeks after the close of the period in order to
see whether fictious sales or returns had been recorded to inflate profits;
vii. Cancelled invoices should be checked with the duplicate copy of the invoice;
viii. Value added tax, Insurance charges etc., which are recoverable from the customers
should be debited to the customer’s account and credited to the appropriate account;
ix. Sales to allied or sister concern should be carefully examined as they may be fictious
entries with a view to inflate profits; &
x. If there is significant difference of trade discount allowed to two different customers,

auditor should inquire into the reason of such distinction.

AUDIT AND ASSURANCE
b.3 Goods Sent on Consignment

i. Verify the ‘Accounts Sales’ submitted by the consignee showing goods sold and
stock of goods in hand;
ii. Reconcile the figure of the goods on hand, as given in the last Accounts Sales,
with the Proforma Invoices and Accounts Sales received during the year. If any
consignment stock was in the hands of the consignee at the beginning of the year,
the same should be taken into account in the reconciliation;
iii. Obtain confirmation from the consignee for the goods held on consignment on the
Statement of Financial Position date. Verify the terms of agreement between the
consignor and the consignee to check the commission and other expenses debited
to the consignment account and credited to the consignee’s account. The Accounts
Sales also must be correspondingly checked;
iv. Ensure that the quantity of goods in hand with the consignee has been valued at
cost plus proportionate non-recurring expenses, e.g., freight, dock dues, customs
due, etc., unless the value is lower. In case net realisable value is lower, the stock
in hand of the consignee should be valued at net realisable value. Also see that the
allowance has been made for damaged and obsolete goods while computing the
valuation; &
v. See that goods in hand with the consignee have been shown distinctly under stocks.
b.4 Goods sent out on sale or return basis

i. Check whether a separate memoranda record of goods sent out on sale or return
basis is maintained. The party accounts are debited only after the goods have been
sold and the sales account is credited;
ii. See that price of such goods is unloaded from the sales account and the debtor’s
record. Refer to the memoranda record to confirm that on the receipt of acceptance
from each party, his account has been debited and the sales account correspondingly
credited.
iii. Ensure that the goods in respect of which the period of approval has expired at
the close of the year either have been received back subsequently or customers’
accounts have been debited.
iv. Confirm that the stock of goods sent out on approval basis has been included in the
closing stock, if the period of approval had not expired till the close of the year lying
with the party,

CHAPER 5 : VOUCHING
b.5 Sales Return

i. Examine the accounting basis for such transactions with reference to corresponding
Debit Note. The relevant correspondence from the parties may also be examined.
ii. Verify the goods returned by customer by reference to relevant corresponding record
in good inward book or the stores records. Further, the figures in these documentary
evidences should be compared with the original invoices for rates and other charges
and calculation should also be checked. Store records should be reviewed to check if
the goods returned are not recorded twice i.e., once on receivable of Debit Note and
next on receivable of actual quantity returned from the customers.
iii. Examine in depth to eliminate the possibility of fictitious sales returns for covering
bogus sales recorded earlier when such returns outwards are in substantial figure
either at the start or end of the accounting year.
iv. Cross-check with reference to original invoices or any rebates in price or allowances
if any given by buyers on strength of their Debit Notes.
b.6 Sales Commission

i. Review the rules, regulation, policies and manual of the organization in respect of
sales commission.
ii. Ascertain agreement, if any, in respect of sales transaction actually occurred during
the year carried out by authorized parties on its behalf. Sales commission on such
transaction should be in accordance with the terms and conditions as specified.
iii. Check evidence of services rendered by the party to whom commission is paid with
reference to correspondence etc.
iv. Ensure that the sales in fact have taken place and the same has been charged to
Statement of Profit or Loss.
v. Compare the amount incurred in previous years with reference to total turnover.
b.7 Sales Ledger

A sales ledger is a detailed itemization of sales made, presented in date sequence. It
may also contain credits issued that reduce the amount of sales, perhaps for products
returned by customers. The information in a sales ledger can be quite detailed, including
such items as the sale date, invoice number, customer name, items sold, sale amounts,
freight charged, sales taxes, value-added tax, and more.
The information in a sales ledger is summarized periodically and the aggregated

amounts are then posted to the sales accounts in the general ledger. This posting can
be as infrequent as the end of each month (as part of the month-end closing process) or
even every day. The detail level information in the sales ledger is kept separate from the
general ledger, in order to keep the general ledger from being overwhelmed with too
much information.

AUDIT AND ASSURANCE
Audit Procedure of Sales Ledger includes:

1. Test of Controls
An auditor tests the controls the company has set up for the sales cycle to determine
how strong and reliable they are. If they are strong, the auditor can reduce the amount
of transaction testing. Common internal controls over the sales cycle include numbered
sales invoices, purchase order authorization over a certain limit and authorization over
receivables write-offs. The auditor selects a random sample of transactions and examines
the related sales orders, invoices and customer statements. If the control being tested
is numbered sales invoices, for example, the auditor ensures that all numbers in a
section are accounted for and that none are missing. If the control is that all sales orders
are approved by management, the auditor checks for a manager's signature on each
document. If control errors are found, the auditor increases the amount of transactional
testing to obtain more reliable and relevance evidence.
2. Transactional Testing
An auditor determines if the financial statement amounts of sales and accounts receivable
are correct by verifying individual transactions. Accounts receivable balances are tested
by sending confirmation letters to customers to obtain objective assurance that the
balance is correct. The auditor also chooses sales transactions from the sales ledger and
verifies that there are legitimate sales receipts to back up the transaction. To test the
accuracy of the sales figure, the auditor reviews sales transactions in the ledger close to
the financial statement date to ensure that the company only included sales prior to that
date.
3. Fraud
The purpose of an external financial statement audit is to provide assurance on the
numbers and not to uncover employee or owner fraud. However, many of the sales
cycle audit procedures can lead to the discovery of fraud. A common employee scheme
is to steal customer payments and write them off in the accounting system so that the
receivable no longer shows. If an employee has access to both the accounting system
and the incoming mail, the auditor spends more time reviewing receivable write-offs
to ensure that they were authorized and legitimate. A review of sales orders often can
uncover another common fraud where an employee creates sales to fictitious companies
and steals the product.
b.8 Returnable Containers

In some industries, entities that distribute their products in returnable containers collect
a deposit for each container delivered. Entity have an obligation to refund this deposit
when containers are returned by the customer. It is of no doubt that such deposit is a
liability.

CHAPER 5 : VOUCHING
Audit procedure:
i. Ensure that policy exist for the managing returnable containers.
ii. Ensure that deposit for such container has been obtained and has been adequate.
iii. Ensure that refund of the deposits on submission of containers is according to the
approved policy.
iv. Ensure either of the following accounting treatment has been followed for deposits
of refundable containers.
When containers are returnable, there are two alternatives for accounting treatment:
a. When no separate charge is made-

The packages, tins, boxes, bottles etc. are necessary for packaging goods. While selling
such types of well packed goods, a provision could be made with the customers for
the returns of such type of containers. The provision of repair and maintenance is also
necessary to make the container moveable regularly. When no separate charge is made
even for returnable container, it is being expected that the customer will return the
container within a specified period. If the customer returns the containers on time his
account will be credited with the value less than the original cost of the container. This is
carried out for maintaining the provision of depreciation.
b. When separate charge is made-

When separate charge is made for returnable container, there are various methods to
deal with the situation. But widely used methods are as follows:
With opening containers stock and trading account-

• Containers stock account
• Containers trading and Statement of Profit or Loss
• Containers reserve/suspense/deposit account
Without opening containers stock account separately-

• Containers trading and Statement of Profit or Loss
• Containers reserve/suspense/provision account
b.9 Sale on Approval Basis

It is a business arrangement where an individual or company who is interested in
purchasing a specific item is allowed to use the item for a given length of time. At the
end of that time, if the individual is satisfied with the item, they agree to purchase it.
However, if the individual is unsatisfied for any reason, they are able to return the item
and are not committed to purchasing it.

AUDIT AND ASSURANCE
Audit procedure in respect to goods sales on approval basis are-
i. Documents to be verified
- Receipt of approval from the customer
- Sales invoices
- Stock records
- Goods outward books
- Goods inward books
ii. Scrutinize whether separate record for goods on sale on approval basis has been
maintained or not.
iii. Ensure goods sent on sale on approval basis are not included on sales book unless
approval from customer or stipulated time has been expired.
iv. Assess the internal control system of the entity regarding sales on approval basis.
v. Ensure that goods on sale on approval basis has been included on closing stocks.
vi. Also obtained customer confirmation for the goods lying on their custody.
c. Audit of Payment and General Expenses

General Consideration
Mode of payment or disbursement is, in some situations, governed by law of the land and
in some other situations regulated by the underlying contracts or other key documents. In
general, firms, companies are required to make payments through banking channels, except
for small and repetitive nature expenses, which can be paid through petty cash accounts.
So, auditor has to consider payment systems of the entity as to various expenses. Payments
may be based on nature of expenditure and an item procured/ or service being received. For
example, a payment for goods imported is required to be paid through bank letter of credit.
In some other cases telegraphic transfer may be permitted to certain limit of foreign currency
involved.
c.1 Salaries
While vouching salaries auditor should pay attention to the following points:
i. check the salary book,
ii. check the salaries actually paid during the year,
iii. compare the salary book and cheque drawn for a particular month,
iv. compare salary book with the salary payment or bank transfer order ,

CHAPER 5 : VOUCHING
v. ensure that the salaries are paid through bank accounts
vi. check that sign of each employee are available on the book,
vii. confirm that the salaries are paid to the employees having permanent account
number (PAN)
viii. examine, terms and conditions of the employment,
ix. verify that all the deductions like income tax, and other funds have been credited in
the irrespective accounts,
x. check that unpaid salaries are taken into account for that period,
xi. check that increment given to the employee was correct or not as per authorised
decision.
c.2 Wages
To vouch the wages following points must be considered:
i. Test the system of internal check that internal control system is sufficient to provide
a reasonable protection against errors,
ii. Apply the test check to see that all the calculations are correct,
iii. Examine the time work wages and piece work wages thoroughly,
iv. Check that wages computing and paying system is sound or not,
v. Check payment in both the cases (time and piece of work) as per practice followed,
check that amount paid should be same with amount drawn,
vi. Check that payment has been made to those employees whose names are given and
who have obtained PAN,
vii. Check that there should be no dummy worker in them,
viii. Check that wages sheets should be properly authorized and signed by the reasonable
officer,
ix. Verify signature and thumb impressions of workers by using the test check, check
that all unpaid wages are taken into account or not,
x. Check that deductions like income tax and social security tax are properly made in
their respective heads.
xi. In case of foreign workers, examine the related provisions as per labor act and
industrial enterprise act has been followed such as criteria to employee foreign
workers, approval for employing them.

AUDIT AND ASSURANCE
c.3 Premium paid for insurance of a motor car

Vouch from the following aspects:
i. Insurance cover note issued by the insurance company should be verified for the
identity of insured vehicle and period of insurance coverage.
ii. Verify that no claim bonus is given, where entitled, by the insurance company.
iii. Ensure that proper adjustment is made for pre-paid insurance premium.
iv. Check for timeliness of renewal for subsequent period premium.
c.4 Foreign Travel Expenses

i. Examine Travelling Allowance (T. A.) bills submitted by the employees stating
the details of tour, details of expenses, etc.
ii. Verify that the tour programme was properly authorised by the competent
authority through travel order (TO).
iii. Check the T. A. bills along with accompanying supporting documents such
as air tickets, travel agents bill, hotel bills with reference to the internal rules
for entitlement of the employees and also make sure that the bills are properly
passed.
iv. See that the tour report accompanies the T. A. bill. The tour report will show the
purpose of the tour. Satisfy that the purpose of the tour as shown by the tour
report conforms to the authorisation for the tour.
v. Check the regulations relating to foreign exchange provided by Nepal Rastra

Bank.
c.5 Research and Development Expenses

i. Ascertain the nature of research and development work at the outset and enquire
whether separate Research and Development Department exists.
ii. See allocation of expenses under revenue and deferred revenue. Ensure that
expenses which are routine development expenses are charged to Statement of
Profit or Loss.
iii. Check whether the concerned research activity is authorised by the Board and
has relevance to the objectives of the company.
iv. Examine that generally research expenses for developing products or for inventing
a new product are treated as deferred revenue expenditure to be written off over
a period of three to five years, if successful. In case it is established that the
research effort is not going to succeed, the entire expenses incurred should be
written off to the Statement of Profit or Loss.

CHAPER 5 : VOUCHING
v. Ensure that if any machinery and equipment have been bought specially for the
purpose of research activity, the cost thereof less the residual value should be
appropriately debited to the Research and Development Account over the years
of research.
c.6 Petty Cash Expenses

Petty cash accounts are used by companies to cover small, miscellaneous expenses
that are not easily categorized. For many business owners, the difficulty with petty
cash accounts is keeping track of the purchases made. It can be easy for employees to
abuse the petty cash system if some controls are not in place to keep track of the various
expenses. Having audit testing procedures and internal control system can help ensure
the money is spent properly.
Assign one person to serve as the custodian of the petty cash fund. Doing so will make
it more difficult for others who have access to the petty cash account to misappropriate
funds. The custodian should be in charge of disbursing the funds and recording the type
of transaction and what it was used for. An ongoing log stating the time, date, recipient
and purpose of the withdrawal will be helpful for auditing purposes.
Being control of the petty cash account in the hands of one person, it's important that
person knows that the account could be audited at any time. This helps keep the record-
keeping up to date and transparent. A system of random audits keeps the custodian and
all those who have access to the petty cash fund honest and forces them to constantly be
ready for the possibility that you or an assigned auditor will follow up on their record-
keeping and spending activities.
Accurate record-keeping is essential to the auditing process. Keeping detailed records

of the petty cash transaction helps ensure balances are accurate and reflect the actual
amount of money in the account versus the amount of money spent. The custodian's
log should contain receipts for all withdrawals. Itemize receipts to provide a specific
breakdown of the spending and the time, date and recipient. Those who use the petty
cash account should be required to keep their copy of all receipts. The amount in the
petty cash fund and the reimbursement of expenses from organisations should always
equal the amount originally in the fund.
Verification is the most important step in the auditing process. Those in charge of the
auditing process should verify all transactions by checking the receipts and comparing
them against the records in the custodian's log. The explanation for the expense in the
log should line up with the purchase printed on the receipt. Auditors should tally the
receipts and subtract the total from the original petty cash amount. The difference should
be the same amount as the cash remaining in the petty cash account.

AUDIT AND ASSURANCE
d. Audit of reconciliation of bank statements with cash book

Many businesses audit their accounting records to ensure the validity and reliability of their
financial statements. Bank Reconciliation Statement is a critical piece of accounting information
on a business's cash balance. The term reconciliation refers to reconciling the cash balance
reported in a business's bank statement with that shown on the business's own cash records.
Differences between a bank's record of cash and a business's record often exist because of the
reporting time delay from when a business deposits or writes cheques to when a bank clears
the cheques and records them. Cash reporting differences may also result from the time lapse
during which bank charges and credits remain unknown to a business until a bank statement
becomes available. Each month, a business must perform a bank reconciliation to determine
the correct cash balance, and auditing the bank reconciliation ensures that the reconciled cash
balance reflects correct adjustments. Following are the common approaches of taking comfort
on bank reconciliation:
i. Test mathematical accuracy: A bank reconciliation statement is a working paper in

which a business applies various adjustments, such as deposits in transit, outstanding
cheques, bank charges and credits to both the bank statement balance and a balance of
the books and find agreement between the two sets of cash records. In auditing a bank
reconciliation, the auditor always performs a basic arithmetic test to ensure that cash
additions and deductions made to bank and book balances are mathematically correct.
ii. Confirm bank and book balances: While some auditing work focuses on detecting
potentially non-compliance accounting practices, one of the auditing goals is simply to
uncover any clerical errors from compiling accounting information. Bank reconciliation
usually lists the cash balance as per bank statement and the cash balance as per the
business's books as the reconciliation starting points. The auditor checks the original
balances on the bank reconciliation working paper to ensure that they agree with the
source information shown on the bank statement and the business's book records.
iii. Trace deposits in transit: Deposits in transit shown on bank reconciliation statements
are the deposits made and recorded as cash additions by a business before the bank-
statement cutoff time but cleared the bank account and recorded by the bank in the
bank-statement of following period. Thus, the bank statement understates the current
cash balance. To arrive at the correct cash balance and agree with the book records, bank
reconciliation adds deposits in transit to the bank-statement balance. The auditor's task
is to trace deposits in transit to the bank-statement cutoff time to ensure that no deposits
made by a business after the cutoff or cleared by the bank before the cutoff appear on the
bank reconciliation statements, eliminating potential accounting irregularities.
iv. Compare outstanding cheques: Outstanding cheques shown on a bank reconciliation

statements are cheques written and recorded as cash deductions by a business before
the bank-statement cutoff-time but cleared the bank account and recorded by the bank

CHAPER 5 : VOUCHING
in the following bank-statement period. Thus, the bank statement overstates the current
cash balance. To arrive at the correct cash balance and agree with the book records,
bank reconciliation statement deducts outstanding cheques from the bank-statement
balance. The auditor's task is to compare outstanding cheques with canceled cheques in
relation to the cutoff time to ensure that only cheques written before the cutoff period but
cleared after the cutoff period appear as outstanding cheques on the Bank Reconciliation
Statement.
v. Verify bank charges and credits: Bank charges are bank fees assessed on a business's
bank account and credits are interest or other collections allocated to the bank account.
Bank charges and credits may be unknown to a business until the receipt of its bank
statement. As a result, book records may overstate or understate the cash balance. Thus,
a bank reconciliation deducts bank charges from and adds bank credits to a business's
book balance. The auditor's task is to ensure that the bank charges and credits used in the
bank reconciliation agree with those included in the bank statement.
vi. Validate adjusted book balance: Free of accounting error and fraud, the adjusted book
balance should equal the adjusted bank balance after accurate and compliant bank
reconciliation. The purpose of auditing a bank reconciliation is to validate the adjusted
book balance of cash, which a business later includes in the cash account of the financial
statements. The auditor also checks to see whether the adjusted book balance of cash is
in agreement with the cash account balance recorded in the general ledger.
e. Audit of Receipts and Income

e.1 Cheque or Cash receipts
In case of cash receipts, auditors should consider:
i. Internal controls pertinent to cash receipts transactions safeguard the organization

from theft,
ii. Check/review documents that establish accountability for the reception of cash
and completion of bank deposits, an accurate daily cash summary and deposit slip,
requiring daily journal entries that post the amount received to customer accounts
and appropriate segregation of duties,
iii. Ensure that there is an appropriate segregation of duties, so as to best prevent

lapping from occurring,
iv. Verify that prices of goods sold have been correctly recorded and check the
calculation,
v. Confirm accounts receivable balances with customers, compare the details of cash
receipts with journal entries and corresponding bank deposit slips and make a
surprise count of the cash on hand,

AUDIT AND ASSURANCE
vi. Verify the entry in the goods outward book with the sales summary,
vii. See that the cancelled cash memos are not removed from the receipt book,
viii. As part of analytical procedures, compare cash balances with forecasts and budgets.
When cash balances greatly exceed or fall below expectations for the year, it should
place the auditor on alert for items to look for during the tests of details.
ix. Review company policies regarding minimum cash balances and the investment of
surplus cash,
x. Trace bank transfers and performs cash cutoff tests to ensure that all of the
appropriate transactions are included in the financial statements.
e.2 Recovery of Bad Debts written off

i. Ascertain the total amount of bad debts.
ii. Ensure that all recoveries of bad debts have been properly recorded in the books of
account.
iii. Examine notification from the Court or from bankruptcy trustee, letters from
collecting agencies or from debtors should also be seen.
iv. Check Credit Manager’s file for the amount received and see that the said amount
has been deposited into the bank promptly.
e.3 Receipt of Capital Subsidy

i. Refer to application made for the claim of subsidy to ascertain the purpose and the
scheme under which the subsidy has been made available.
ii. Examine documents for the grant of subsidy and note the conditions attached with
the same relating to its use, etc.
iii. See that conditions to be fulfilled and other terms especially whether the same is for
a specific asset or is for setting up a factory at a specific location.
iv. Check relevant entries for receipt of subsidy.
v. Check compliance with requirements of NAS 20 on “Accounting for Government

Grants and Disclosure of Government Assistance” i.e. whether it relates to specific
amount or in the form of promoters’ contribution and accordingly accounted for as
also compliance with the disclosure requirements.
e.4 Sale Proceeds of Scrap Materials

i. Review the internal control on scrap materials, as regards its generation, storage
and disposal and see whether it was properly followed at every stage.

CHAPER 5 : VOUCHING
ii. Ascertain whether the organisation is maintaining reasonable records for the sale
and disposal of scrap materials.
iii. Review the production and cost records for determination of the extent of scrap
materials that may arise in a given period.
iv. Compare the income from the sale of scrap materials with the corresponding figures
of the preceding three years.
v. Check the rates at which different types of scrap materials have been sold and
compare the same with the rates that prevailed in the preceding year.
vi. See that scrap materials sold have been billed and check the calculations on the
invoices.
vii. Ensure that there exists a proper procedure to identify the scrap material and good
quality material is not mixed up with it.
viii. Make an overall assessment of the value of the realisation from the sale of scrap
materials as to its reasonableness.
e.5 Sale of Investments

i. See that sale of investment has been made on the proper authorisation of Board or
other competent authority.
ii. Ascertain the method of selling investments. It may be either through broker,
directly or through a bank. See the broker’s sold note.
iii. See that the difference between the carrying amount and the sales proceeds, net of
expenses, is recognised in the Profit & Loss Account. Ensure that when only a part
of the holding of an individual investment is sold, the carrying amount is allocated
on the basis of average carrying amount of the total holding of the investments.
iv. See that proper disclosures as required by NAS is made as follows:
 Interest, dividends, rentals on investments are to be shown in P& L A/c at

Gross Value and Tax Deducted at Source as advance tax paid.
 Shown separately profit or Loss on disposal and changes in carrying amount of

current and long term investments.
v. Calculate the capital gain tax on sale of investment and its treatment as per Income
Tax act.

AUDIT AND ASSURANCE
e.6 Rental Receipts

i. Check copies of bills or rent receipt issued to the tenant with reference to tenancy
agreement and bills of charges paid by the landlord on behalf of tenants.
ii. The entries in the rental register in respect of rent accrued should be traced with
reference to copies of rental bills.
iii. Scrutinize the account of collecting agent when the rent is collected by such agent.
iv. Vouch the entries for rent received in advance and ensure proper adjustment is
made.
v. Investigate into abnormal rent outstanding.
vi. Reconcile the outstanding rent and see that proper provision is made if unrecoverable.
vii. If rent is received net of TDS/local tax, see that rent income is shown at gross and TDS
is shown in Statement of Financial Position as advance Tax and local government
tax is shown as expenses.
e.7 Receipt of special backward area subsidy from Nepal Government

i. The claim for backward area subsidy submitted to the authorities should be
reviewed.
ii. It should be ascertained whether the grant is of a capital nature for funding assets or
of a revenue nature. Mere computation formula of quantum of grant with reference
to the cost of project of itself will not make the grant a capital nature ipso facto.
iii. The accounting of grant should be in accordance with NAS 20 “Accounting for
Government Grants and disclosure of Government Assistance”. The revenue grant
can be taken to income statement, with appropriate disclosure.
iv. The capital grant may be adjusted against cost of asset or may be kept in a capital
reserve to be transferred to Statement of Profit or Loss each year in proportion to
depreciation of that asset charged in Statement of Profit or Loss.
v. The receipt of the grant should be checked with bank statement, remittance challan etc.
vi. The conditions attached to grant should be fulfilled by the company. The auditor should
check whether any liability or refund of grant for breach of conditions could arise.
f. Audit of Impersonal Ledgers

f.1 Payment of Revenue Expenses
i. See that all payments have been duly authorised by a competent authority.
ii. Ensure that all payments relate to business and ensure that no personal expenses
are charged as business expenditure.

CHAPER 5 : VOUCHING
iii. Ensure that all payments have been received by the correct payee and
acknowledged by a receipt note or in the voucher itself.
iv. See that expenses relate to the period under audit.
v. See that all payments have been correctly recorded in the books under appropriate
sub-head.
vi. See that if the payment relates to prior period it is classified so and the amount
payable is correctly authorised.
vii. See mode of Payment cash, cheque etc., and relate to corresponding entry in cash
or Bank book.
viii. Verify the cash memos, invoice with the amount paid.
ix. Ensure that if any payment relates to period that extends to next year, a
proportionate amount is carried forward as pre-paid expenses.
x. Ensure the deduction of TDS on the payment where the nature of expenses
attracts TDS as per income tax act.
xi. Ensure the deduction of other amount in payment as per other laws and
regulations.
f.2 Provision for Income Tax

i. Obtain the computation of income prepared by the auditee and verify whether it is
as per the Income Tax Act, 2058 and Rules made there under.
ii. Review adjustments, expenses, disallowed special rebates, etc. with particular
reference to the last available completed assessment.
iii. Examine relevant records and documents pertaining to advance tax, self assessment
tax and other demands.
iv. Compute tax payable as per the latest applicable rates in the Finance Act.
v. Ensure that overall provisions on the date of the Statement of Financial Position is
adequate having regard to current year provision, advance tax paid, assessment
orders, etc.
f.3 Amount due to subsidiary companies

i. Examine whether the subsidiary company is authorised by its memorandum of
association to advance loan to its holding company.
ii. In the absence of such a power, see whether such power could be inferred from the
other objects of the company.
iii. Verify the interest rate and particulars of security, if any, furnished.

AUDIT AND ASSURANCE
iv. Inspect the documents executed by the holding company.
v. Verify the loan agreement and see that terms of loan have been duly complied with.
vi. Verify that the loan has been properly reflected in the Statement of Financial Position
f.4 Liability towards gratuity

i. The liability towards gratuity payable to the employees on monthly basis of service
should be ascertained and provided for in the accounts when the employees are in
service as per new Labor Act and Regulation.
ii. The auditor should check the quantification of the gratuity liability. He should
ascertain whether the same had been actuarially determined.
iii. The auditor should treat the actuary as an expert and conduct procedures relevant
to checking the opinion of an expert in accordance with NSA 620.
iv. The auditor should check the technical competence of actuary, the input fed to the
actuary, the assumptions made by the actuary, the methodology adopted by the
actuary, opinion given etc.
v. The auditor should bear in mind the relevant pronouncements of NAS 19 “Employee
Benefits” in this regard. He should check whether the expenses of provision for
gratuity are towards a defined benefit plan or contribution plan.
vi. If the contributions are made to outside agency, say the insurance companies,
he should check the premium paid, the acknowledgement receipts issued by the
insurance company, the coverage of policy etc. Premium due but not paid, prepaid
premium etc. should be appropriately accounted.
vii. If the company maintains its trust for gratuity, the auditor may peruse whether
the trust is an approved one under income tax law, whether the trust accounts are
audited, copy of the latest accounts etc.
f.5 Outstanding Expense and Income:

It is required that all incomes and expenses pertaining to a particular accounting period
are duly accounted in that period itself, so as to present:
i) A fair operational result of the period; and
ii) A fair financial position (liabilities & assets) at the end of the period.
Outstanding Expenses
All expenses payable at the year-end such as wages, salaries, rent, electricity & water
charges, commission, interest etc., are properly charged to Statement of Profit or Loss
and shown in the Statement of Financial Position as “Outstanding Expenses/Payable”

CHAPER 5 : VOUCHING
Unearned Incomes
Generally certain incomes relating to the following years are received in advance during
the year. Such incomes are not taken as income of the year in which the amount is
received. These receipts are simply shown payable in the Statement of Financial Position
as “Unearned Income”
g. Audit of Deferred Revenue Expenditure

g.1 Expenditure incurred for promotion of a product
The expenditure incurred for promotion of a new or existing product may entail
future benefits. It may be like advertisement in the papers, television, sales exhibition,
participation in trade fair, issue of promotional pamphlets, free gifts etc.
i. The auditor should vouch the authority and accuracy of the transactions. He should
read the contract with advertisement agencies, promotional policies decided by the
management from the board minutes etc.
ii. He should check the amounts paid to the agencies from bank book. He should check
the accuracy for ascertainment of income tax withholding in accordance with the tax
law provisions if any applicable in this regard.
iii. He should check whether the unpaid amounts and accrued liability towards
promotional advertisement contracts had been duly provided for in the accounts.
iv. The provision for fringe benefit tax in regard to sales promotion expenditure must
be ascertained.
v. The huge expenditure should not be treated as deferred revenue expenditure.

According to NAS, these are not intangible assets that may be carried over the
periods of accounting. These must be expensed with in the year in which these arise.
g.2 Advertisement Expenses

It should be vouched on the following basis:
i. Verify the bill/invoice from advertising agency to ensure that rates charged for
different types of advertisement are as per contract.
ii. See that advertisement relates to client’s business.
iii. Inspect the receipt issued by the agency.
iv. Ascertain the nature of expenditure, revenue or deferred one and see that it has
been recorded properly.
v. Ascertain the period for which payment is made and see that pre-paid is carried
forward to Statement of Financial Position.

AUDIT AND ASSURANCE
vi. Compare the statement of account with the ledger account.
vii. See that all outstanding advertisement bills have been provided for.
g.3 Preliminary Expenses

The auditor takes following steps to vouch preliminary expenses:
i. All such kind of expenses should be related to the formation of the enterprise.
ii. With all preliminary expenses, relevant supporting documents should be there.
iii. He should examine company’s minute’s book to determine the pattern of writing
off the preliminary expenses over the period.
iv. He must check that if such kinds of expenses are incurred by the promoters or they
have been reimbursed to the promoters, it is as per the instructions of the BOD and
the powers in AOA.
v. He should make a cross check of the amount of preliminary expenses with that of
amount mentioned in the prospectus, statutory report and Statement of Financial
Position.
h. Few Illustrations on Vouching

Question 1
In the course of audit of a trade, you noticed that although there is no change in either selling
or purchase price of the goods, but there is considerable increase in Gross Profit Ratio in
comparison to previous year. What matters would you examine to assess the reason for such
increase?
Answer
In assessing the reason for considerable increase in Gross Profit Ratio, the auditor should
examine the followings:
(i) Under valuation of opening stock due to non-inclusion of certain items or applying
lower rate to one or more items of stock.
(ii) Over valuation of closing stock either by the inclusion of fictitious items or over valuing
some of the items of Stock.
(iii) Change in the method of valuation of opening and closing stock. For example, opening
stock was valued at lower of cost and market value, whereas closing stock has been
valued at market price which is higher than cost.
(iv) Goods sold but not delivered are included in stock.
(v) Goods delivered last year but sales invoice raised in current year.

CHAPER 5 : VOUCHING
(vi) Recording of fictitious sales to boost up profits.
(vii) Goods returned to supplier awarding dispatch and included in closing stock.
(viii) Goods returned by customers but not debited to sales return and included in closing
stock.
(ix) Inclusion in the closing stock of goods received for sale on approval or consignment
basis.
(x) Treatment of goods sent on consignment basis as regular sales.
(xi) Non-provision of outstanding expenses like wages, carriage inward etc.
(xii) Wrong allocation of expenses in Trading and Profit & Loss Account.
Question 2
Give your comments and observations on the No Entry is passed for cheques received by the
auditee on the last day of the year but not yet deposited with the bank.
Answer
It is a quite normal that in any ongoing business entity many times cheques are received from
the customs on the last day of the accounting year. It is also quite likely, that cheques received
on the last day of the accounting year could not be deposited in the bank. Though normally
speaking, it is expected that all cheques should be deposited in the bank daily. But there may
be a possibility that such cheques which are received particularly during the late hours could
not be deposited in the bank. Therefore, it is quite important to ensure that the system of
internal control is effective and such cheques should be properly accounted for to avoid any
frauds and that the financial statements reflect a true and fair view.
As far as internal control system is concerned, it should be ensured that a list of such cheques is
prepared in duplicate and a copy of the same has been sent to person controlling the debtors’
ledger and a second copy is handed over to cashier along with the cheques received. The
person who is controlling the debtors’ ledger should ensure that proper accounting entries
have been passed by crediting respective debtors’ accounts. The balance of cheques-in-hand
should also be disclosed along with the cash and bank balances in the financial statements.
Question 3
‘In vouching payments, the auditor does not merely check proof that money has been paid away.’
Discuss.
Answer
Vouching is a substantive audit procedure which aims at verifying the genuineness and
validity of a transaction contained in the accounting records. It involves examination of

AUDIT AND ASSURANCE
documentary evidence to support the genuineness of transaction. Thus the object of vouching
the payments of a business is not merely to ascertain that money has been paid away; but the
auditor aims to obtain reasonable assurance in respect of following assertions in regard to
transactions recorded in the books of account that –
(i) a transaction is recorded in the proper account and revenue or expense is properly
allocated to the accounting period;
(ii) a transaction pertains to entity and took place during the relevant period;
(iii) all transactions which have actually occurred have been recorded;
(iv) all transactions were properly authorised; and
(v) transactions have been classified and disclosed in accordance with recognised accounting
policies and practices.
Thus, it is through vouching that the auditor comes to know the genuineness of transactions
recorded in the client’s books of account from where the financial statements are drawn up.
Apart from genuineness, vouching also helps the auditor to know the regularity and validity
of the transaction in the context of the client’s business, nature of the organisation and
organisational rules.
Thus, the auditor’s basic duty is to examine the accounts, not merely to see its arithmetical
accuracy but also to see its substantial accuracy and then to make a report thereon.
This substantial accuracy of the accounts and emerging financial statements can be known
principally by examination of vouchers which are the primary documents relating to the
transactions. If the primary document is wrong or irregular, the whole accounting statement
would, in turn, become wrong and irregular. Precisely auditor’s role is to see whether or not
the financial statements are wrong or irregular, and for this, vouching is simply imperative.
Thus, vouching which has traditionally been the backbone of auditing does not merely involve
checking arithmetical accuracy but goes much beyond and aims to check the genuineness as
well as validity of transactions contained in accounting records
Question 4
‘The cash-book showed a huge cash balance on hand consistently throughout the year.’ Comment.
Answer
Cash balance is maintained to meet the day to day operational needs of an organisation.
So the auditor has to perform audit procedures particularly having regard to the fact that
maintaining such huge balance is highly prone to misappropriation and other forms of fraud.
Accordingly, if the entity is consistently maintaining huge cash balance, which is not justified
by its operational requirement needs, the Guidance Note on Audit of Cash and Bank Balances

CHAPER 5 : VOUCHING
recommends that the auditor should carry out surprise verification of cash more frequently
to ascertain whether the actual cash-on-hand agrees with the balance as shown by the books.
If the cash-on-hand is not in agreement with the balance as shown in the books, he should
seek explanations from a senior official of the entity. In case any material difference is not
satisfactorily explained, the auditor should state this fact appropriately in audit report. In
any case, he should satisfy himself regarding the necessity for such large balances having
regard to the normal working requirements of the entity. The entity may also be advised to
deposit the whole or the major part of the cash balance in the bank at reasonable intervals.
Question 5
‘Responsibility for properly determining the quantity and value of inventories rests with the
management of the entity’. Comment.
Answer
The responsibility for properly determining the quantity and value of inventories rests with
of the management of the entity. Therefore, it is the responsibility of the management the
entity to ensure that the inventories included in the financial information are physically in
existence and represent all owned by the entity.
The management can satisfy this responsibility by carrying out appropriate procedures such as
verification of all items of inventory at least once in every financial year. The auditor is expected
to examine the adequacy of the methods and procedures of physical verification followed by the
entity. an auditor is also required to determine whether the procedures for identifying defective,
damaged, obsolete, excess and slow-moving items are well-designed and operate properly.
This responsibility of the management is not reduced even where the auditor attends any
physical count of inventories in order to obtain audit evidence. The entities usually maintain
detailed stock records in the form of Stores/Stock ledgers showing in respect of each major
item the receipts, issues and balances. The extent of examination of these records by an
auditor with reference to the relevant basic documents (e.g., goods received notes, inspection
reports, material issue notes, bin cards, etc.) depends upon the facts and circumstances of
each case. In valuation aspects, compliance with NAS 2 should also be ensured.
Question 6
Discuss accounting treatment of the revaluation of fixed assets.
Answer
The revaluation of fixed assets is a normally accepted practice which involves writing up
the book value of fixed assets. NAS 16 on ‘PPE’ requires that an increase in net book value
arising on revaluation of fixed assets is normally credited directly to owner’s interests

AUDIT AND ASSURANCE
under the heading of revaluation reserves and is regarded as not available for distribution.
Thus, creation of revaluation reserves does not result into any cash inflows and represents
unrealized gains. However, brought forward losses are in the nature of revenue losses. As a
matter of prudence, revenue losses can be adjusted against revenue reserves only and not the
capital reserves. Therefore, the accounting treatment followed by the entity is not correct and
the auditor should qualify the audit report by mentioning the above fact.
Question 7
Discuss the depreciation and fluctuation in value of assets.
Answer
Depreciation is a measure of the wearing out, consumption or other loss of value of a
depreciable asset arising from use, effluxion of time or obsolescence through technology and
market changes. It directly affects the earning capacity of an asset. Hence, it is a charge
against the profit of the year.
Fluctuation, on the other hand, is a temporary shrinkage or decrease and increase in the value
of an asset usually due to external causes such as rise and fall in market price of an asset. But
the fluctuation does not affect the earning capacity or working life of an asset. Hence, it is not
taken into account and no charge is made against the profit of the year.
Depreciation is only in connection with fixed assets while fluctuation is usually in connection
with current assets. Depreciation generally means fall in the value of fixed asset while
fluctuation may mean either increase or decrease in the value of any asset, current as well as
fixed. Depreciation has a significant effect determining and presenting the financial position
and results of operations of an enterprise. Depreciation is charged in each accounting period
by reference to the extent of the depreciable amount, irrespective of an increase in the market
value of the assets.
Question 8
Discuss provisions versus specific reserves.
Answers
Provisions are amounts charged against revenue to provide for depreciation, renewal
or diminution in the value of assets or a known liability, the amount of which cannot be
determined with substantial accuracy or a claim which is disputed.
Amounts contributed or transferred from profits to make good the diminution in assets values
due to the fact that some of them have been lost or destroyed, as a result of some natural
calamity or debts have proved to be irrecoverable are also described as provisions. Provisions
are normally charged to the Statement of Profit or Loss before arriving at the amount of profit.

CHAPER 5 : VOUCHING
On the other hand, a specific reserve is created for some definite purpose out of the profits
of the company. The purpose may be anything connected with the business which the
Article of Association or the directors want to be provided for, such as dividend equalization,
replacement of fixed assets, expansion of the organization, Income-tax liability for future
foreign exchange fluctuation etc. Though the concerned amounts are carried under the
earmarked heads, these are available for distribution as dividend on the recommendation of
directors but subject to the approval of shareholders, since these are created by appropriation
of profits. Some of the specific reserves may be required under the contractual obligations or
legal compulsion.
Thus provisions are amounts set apart to meet specific liabilities. These must be provided
for regardless of the fact whether or not any profit has been earned by the concern. While to
create any specific reserve, existence of profit is essential.

AUDIT AND ASSURANCE
Question 1 What are the general considerations in auditing of payments?
Question 2 What are general considerations in auditing receipts?
Question 3 How do you vouch purchase returns?
Question 4 Explain the procedure to vouch Electricity expenses payable to NEA?
Question 5 As an auditor explain the steps to vouch the following-
• Bonus Payable to Employees
• Gratuity Payable
• Salary of Manager
• Meeting Fees expenses of Audit Committee members
• SCT charges and VISA charges payable by banks

CHAPER 6 : VERIFICATION OF ASSETS AND LIABILITIES
CHAPTER 6
VERIFICATION OF
ASSETS AND LIABILITIES
To learn-
 Verify the ownership, existence and valuation of assets and

liabilities
 Detect fraud and errors
 Ensure proper recording of assets and liabilities
 Audit of incomplete records
 Concept of accounting estimates

AUDIT AND ASSURANCE
6.1 VERIFICATION OF ASSETS AND LIABILITIES
A large part of the audit process will be taken up with the verification of the assets and liabilities
appearing in the Statement of Financial Position. There are well established techniques for
verifying specific assets and liabilities.
NSA 500, Audit Evidence suggests that the auditor should consider the sufficiency and
appropriateness of audit evidence to support financial statement assertions1. Following are the
assertions about account balances at the period end:
(a) Existence - assets, liabilities, and equity interests exist.
(b) Rights and Obligations - the entity holds or controls the rights to assets, and liabilities
are the obligations of the entity.
(c) Completeness - all assets, liabilities and equity interests that should have been recorded
have been recorded.
(d) Valuation and allocation - assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded.
Similarly, assertions about presentation and disclosure:
(a) Occurrence and rights and obligations - disclosed events, transactions, and other
matters have occurred and pertain to the entity.
(b) Completeness - all disclosures that should have been included in the financial statements
have been included.
(c) Classification and understandability - financial information is appropriately presented

and described, and disclosures are clearly expressed.
(d) Accuracy and valuation - financial and other information are disclosed fairly and at
appropriate amounts.
The types of assets and liabilities vary from entity to entity. The verification process depends on
the type of the asset or liability under audit. However, the above assertions can be taken as base
and generalized for verify the same. The auditor may use the assertions as described above or
may verify them differently provided all aspects described above have been covered.
1 Representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the
auditor to consider the different types of potential misstatements that may occur.

6.2 AUDIT OF STATEMENT OF FINANCIAL POSITION
A Statement of Financial Position audit consists of the verification of all includible items, together
with the examination of expenses and income accounts which are so closely related to these items
that it cannot be properly verified without such analysis and tests. Records vouchers, books and
accounts are examined, capitals and revenue accounts are analyzed. Generally, audit of Statement
of Financial Position includes-
 Examination of partnership agreement, Memorandum & Article of Association, Minutes

of BOD, system of accounting;
 The entity owned assets as disclosed in Statement of Financial Position.
 The entity’s liability as discussed in Statement of Financial Position.
 Examination of adjustment entries necessary to prepare a Statement of Financial Position.
 Examination of evidences that distinction has been made in recording transaction

between Capital and Revenue.
 Examination of share issued, whether they are according to legal provisions or not.
 Examination of revenue Account (Amount recovered and included in Statement of

Financial Position).
6.3 AUDIT OF PROFIT LOSS ACCOUNT
Being income and expenses the only critical part of income statement, the audit of Income and
Expenses Account is crucial. The expenses may be verified as under:
• Checking direct expenses such as customs duty, excise duty, value added tax, carriage
inwards etc.
• The expenses incurred in this period are compared to the similar expenses incurred in
previous year. If there is any material variation it should be disclosed.
• Investigate the causes of any extraordinary expenses e.g. donation, foreign tour, heavy
advertisement etc.
• Determine whether there have been any changes in basis of treatment of expenses.
• If there was provision made in last year for the expenses and now material variation is
seen when actually expenses is made, the reason should be ascertained.
Income Accounts are verified as:
• Classify income on the basis of sources and examine them if necessary. If any amount is
to be received confirm that they had adjusted.

AUDIT AND ASSURANCE
• Examine the system of invoicing and pricing.
• Reconcile the quantity of raw material with quantity of finished product and compare
the rate of wastage with that in earlier period.
• Compare the income of this period with the previous period. If material variation arises
the reasons should be ascertained.
6.4 VERIFICATION OF ASSETS
Verification of assets is an important audit process. By convention, its scope has been limited
to inspection of assets, where it is practicable, and collection of information about them on an
examination of documentary and other evidence so as to confirm:
(a) that the assets were in existence on the date of the Statement of Financial Position
(Existence);
(b) that the assets had been acquired for the purpose of the business and under a proper
authority (Authorization);
(c) that the right of ownership of the assets vested in or belonged to the undertaking
(Beneficial Ownership) ;
(d) that they were free from any lien or charge not disclosed in the Statement of Financial
Position (free from charge);
(e) that the cost of assets has been correctly ascertained (Cost);
(f) that they had been correctly valued having regard to their physical condition (Valuation)
; and
(g) that their values are correctly disclosed in the Statement of Financial Position ( Disclosure).
Verification of assets is primarily the responsibility of the management since the proprietor or the
officials of the entity are expected to have a much greater intimate knowledge of the assets of the
business as regards location, condition, etc. than that which an outsider might be able to acquire
on their inspection. They alone thus are competent to determine the values at which these should
be included in the Statement of Financial Position. The auditor's function in the circumstances is
limited only to an appraisal of the evidence, their inspection and reporting on matters affecting
their valuation, existence and title, observed in the course of such an examination. Principally, the
auditor is required to verify the original cost of assets and to confirm, as far as practicable, that
such a valuation is fair and reasonable. As regards the manner in which the original cost should be
ascertained, there are well defined modes of valuation which auditor is expected to follow.
Assets are valued either on a ‘going concern' or a ‘break-up value' basis. The first mentioned
basis considered appropriate when the concern is working and the second, when it has closed

down and is being wound-up. NAS - 1 mentions that "Going Concern" is one of the fundamental
accounting assumptions to be followed in preparation and presentation of financial statements.
In case of non-observance, the fact that "Going Concern" assumption has not been followed is to
be specified. If considered necessary, the auditor can also obtain the assistance of expert valuer.
Auditor must further ensure that the Statement of Financial Position discloses the basis on which
different assets have been valued.
General Audit Steps Regarding Verification of Assets

(1) Where a company or a partnership has taken over the assets of a going concern, the agreement
of sale should be inspected and that amount paid for them ascertained. It should be further
verified that the allocation of the total cost among the various assets is fair and reasonable.
(2) The cost of assets acquired piecemeal should be verified with their invoices, purchase
agreements or ownership rights and the receipt of the sellers in respect of the price paid. It
should be verified that expenditure on assets newly acquired and that on the renewal and
replacement of old assets has been correctly recorded, consistent with the method that has
been generally followed in the past.
(3) When an asset is sold, its sale-proceeds should be vouched by reference to the agreement,
containing the terms and conditions of sale, counterfoil of the receipt issued to the purchaser
or any other evidence which may be available. If the sale of a fixed asset has resulted in capital
profit, it should be transferred to capital reserve. However, the profit limited to the original
cost or a loss should be transferred to the Profit & Loss Account.
(4) Entity has to provide for depreciation out of the profits in accordance with NAS 06
(5) The existence of fixed assets, where practicable, should be verified by a physical inspection
and, or by comparing the particulars of assets as are entered in the Schedule attached to the
Statement of Financial Position, with the Plant or Property Register and reconciling their total
value with the General Ledger balances.
(6) Wherever possible, all the securities and documents of title, cash, negotiable instruments,
etc. representing the assets, should be inspected at the close of the last day of the accounting
period. If this be not practicable and the examination is undertaken at the later date, a careful
scrutiny of transactions subsequent to the date of the Statement of Financial Position must be
made to ensure that the changes in their balance that have subsequently taken place are bona
fide and are supported by adequate evidence.
(7) It should be ascertained that no unauthorised charge has been created against an asset and all
the charges are duly registered and disclosed. Where shares or securities are lodged with a
bank to secure a loan or an overdraft, a certificate should be obtained from the bank showing
the nature of the charge, if any.

AUDIT AND ASSURANCE
(8) Where assets, e.g., government securities, share scrips and debenture bonds are in the custody
of a third party other than a bank, these must be inspected.
(9) Where depreciable assets are disposed of, discarded, demolished or destroyed, the net surplus
or deficiency, if material, should be disclosed separately.
(10) NAS 16 provides that a class of property, plant and equipment is a grouping of assets of
a similar nature and use in an entity’s operations. The following are examples of separate
classes:
a. land;
b. land and buildings;
c. machinery;
d. ships;
e. aircraft;
f. motor vehicles;
g. furniture and fixtures; and
h. office equipment.
It is the duty of the management to ensure that the fixed assets of the company are in existence and
for this purpose, it is important that physical examination of plant and machinery and other fixed
assets should be carried out periodically depending upon the size of the company.
6.5 VERIFICATION OF SPECIFIC ASSETS
a. Land and Buildings

The land holdings should be verified by an inspection of the original title deed (Lalpurja/
Dhanipurja) to ensure that the land described therein covers all the lands the cost of which is
debited in the books of the concern. The auditor however, not being competent to verify the
regularity of the title of the concern to the land, is not responsible for doing so. Therefore,
generally, a certificate should be obtained from the legal adviser of the client confirming the
validity of his title to the land. If the property is mortgaged, the title deed would be in the
possession of the mortgagee or his solicitors. A certificate to this effect should be obtained
from them. It should also be ascertained whether there is any second or subsequent mortgage.
If ground rents, outstanding for recovery, are included in the Statement of Financial Position
as an asset, the auditor must examine the counter parts of leases granted and also verify
that the ground rents which were outstanding for recovery on the date of the Statement of
Financial Position have since been recovered. If there has been any sale of land or building,
it should be verified that the amount of profit or loss resulting on sale has been correctly
adjusted in the accounts.

The cost of buildings, as is entered in the books, should be depreciated at appropriate rates,
depending upon the quality of their structure and the use which is being made of them. The
cost of fittings and fixtures to the building should be adjusted separately in the account from
the cost of buildings, since these suffer higher rate of wear and tear than the brick and mortar
structure and therefore, have to be depreciated at a higher rate.
If the values of land and buildings are not separately recorded in the books of account, the
same should be separated for purposes of calculating the amount of deprecation. This should
be done with the assistance of a valuer, unless the same can be achieved on the basis of some
documentary evidence available in the record.
Since buildings are continually repaired and there is only a thin margin of differentiation
between the expenditure of their improvement and that on repairs, it is necessary for the
auditor to scrutinise closely the expenditure on repairs so as to exclude from its expenditure
that could legitimately be considered to have added either to the life or the utility of the asset.
Such expenditure should be added to their cost while the amount incurred on current repairs
is written off.
It is not customary to write up the book values of land and buildings even though their market
values have increased, but where this has been done, it will be necessary for the auditor to
verify that the appreciation adjusted has been disclosed as required by the law. On the same
consideration, no notice need to be taken of any fall in the market value of such an asset until
the same has crystallized by the asset being sold. The land holding in the case of real estate
dealer will be a current asset and not a fixed asset. The same should, therefore, be valued at
cost or market value whichever is less.
Audit procedures of Building

i. Examine the title deeds of buildings to see whether the client holds the title on the
Statement of Financial Position date. If the property has been mortgaged, the title deeds
will be in the possession of the mortgagee, from whom a certificate should be obtained
to that effect.
ii. Verify the original cost of buildings by reference to the deed of conveyance. If the
building is constructed by the client, verify the original cost by reference to the cost as
recorded in the books of account of the year in which the construction was completed.
Also verify the borrowing cost to be capitalized if applicable as per NAS 23.
iii. Ensure the cost of land and buildings are segregated for the purpose of depreciation.
iv. Verify that appropriate depreciation has been provided against the buildings. In case
no depreciation is provided on the buildings, a note to this effect should be given in the
Statement of Profit or Loss.

AUDIT AND ASSURANCE
v. See the appropriate lease deed, if the building is leasehold, to ascertain the cost,
amortisation, etc. Also ensure that all covenants in the lease deed have been fulfilled by
the client.
vi. See that the buildings have been valued at cost less depreciation. If any revaluation has
taken place, see the basis of revaluation and ensure that the disclosure of the same has
been made.
vii. See that the relevant particulars of buildings have been entered in the fixed assets record
maintained by the client.
viii. If valuation is done by valuator, obtain certificate from him and apply NSA 620.
b. Assets acquired on Hire purchase

i. Inspect the hire purchase agreement to ascertain the terms and condition, the installment
and amount of interest included in the installment.
ii. Ensure that these are treated as assets acquired under finance lease as per NAS 17- Lease.
iii. Verify that initial recognition of lease should be as an asset and a liability at equal
amounts.
iv. If it is reasonably certain that lessee will get ownership at the end of the term, see that
asset is depreciated over its useful life. Otherwise confirm that asset is depreciated over
the shorter of its useful life and the lease term.
v. Ensure that it is shown separately in the Statement of Financial Position.
c. Bank Balances
i. Ask for and Collect the approved bank accounts details as current, call, loan etc.
ii. Verify bank balance by reference to bank statements.
iii. Examine the bank reconciliation statement prepared as on the last day of the year and see
whether (a) cheques issued by the entity but not presented for payment, and (b) cheques
deposited for collection by the entity but not credited in the bank account have been duly
debited/credited in the subsequent period.
iv. Pay special attention to those items in the reconciliation statements which are outstanding
for an unduly long period. The auditor should ascertain the reasons for such outstanding
items from the management. Auditor should also examine whether any such items
require an adjustment write-off.
v. Examine relevant certificates in respect of fixed deposits or any type of deposits with
banks duly supported by bank advices.
vi. Check the disclosure.

d. Patent Rights
i. Obtain the schedule containing particulars of the patents owned by the client as on
the Statement of Financial Position date. The particulars should contain the dates of
registration of the patents with the related authorities and the dates in respect of the last
renewal.
ii. See that the total of the values of the patent rights shown in each list agree with the
values shown in the respective ledger accounts.
iii. Examine the cost of patent rights. In case of outright purchase of patent rights, the
purchase consideration, legal fees and registration charges should be included in cost.
When they are developed within the organisation, all costs incurred on their development
including legal and registration expenses for registration of the patent should constitute
the cost.
iv. See that the renewal fees in respect of the patent rights have been paid and the same has
been treated as a revenue charge.
v. Examine the valuation of the patent rights. It should be seen that the patent rights have
been valued at cost less amortisation attributable to the expired legal life of the patent
rights. However, if it is found that the patent rights have already lost substantial part of
their commercial value, it would be proper to value it at their residual commercial value,
when it is less than the book value for their unexpired legal life. In case the product
covered by the patent rights does not have any sale value then patents should be shown
at nil valuation notwithstanding any residual life.
e. Trademark and Copyright

The existence of a trademark is verified by an inspection of the certificate as regards grant of the
trademark. Where it has been purchased, the agreement surrendering it in favour of the client
should be examined. It must also be observed that the rights are alive and legally enforceable.
Copyrights are also acquired by surrender of rights and they also should be verified similarly.
The auditor should obtain a schedule of trademarks and copyrights and verify that renewal
fee has been paid and charged to revenue. The last renewal receipt should, in each case, be
examined to ascertain that the trade mark has not lapsed. Copyrights and trademarks are
generally revalued at cost less amortization charges till date. Auditor should check whether
copyright and trademarks are generally revalued at cost less amortization charges till date. If
copyright and trademarks were purchased, the cost includes purchase price and registration
charges. If it has been developed by the client, the cost should include cost of developing
outlays, design costs and other associated direct cost. The cost of trademarks and copyright
should be amortized over the period of legal validity or useful commercial life, whichever is
short. Where auditor finds that any publication has ceased to command sale, auditor should
have asked client for the amount of its copyright written off to revenue. Following specific
points shall be followed:

AUDIT AND ASSURANCE
i. Obtain schedule of Trade Marks and Copyrights duly signed by the responsible officer
and scrutinise the same and confirm that all of them are shown in the Statement of
Financial Position.
ii. Examine the written agreement in case of assignment of Copyrights and Assignment
Deed in case of transfer of trade marks. Also ensure that trademarks and copyrights have
been duly registered.
iii. Verify existence of copyright by reference to contract between parties and noting down
the terms of payment of royalty.
iv. See that the value has been determined properly and the costs incurred for the purpose
of obtaining the trademarks and copyrights have been capitalised.
v. Verify existence of copyright by reference to contract between the author and the entity
and to check the payments of royalty made to author.
vi. Ascertain that the legal life of the trademarks and copyrights has not expired.
vii. Ensure that amount paid for both the intangible assets is properly amortised having
regard to appropriate legal and commercial considerations.
f. Assets Abroad
i. Examine the title deeds of immovable properties abroad.
ii. Ensure that the immovable properties abroad have been properly classified and disclosed.
iii. Where documents of title relating to assets held abroad are not available for inspection,
a certificate should be obtained from the agent or any other party holding the document.
iv. Ascertain that certificate has been obtained disclosing unequivocally that they are free
from any charge or encumbrance.
g. Plant and machinery

i. Verify the existence of plant and machinery by reference to documentary evidence
available and by evaluation of internal controls. Plant and machinery in existence at the
commencement of the year is normally verified by examining the schedule of plant and
machinery and the fixed assets register. Acquisition during the year can be verified by
reference to the Board’s minutes, purchase invoice and entry in the fixed assets register.
ii. Verify the authorisation for the purchase of new plant and machinery and examine the
compliance of procurement laws and byelaws during the procurement
iii. Vouch the cost price of any plant and machinery including freight and insurance plus
any cost of installation with relevant invoices and other costs such as borrowing cost to
be capitalized.

iv. Ensure that the routine repair and maintenance are debited to statement of profit or loss.
v. The auditor should verify that due provision for depreciation has been made. When
an asset has been revalued, depreciation should be provided on the revised value
and not on the historical value. The mode of disclosure in the Statement of Financial
Position should also be seen. Check that requirement of Nepal Accounting Standards 16
regarding accounting treatment, presentation and disclosures have been followed.
vi. Examine whether the profit or loss on sale of machinery has been calculated and disclosed
properly in the financial statements
vii. See that the various items of plant and machinery possessed by the client at the year
end are recorded in the financial ledger and in the fixed assets register. Proper inquiry
should be made to ensure that plant and machinery scrapped, destroyed or sold during
the year has been properly adjusted in the books of account as also in the fixed assets
register. If on physical verification material discrepancies are found, the auditor should
see that the discrepancies have been properly adjusted in the books of account.
viii. Comment on physical verification made by the management. In general, physical

verification of the fixed assets including plant and machinery is the responsibility of
the management not associated with procurement and maintenance of the assets. This
they can do by examination of physical verification instruction programme and working
papers.
h. Capital Work-in-Progress
Capital Work-in-Progress denotes assets under construction or installation. This could either
be plant or machinery under construction, or that construction project for establishment of a
new factory is under progress. The auditor should take the following steps to verify the same:
i. Ensure that the capital project is authorised by the Board. See the relevant Board Minutes
for the purpose.
ii. Obtain the break up in details of the amount shown in the Statement of Financial Position
under this head.
iii. Check purchase cost of plant machinery or other assets with reference to the contract
with, and amount paid to the suppliers.
iv. Examine the allocation of common costs to the Capital Work-in-Progress in case such
items have been constructed internally.
v. Ensure that the assets already put to commercial use are not included under Capital
Work-in-Progress.
vi. Verify that only expenses incurred up to pre-commissioning stage are capitalised under
this head.

AUDIT AND ASSURANCE
vii. Obtain the certificate of the engineering department to ascertain the quantum of
the Capital Work-in-Progress, and whether the value is correctly represented in the
Statement of Financial Position, and its transfer to Fixed Assets on completion of the
project or installation of the plant.
viii. See that Capital Work-in-Progress is properly disclosed in the Statement of Financial
Position under the head Fixed Assets.
i. Stock lying with the third party

i. Obtain confirmations from the third party including the time period and reasons thereof.
ii. Evaluate condition of goods and see whether adequate provision has been made.
iii. Check whether subsequently the goods lying with third party were sold or received back
after the expiry of stipulated time period.
iv. Ensure that the goods have been included in the closing stock though lying with third
party.
j. Discontinued bill receivable dishonored

i. Verify entries for dishonor passed in the parties account.
ii. Confirm whether bank charges, noting charges, etc. have been debited to party.
iii. Verify whether B/R2 has been returned along with banker’s advice.
iv. Obtain a schedule of Bills discounted / dishonored and examine the same.
v. Trace the credit entry and subsequent dishonour entry in the bank statement.
vi. Confirm that no debit is raised by the banker for dishonour, without first adding the
amounts ensure that the dishonour has been properly noted on the B/R.
vii. Examine correspondence with lawyer and other subsequent events, which may provide
other evidence of the debt becoming band or doubtful, etc.
k. Amounts due to Subsidiary Companies

i. Examine whether the subsidiary company is authorized by its Memorandum of
Association to advance the loan to the holding company.
ii. Verify the interest rate at which the loan has been obtained and particulars of the security
that has been furnished for confirming the amount of interest and disclosure of the
charge in the Statement of Financial Position.
iii. Inspect the documents executed by the holding company which constitute the basis of
the loan and the provision in the Memorandum under which the loan has been raised.
2 Short form of bills receivable

l. Goodwill
i. Ensure that as required by NAS 16 or NAS38 or NFRS 3, goodwill has been recorded in
the books only when some consideration in money or money's worth has been paid for.
Goodwill arises from business connections, trade name or reputation of an enterprise or
from other intangible benefits enjoyed by an enterprise.
ii. Check the vendor's agreement on the basis of which assets of the running business have
been acquired by the company at a price existing in the book value of the assets or where
a specific sum has been paid for the goodwill.
iii. See that only the amount paid to the vendors not represented by tangible assets has
been debited to the goodwill account. Therefore, it is not prudent that goodwill should
be shown in the company's accounts by way of writing up the value of its assets on
revaluation or writing back the amount of goodwill earlier written off by the company.
iv. See whether goodwill has been written off as a matter of financial prudence.
m. Machinery acquired under Hire-purchase system

i. Examine the Board’s Minute Book approving the purchase on hire-purchase terms.
ii. Examine the hire-purchase agreement carefully and note the description of the machinery,
cost of the machinery, hire purchase charges, terms of payment and rate of purchase.
iii. Ascertain that the machinery has been included in the related assets account at its cash
value. Also, instalments due have been paid and the hire-purchase charges applicable
to the period from the commencement of the agreement to the end of the financial year
have been charged against current profits.
iv. Ensure that machinery acquired on hire purchase basis has been included at its cash
value in the Statement of Financial Position and depreciation has been calculated on
the cash value from the date of the purchase. The amount due to the hire purchase
company in respect of the capital outstanding has either been shown as a deduction from
the machinery account or as a separate amount under current liabilities.
v. Examine the hire purchase agreement to ascertain the terms and conditions, the
installments and the amount of interest included in the installments.
vi. Ensure that asset is correctly classified as required by NAS 15.
vii. Verify that initial recognition as an asset and a liability at equal amount is made. The
amount to be taken should be lower of fair value of the asset or present value of the
minimum lease payments (installments).
viii. See that interest including penalties has been charged off to revenue.
ix. Ensure that adequate depreciation has been provided.

AUDIT AND ASSURANCE
n. Work-in-Progress
The audit procedures regarding work-in-progress are similar to those used for raw materials
and finished goods. However, the auditor has to carefully assess the stage of completion
of the work-in-progress for assessing the appropriateness of its valuation. For this purpose,
the auditor may examine the production/costing records (i.e., cost sheets), hold discussions
with the personnel concerned, and obtain expert opinion, where necessary. The auditor may
advise his client that where possible the work-in-progress should be reduced to the minimum
before the closing date. Cost sheets of work-in-progress should be verified as follows:
i. Ascertain that the cost sheets are duly attested by the works engineer and works manager.
ii. Test the correctness of the cost as disclosed by the cost records by verification of quantities
and cost of materials, wages and other charges included in the cost sheets by reference to
the records maintained in respect thereof.
iii. Compare the unit cost or job cost as shown by the cost sheet with the standard cost or the
estimated cost expected.
iv. Ensure that the allocation of overhead expenses had been made on a rational basis.
v. Compare the cost sheet in detail with that of the previous year. If they vary materially,
investigate the cause thereof.
6.6 VERIFICATION OF LIABILITIES
General Considerations
Liabilities are the financial obligations of an enterprise other than owners' funds. Liabilities
include loans and borrowings, trade creditors and other current liabilities, deferred payment
credits, installments, payable under hire purchase agreements, and provisions. Besides liabilities,
contingent liabilities, i.e., obligations relating to past transactions or other events or conditions
that may arise in consequence of one or more future events which are presently deemed possible
but not probable, also need special attention from auditors. An important feature of liabilities
which has a significant effect on the related audit procedure is that these are represented only
by documentary evidence which originates mostly from third parties in their dealings with the
entity. Verification of liabilities is as important as that of assets, for, if any liability is omitted
(or understated) or overstated, the Statement of Financial Position would not show a true and
fair view of the state of affairs of the concern. For example, if the liability for certain expenses
if found to have been omitted or understated, it would signify that against the revenue for the
relative period, the full amount of expenses has not been charged. As a result, the figure of profit
as disclosed by the Statement of Profit or Loss would be larger by the amount of the liability
which has been omitted. Moreover, since the liability would not be included in the Statement of
Financial Position, it would also be incorrect. Conversely, where a fictitious liability for expenses

is adjusted in the accounts or when a liability is overstated, the result will be that the revenue
would bear an increased charge which would have the effect of artificially reducing the profits.
This will falsify the figure of profit or loss disclosed by the Statement of Profit or Loss. Besides,
on account of the inclusion of the liability, the Statement of Financial Position also will be false,
since it would include an undisclosed amount in the nature of secret reserve. The auditor must,
therefore, apart from vouching the entries in regard to the adjustment of liabilities, verify at the
close of the year that the liabilities stated in the Statement of Financial Position are in fact payable
and all its liabilities that could be traced by the exercise of the diligence and care on the part of the
auditor have been accounted for. Auditor must also obtain a certificate from a responsible official
stating that to the best of his knowledge and belief, all liabilities, whether for purchases (supplies)
or expenses or any other account existing at the date of the Statement of Financial Position have
been included in the books of account; also that all the contingent liabilities have either been
disclosed in footnote to the Statement of Financial Position have been provided for.
Verification of liabilities may be carried out by employing the following procedures:
(a) examination of records;
(b) direct confirmation procedure;
(c) examination of disclosure;
(d) analytical review procedures,
(e) obtaining management representations.
The nature, timing and extent of substantive procedures to be performed are, however, a matter of
professional judgement of the auditor which is based, inter alia, on the auditor's evaluation of the
effectiveness of the related internal controls.
6.7 VERIFICATION OF SPECIFIC LIABILITIES
a. Bills Payable
These are acknowledgements of debts payable. For their verification, it is necessary to see
that bills paid have been cancelled and the liability in respect of those outstanding has been
correctly ascertained and disclosed. Steps involved in their verification are:
i. Vouch payments made to retire bills on their maturity or earlier and confirm that the
relevant bills have been duly cancelled.
ii. Trace all the entries in the Bills Payable Book to the Bills Payable Account to confirm that
the liability in respect of the bills has been correctly recorded.
iii. Reconcile the total of the schedule of bills payable outstanding at the end of the year with
the balance in the Bills Payable Account.

AUDIT AND ASSURANCE
iv. Obtain confirmation from the drawers or holders of the bills in respect of amount due on
the bills accepted by the client that are held by them.
v. Verify that the charge, if any, created on any asset for the due payment of bills has been
appropriately disclosed.
b. Borrowing from Banks

Borrowing from banks may be either in the form of overdraft limits or short term or long term
loans. In each case, the borrowings should be verified as follows:
i. Reconcile the balances in the overdraft or loan account with that shown in the pass books
and confirm the last mentioned balance by obtaining a certificate from the bank showing
the balance in the accounts as at the end of the year.
ii. Obtain a certificate from the bank showing the particulars of securities deposited with
the bank as security for the loans or the charge created on an asset or assets of the
concern and confirm that the same has been correctly disclosed and duly registered
with Registrar of Companies and recorded in the Register of Charges.
iii. Verify the authority under which the loan or overdraft has been raised. In the case of a
company, only the Board of Directors is authorized to raise a loan or borrow from a bank.
iv. Confirm the compliance with Companies Act, 2063 as regards loan.
v. Ascertain the purpose for which loan has been raised and the manner in which it has
been utilised and that this has not prejudicially affected the concern.
vi. Obtain the loan offer letter from the bank and examine the terms and conditions of the
loan have been fulfilled by the entity and whether there is any implication due to non-
compliance of such terms and conditions.
c. Contingent Liability
NAS 37 defines the contingent liability as:
(a) A possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity; or
(b) A present obligation that arises from past events but is not recognised because:
(i) It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.
A contingent liability will be known or determined only on the occurrence or non-occurrence

of one or more uncertain future events. The uncertainty as to whether there will be any legal

obligation distinguishes a contingent liability from an actual liability. An obligation may be

a contingent liability when the very basis of the obligation is contested. For example, when a
claim is made against a company in respect of infringement of a patent and the suing company
does not possess a legitimate title. Some examples of contingent liabilities include claims
against the company not acknowledged as debts, arrears of fixed cumulative dividends, etc.
NAS 37requires that in case there is a probability that a loss may be incurred and a reasonable
estimate of the amount can be made, then such contingent liability must be adjusted in the
financial statements. Otherwise, disclosure will have to be made describing nature of the
event, uncertainties affecting the event and estimate of the financial effect or a statement that
such an estimate cannot be made.
The auditor may take following steps to verify the contingent liabilities:
i. Inspect the minute books of the company to ascertain all contingent liabilities known to
the company.
ii. Examine the contracts entered into by the company and the likelihood of contingent
liabilities emanating there from.
iii. Scrutinize the lawyer’s bills to track unreported contingent liabilities.
iv. Examine bank letters in respect of bills discounted and not matured.
v. Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
vi. Discuss with various functional officers of the company about the possibility of contingent
liability existing in their respective field.
vii. Obtain a certificate from the management that all known contingent liabilities have been
included in the accounts and they have been properly disclosed.
viii. Ensure that proper disclosure has been made as per NAS 12, Provisions, Contingent
Liabilities and Contingent Assets.
d. Provisions
The term ‘provision' means amounts retained by way of providing for depreciation or
diminution in value of assets or retained by way of providing for any known liability, the
amount of which cannot be determined with substantial accuracy. Provisions include those
in respect of depreciation or diminution in the value of assets, product warranties,
service contracts and guarantees, taxes and levies, gratuity, proposed dividend etc.
The audit of provisions primarily involves examining the reasonableness and adequacy o f
the amounts provided for. The auditor should also examine that the provisions made are not
in excess of what is reasonably required.

AUDIT AND ASSURANCE
Provisions for Taxes

The adequacy of the provision for taxation for the year should be examined. The position
regarding the overall outstanding liability of the entity as at the date of Statement of Financial
Position should be reviewed. In respect of assessments completed, revised or rectified
during the year, the auditor should examine whether suitable adjustments have been made
in respect of additional demands or refunds, as the case may be. Similarly, auditor should
examine whether excess provisions or refunds have been properly adjusted. The relevant
orders received up to the time of audit should be considered and, on this basis, it should
be examined whether any short provisions have been made good. If there is a material tax
liability for which no provision is made in the accounts, the auditor should qualify his report
in this respect even if the reserves are adequate to cover the liability.
Provision for Bonus

In the case of provision for bonus, the auditor should examine whether the liability is provided
for in accordance with the Bonus Act, 2030 (1973) & Some Nepalese Laws Amendments Act,
2075 and/or agreement with the employees or award of competent authority.
As per the Acts, the Bonus shall be paid on the following amount obtainable by the personnel:
Monthly Remuneration/Wage Ceiling of Bonus

Two (2) times of the minimum remuneration Amount equivalent to 8 (eight) months’
fixed by the GoN remuneration/wage
More than two (2) times the minimum Amount equivalent to 6 (six) months’
remuneration determined by the GoN remuneration/wage
Where the bonus actually paid is in excess of the amount required to be paid as per the
provisions of the applicable law/agreement/award, the auditor should specifically examine
the authority for the same. Auditor should check whether the appropriate amount have been
transferred to Welfare Fund Account. As per the Act, seventy percent of the rest amount after
the distribution of Bonus from the amount allocated for Bonus shall be deposited in Welfare
Fund established in accordance with Labour Act, 2074 and the rest thirty percent shall be
deposited in the National Level Welfare Fund which has been established by Government of
Nepal for the benefit of the personnel of the Enterprise.
Distinction Between Reserves and Provisions

The following are the main differences between reserve and provision:
Mode of Creation
Reserve is created against the charge of the profit and loss appropriation account. Provision
is created against the charge of the Statement of Profit or Loss.

Objective
Main objective of reserve is to strengthen the financial position and to meet future unknown
losses and liabilities. Objective of provision is to meet known losses and liabilities the amount of
which is not certain.
Accounting Treatment
Reserve is shown on debit side of profit and loss appropriation account and liabilities side
of Statement of Financial Position. Provision is shown on debit side of Statement of Profit or
Loss and assets side of Statement of Financial Position as deduction from the concerned asset.
Relation with Profit

Reserve is created when there is enough profit in the business. Provision is created even if
there is loss in the business.
Distribution
Reserve can be distributed to shareholders as dividend. Provision cannot be distributed as
dividend to shareholders.
Future Requirement
Reserve is created without considering the future requirement of the business. Provision is
created by estimating the future requirement of the business.
Impact
Impact of reserve will be on financial position. Impact of provision will be on profit or loss of
the business.
6.8 EXAMINATION OF DISCLOSURE
The auditor should satisfy himself that the liabilities have been disclosed properly in the financial
statements. Where the relevant statute lays down any disclosure requirements in this behalf, the
auditor should examine whether the same have been complied with.
In some cases, loans are guaranteed by third parties in whose favour the assets of the entity
are charged. The auditor should examine whether the disclosures concerning such loans are
appropriate, e.g., they may be classified as secured with disclosure of the fact that the assets of the
entity have been charged in favour of third parties which, in turn, have given guarantees to parties
from whom loans have been obtained.
The auditor should recommend to the entity to disclose, in parentheses or in footnotes, the
installments of term loans, if any, falling due for repayment within the next twelve months.

AUDIT AND ASSURANCE
The auditor should examine that the following have been disclosed in respect of contingent
liabilities:
a. nature of each contingent liability;
b. the uncertainties which may affect the future outcome;
c. an estimate of the financial effect or a statement that such estimate cannot be made.
6.9 CHANGE IN ACCOUNTING POLICIES AND ITS IMPLICATION
As per NAS 8-Accounting Policies, Changes in accounting estimates and Errors, an entity shall
change an accounting policy only if the change:
(a) is required by NFRSs; or
(b) results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity’s financial
position, financial performance or cash flows.
The initial application of a policy to revalue assets in accordance with NAS 16 Property, Plant and
Equipment or NAS 38 Intangible Assets is a change in an accounting policy to be dealt with as a
revaluation in accordance with NAS 16 or NAS 38, rather than in accordance with this Standard.
As per NAS 8,
(a) an entity shall account for a change in accounting policy resulting from the initial
application of a NFRS in accordance with the specific transitional provisions, if any, in
that NFRS ; and
(b) when an entity changes an accounting policy upon initial application of a NFRS that
does not include specific transitional provisions applying to that change, or changes an
accounting policy voluntarily, it shall apply the change retrospectively.
When a change in accounting policy is applied retrospectively, the entity shall adjust the opening
balance of each affected component of equity for the earliest prior period presented and the other
comparative amounts disclosed for each prior period presented as if the new accounting policy
had always been applied.
When retrospective application is required, a change in accounting policy shall be applied

retrospectively except to the extent that it is impracticable to determine either the period – specific
effects or the cumulative effect of the change.

6.10 AUDITING OF ACCOUNTING ESTIMATES
“Accounting estimate” means an approximation of the amount of an item in the absence of a

precise means of measurement.
It means an approximation of the amount of an item in the absence of a precise means of

measurement. Accounting estimates are made in conditions of uncertainty and involve the use
of judgement. The use of reasonable estimates is an essential part of the preparation of financial
statements. Estimation requires revision when the circumstances on which the estimation was
based got changed. Estimation of accounting information is the responsibility of the management.
The auditor has to assess reasonableness of accounting estimates made by the management.
Following are some of the examples of accounting estimates:
(i) Allowances to reduce inventory and accounts receivables to their estimated realisable
value.
(ii) Provision to allocate the cost of fixed assets over their estimated useful life – i.e.
depreciation.
(iii) Accrued income.
(iv) Provision for taxation.
(v) Provision to meet warranty claims.
(vi) Provision for retirement benefits in the financial statements of employers.
Techniques to obtain audit evidence regarding the appropriateness of using the right estimate
by management
Management is responsible for making accounting estimates included in financial statements.

These estimates are often made in conditions of uncertainty regarding the outcome of events that
have occurred or are likely to occur and involve the use of judgement. As a result, the risk of
material misstatement is greater when accounting estimates are involved.
The auditor should obtain sufficient appropriate audit evidence as to whether an accounting
estimate is reasonable in the circumstances and, when required, is appropriately disclosed.
The auditor should adopt one or a combination of the following approaches in the audit of an
accounting estimate:
• Review and test the process used by management to develop the estimate;
• Use an independent estimate for comparison with that prepared by management;
• Review subsequent events which confirm the estimate made.

AUDIT AND ASSURANCE
Reviewing and Testing the Process Used by Management
The steps ordinarily involved in reviewing and testing of the process used by management are:
• Evaluation of the data and consideration of assumptions on which the estimate is based;
• Testing of the calculations involved in the estimate;
• Comparison, when possible, of estimates made for prior periods with actual results of
those periods; and
• Consideration of management’s approval procedures.
The auditor would perform the following techniques to obtain audit evidence regarding the
appropriateness of using the right estimates by the management.
• Evaluation of Data and Consideration of Assumptions
The auditor would evaluate whether the data on which the estimate is based is accurate,
complete and relevant. When accounting data is used, it will need to be consistent with the data
processed through the accounting system. The auditor may also seek evidence from sources
outside the entity. The auditor would evaluate whether the data collected is appropriately
analysed and projected to form a reasonable basis for determining the accounting estimate.
The auditor would evaluate whether the entity has an appropriate base for the principal
assumptions used in the accounting estimate.
• Testing of Calculations
The auditor would test the calculation procedures used by management. The nature, timing
and extent of the auditor’s testing will depend on such factors as the complexity involved in
calculating the accounting estimate, the auditor’s evaluation of the procedures and methods
used by the entity in producing the estimate and the materiality of the estimate in the context
of the financial statements.
• Comparison of Previous Estimates With Actual Results
When possible, the auditor would compare accounting estimates made for prior periods with
actual results of those periods to assist in:
(a) obtaining evidence about the general reliability of the entity’s estimating procedures;
(b) considering whether adjustments to estimating formulae may be required; and
(c) evaluating whether differences between actual results and previous estimates have been
quantified and that, where necessary, appropriate adjustments or disclosures have been
made.

• Consideration of Management’s Approval Procedures
Material accounting estimates are ordinarily reviewed and approved by management. The
auditor would consider whether such review and approval is performed by the appropriate
level of management and that it is evidenced in the documentation supporting the
determination of the accounting estimate.
Use of an Independent Estimate

The auditor may make or obtain an independent estimate and compare it with the accounting
estimate prepared by management. When using an independent estimate the auditor would
ordinarily evaluate the data, consider the assumptions and test the calculation procedures used
in its development. It may also be appropriate to compare accounting estimates made for prior
periods with actual results of those periods.
Review of Subsequent Events

Transactions and events which occur after period end, but prior to completion of the audit, may
provide audit evidence regarding an accounting estimate made by management. The auditor’s
review of such transactions and events may reduce, or even remove, the need for the auditor to
review and test the process used by management to develop the accounting estimate or to use an
independent estimate in assessing the reasonableness of the accounting estimate.
The auditor should make a final assessment of the reasonableness of the estimate based on the
auditor’s knowledge of the business and whether the estimate is consistent with other audit
evidence obtained during the audit.
6.11 AUDITING OF INCOMPLETE RECORDS
Auditing is a systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of correspondence between
those assertions and established criteria and communicating the results to the interested users.
In order to give an assurance about the financial statements of an entity, the auditor receives
assertions from the management about these reports. These assertions cannot be trusted and the
auditor needs to collect evidence that confirms that the information produced by the management
is accurate. In this case, the auditors’ opinion is based on the collected evidence.
In case the records and documents maintained by an enterprise are incomplete, it would be
difficult to obtain the enough evidence to form an opinion about the incomplete accounts.
The scope of the work undertaken by the auditor is governed by his client's instructions, unless
the work involves the audit of the accounts of a limited company. Auditing like vouching
and verification are employed as far as possible to ascertain basic information and ensure that
items are properly treated in the accounts. The greater the extent to which these procedures are

AUDIT AND ASSURANCE
employed, the greater will be the reliability of the accounts and the degree of responsibility which
the accountant may assume in respect of them.
Generally, an auditor may face the situation of incomplete records under the following
circumstances:
(i) Where records are kept on single entry basis; or
(ii) Where records are kept on double entry basis, but some of the records are destroyed
accidentally, or are seized by authorities, or are otherwise not available for the auditor’s
examination due to similar reasons.
Under the second circumstance, the auditor may direct the management of the enterprise to
complete or reconstruct the accounting records, e.g. if vouchers are available but the cash book,
journal and the ledger are not maintained, then the cash book, journal and ledger should be
written up. However, if vouchers are also not available, then cash book/journal/ledger will have
to be prepared by correlating the evidence available, e.g., memoranda records, bank statements,
statements from outside parties, etc. Even though such books which are prepared may not be
complete, but may still contain useful information for the auditor.
On the other hand, when books are maintained on single entry basis, then the management of the
enterprise would be asked to write up the books, to the extent possible, as they would have been
written up under double entry system.
In any case, the following steps would be required to conduct an audit:
i. Ascertain that the Statement of Financial Position or statement of affairs as at the

beginning of the year should be prepared and all the relevant accounts such as cash,
bank and personal accounts should be opened in the ledger.
ii. Confirming that all entries on receipt side of the cash book are posted in the ledger, even
by opening new account(s) wherever necessary.
iii. Check that all entries on the payment side of cash book are posted in the ledger.
iv. Confirming that all entries appearing in bank account are posted in the ledger.
v. Analyse personal accounts of debtors. This will provide vital information regarding
credit sales, sales returns, discounts allowed, bills received, bills dishonored, etc. It
would be necessary to post such items to relevant accounts, to complete the double entry
from the debtor’s accounts.
vi. Analyse the creditors' accounts and post entries relating to credit purchase made,
discounts earned, purchases returns, bills payable issued to suppliers, bills payable
dishonored, etc., to relevant accounts.

vii. It is normal procedure to make comparisons with previous years' figures and gross profit
percentages; the latter should also be compared with such information as is available
concerning other similar businesses. Variations do not necessarily indicate accounting
inconsistencies, but should be inquired into until an adequate explanation has been
obtained. If the nature of the business permits, a quantity reconciliation of stocks,
purchases and sales should be made
viii. The capital account should also be scrutinised to see whether the drawings shown in
it appear consistent with the client's circumstances (after allowing for other sources of
income) and to ascertain the sources of any new capital introduced. It is usual to show
separately such items as taxation, life assurance premiums, investment purchases and
details of cash introduced. The treatment and description of such items will depend on
the particular circumstances of each case.
ix. Having completed his critical review, the auditor will probably have a number of queries
arising on the accounts which will necessitate an interview with the client. It is important
to discuss the accounts with the client to ensure that they accord with his knowledge
of the facts, and the opportunity may be taken to draw attention to a number of less
obvious points revealed by the accounts, which may be helpful in forming an opinion.
From an auditor's view point, the supervisory controls exercised by the owners are generally less
reliable and hence while auditing incomplete records, auditor will largely depend on extensive
substantive procedures and obtain external evidence, physical examination/ observation,
management representation and perform analytical procedures.
6.12 AUDIT OF SUPPLIERS’ LEDGER AND DEBTORS’ LEDGER
Total and control account

A control account is a summary account in the general ledger. The details that support the balance
in the summary account are contained in a subsidiary ledger- a ledger outside of the general
ledger.
The purpose of the control account is to keep the general ledger free of details, yet have
the correct balance for the financial statements. For example, the Accounts Receivable
account in the general ledger could be a control account. If it were a control account, the
company would merely update the account with a few amounts, such as total collections
for the day, total sales on account for the day, total returns and allowances for the day, etc.
The details on each customer and each transaction would not be recorded in the Accounts
Receivable control account in the general ledger. Rather, these details of the accounts receivable
activity will be in the Accounts Receivable Subsidiary Ledger. This works well because the
employees working with the general ledger probably do not need to see the details for every sale

AUDIT AND ASSURANCE
or every collection transaction. However, the sales manager and the credit manager will need
to know detailed information on individual customers, including whether a customer recently
reduced their account balance. The company can provide these individuals with access to the
Accounts Receivable Subsidiary Ledger and can keep the general ledger free of a tremendous
amount of detail.
Two of the most common Control Accounts are Sales Ledger Control Accounts and Purchases
Ledger Control Accounts. After posting all transactions the balance of the Control Account and
the sum of the detailed records in the Subsidiary Ledger should always be the same. In other
words, a control account deals with summarized information while a subsidiary ledger deals with
detailed information. Because the control accounts contain summarized information they are also
called total accounts. Therefore a control account for a Sales Ledger can be called a Sales ledger
Control accounts or Total Debtors Account. A control account for a Purchases Ledger can be called
a Purchases Ledger Control account or a Total Creditors Account.
Significance of the balances on the control accounts

The closing balances on the sales ledger control accounts should be equal to the sum total of the
closing balances on the individual debtor accounts in the sales ledger. It follows as well that the
closing balances on the purchases ledger control accounts should be equal to the sum total of
the closing balances on the individual creditor accounts in the purchases ledger. If the respective
balances are not in agreement then it would suggest some form of irregularity in the records which
would need investigation.
Self-Balancing Accounts and Sectional Balancing Account

An organization's general ledger holds the accounting entries that describe all money coming into
or leaving a company. Keeping accounting books manually carries the risk of recording one side
of a transaction while omitting the other side of the transaction in error. Self-balanced accounting,
as set up in financial accounting software, causes one transaction to trigger the creation of an
appropriate transaction that offsets the first transaction. For example, when an accountant records
an expense entry, a self-balancing system automatically makes an offsetting entry to the company's
cash account.
Under the sectional system of balancing, accounts of individual customers or suppliers will be
posted without completing double entry; double entry being completed only in the General
Ledger in respect of Total Debtors and Total Creditors Account and other relevant accounts. For
example, individual customers are debited for sales made to them. In the General Ledger, Total
Debtors Account will be debited and Sales Account credited for credit sales. For discount allowed
to customers, they are credited. In the General Ledger, Discount Account will be debited and Total
Debtors Account credited.

Loose Leaf Ledger and Card Ledger

In modem mechanical age, besides the above-mentioned division of ledger two other ledgers i.e.
(a) Loose leaf ledger and (b) Card ledger are found in practice. In modem mechanical age with the
expansion of trade and commerce the volume of transactions has also increased to a great extent.
A lot of time and labor are required to record all these transactions.
To minimize this time and labor in accounting work various machines of accounting have been
discovered. The ledgers mentioned above are all binding ledgers. But binding ledgers are not
usable in machine. That is why loose-leaf ledger and mid card ledger have been innovated.
Loose leaf ledger: As binding ledger cannot be used in accounting machines, loose leaf ledger is
used. Every account is recorded in each loose leaf and is printed by the accounting machine. Serial
numbers are given in each leaf and are classified alphabetically and thereafter they are kept in
locked big binder.
At the time of need, any leaf can be segregated with the help of the key. In normal business
organizations two separate binders are used. In one binder current accounts are recorded and in
the other closed or dead accounts are kept.
Card ledger: It is also kept in similar way as the loose leaf ledgers are kept. In this respect card
ledger is used in time of binding ledger. One account is kept in each card and it is printed in
accounting machine. After giving serial numbers the cards are classified alphabetically. These
cards are kept in the drawer or tray in such a way so that any card can be sorted out at the time of
need. Card ledgers are frequently used in banks.
Advantages of Loose Leaf Ledger and Card Ledger

Advantages of loose leaf ledger and card leaf ledger are stated below:
• Easy presentation: It is very much easy to preserve loose leaf ledger and card ledger.
• New leaf inclusion: If ledgers are kept under this system any titled new leaf or leaves can be
included whenever necessity arises.
• Cancellation of unnecessary leaf: The pages containing dead or obsolete accounts can
be removed easily.
• Index not needed: As the pages of accounts are kept alphabetically, there does not arise any
necessity for index under this system.
• Easy handling: As the leaves of dead or close accounts are separated, the ledger becomes
lighter. Therefore, it becomes easy to handle.
• Promptness in work: Voluminous work can be completed promptly distributing ledger

leaves among various employees.

AUDIT AND ASSURANCE
• New ledger not needed: If ledgers are maintained under this system, there does not raise the
necessity of opening new ledger in every year. The same ledger can be continued by adding
new leaves.
• Easy balancing of accounts: These types of ledgers are very much suitable for those
organizations where accounting machines are used. Being cards are set up in the
machine separately, balancing of accounts becomes easier.
• Comfortable use in machine: As the ledgers are recorded in loose leaf or card, they can be
used easily in the accounting machine and accounts can be maintained nicely getting them
typed.
• Easy presentation: Any loose leaf or card can easily be sorted out and their photocopies are
presented before the court, auditors or any other authority as per their demand. This saves
the trouble of presentation of the entire ledger book.
Disadvantages of Loose Leaf and Card Ledger

Despite the above mentioned advantages, this system has the following disadvantages:
• Expensive: The use of machine under this system is very much expensive. So the small
business organizations cannot afford to follow this system.
• Expert personnel needed: Expert personnel is needed to maintain ledger properly under this
loose leaf and card ledger system. But the small business organizations are deprived of the
benefit of this system as they cannot afford to engage expert supervisors with higher salary.
• Missing possibility: As the leaves or cards are preserved loosely, any of those can easily be
removed or misplaced.
• Possibility of forgery: As the leaves or cards can easily be removed, some dishonest employees
may change any of them intentionally for committing forgery.
• Not acceptable in the eye of law: As the leaves can be replaced easily, court or any other
institutions do not trust these sorts of ledgers.
Confirmatory statements from credit customers and suppliers

Confirmatory statements from credit customers and suppliers is audit evidence obtained as a
direct written response to the auditor from a third party (the confirming party), in paper form,
or through electronic or other medium. Requesting such confirmations is a commonly used audit
procedure in an audit of financial statements. It can be useful in obtaining audit evidence about
relevant financial statement assertions regarding such items as receivables and payables, bank and
other third party deposits and liabilities, investments, inventory, guarantees, contingent liabilities,
significant transactions outside the normal course of business, and related party transactions.

Possibility of Fraud in the External Confirmation Process

External confirmation procedures may be effective in detecting fraud when used properly.
However, certain recent cases of major corporate fraud have brought into focus the importance of
being alert to:
• The circumstances in which the confirmation process is conducted;
• The characteristics of the respondent, particularly its independence, objectivity,

motivation, and authority to respond; and
• The nature of the information received.
A particular circumstance where the auditor may need to be alert to the possibility of receiving a
fraudulent response to a confirmation request is when requesting confirmation about the entity’s
assets from another entity that is both the custodian and manager of those assets. The possible
lack of proper segregation of duties over the custodial and asset management functions in such
a case may create a fraud risk factor in the confirmation process. Consequently, this situation
may need to be considered when designing the confirmation request and evaluating the results in
accordance with NSA 505.
For example, if the auditor knows the identity of an authorized individual within the custodial
function who is not involved in the asset management function, it may be possible to direct the
confirmation request to that individual.
Audit of provision for bad and doubtful debts

- check if the policy of recognizing provision for doubtful debts is reasonable;
- calculate an allowance for bad and doubtful debts very quickly;
- compute doubtful debts provision and you have not much more than a debtors ageing
report;
- check if your computation of allowance for doubtful accounts does not contain material
errors.

AUDIT AND ASSURANCE
Sample Audit Checklist

FURTHER
AREAS OF AUDIT STATUS3
INFORMATION
A. Fixed Assets
Please summarise your audit approach to:
 Verifying the completeness of property, plant equipment
and other tangible assets e.g. by vouching additions and
disposals and inter group transfers.
 Verifying the existence and ownership of: properties;
and other assets e.g. physical inspection of assets and
examination of title deeds.
 Verifying the valuation (including method of valuation) of
fixed assets.
 If any documents of title are held other than by bankers and
mortgagees, please give details and the reason why such
documents are so held.
 Is the company's policy of capitalisation and depreciation
in accordance with applicable Accounting Standards, if any,
and consistent with the previous year? If no, please provide
further details.
 Have the details of leases that should be capitalised been
reported in the financial statements. If no, please provide
further details.
 Are you satisfied that there is no permanent impairment
in the value of the company's fixed assets below the net
book amounts? Please give brief summary of verification
procedure. If no, please provide further details.
 Please give details of asset revaluations during the year
and indicate whether based on professional valuation or
director's estimate.
 Is depreciation provided on all items of Fixed Assets (other
than land) not fully written off or carried at salvage value? If
no, please provide further details.
 Are you satisfied that there are no exceptional or additional
depreciation charges, or circumstances that could warrant
such charges in the future?
 Have idle facilities been separately identified and accounting
treatment for such assets disclosed in the company's
[financial statements]? If no, please provide further details.
 Have the details of any assets which are the subject of an
instalment purchase arrangement been reported in the
financial statements or supporting data? If no, please
provide further details.
3 Put either ‘Yes’ or ‘No’ or ‘NA’ for not applicable

FURTHER
INFORMATION
 Did you encounter any difficulties in assessing the estimated
lives of fixed assets? If yes, please give details including
situations where a permanent diminution has occurred.
 Are you satisfied that costs of repairs and maintenance are
properly charged to operations and have not been carried as
an asset? If no, please provide further details
 Where the company has assets in the course of construction,
can you confirm that you are satisfied that the basis used for
capitalising interest and/or indirect expenses is appropriate.
If you are unable to confirm, please provide further details.
 Have you reviewed transactions recorded as construction
in progress and reasonably determined that there are no
amounts that should have been charged to operations? If no,
please provide further details.
B. INVESTMENTS
 Did you verify the existence and ownership of significant
investments? If no, provide details of the alternative
procedures performed.
 How have you satisfied yourself as to the valuation of
unquoted investments?
 How have you satisfied yourself as to the valuation of
quoted investments?
 Are you satisfied that there has been no other-than-
temporary impairment requiring the write-down of the
carrying amounts of any investments?
 Have investments where the company is able to exercise
significant influence over the operating and financial
policies of the investee corporation been properly accounted
for in accordance with Accounting Standards? If no, please
provide details.
 In respect to the investee corporation financial statements
that were used as a basis for current year's earnings under
the equity method of accounting:
 Did the statements cover the same period as that for the
company upon which you are reporting?
 Were the financial statements audited and an unqualified
opinion expressed? Please provide a copy of the statements.
Have you reviewed the transactions with the company's
investees and confirmed balances with them?
 Have inter company profits been eliminated before including
the company's proportionate share of operations?

AUDIT AND ASSURANCE
FURTHER
INFORMATION
 Have marketable equity securities been accounted for
in accordance with Accounting Standards, and have the
disclosures required been given in the [financial statements]?
If no, provide details.
 Have significant gains or losses on disposals, or changes
in market value, between the dates of the Statement of
Financial Position and your opinion, been disclosed in
the company's financial statements or the consolidation
accounting package? If no, provide details.
C. INTANGIBLE ASSETS
 Have goodwill and other intangible assets been appropriately
accounted for in accordance with Accounting Standards?
 Have you verified the ownership of assets, such as patents
and trademarks? If no, please provide details of the
alternative procedures performed.
 How have you satisfied yourselves that the company's
intangible assets have been appropriately tested for
impairment and their carrying values adjusted, if necessary,
in accordance with Accounting Standards If no, provide
details.
 Have all intangible assets been correctly classified and
disclosed in the financial statements? If no, provide details.
 Is the amortisation policy consistent with prior years and
reasonable with regards to residual values and useful lives?
If no, provide details.
 Are the residual values and useful lives assigned to
intangible assets reasonable with regard to the nature of the
asset and in accordance with NFRS. If no, provide details.
D. INVENTORY
 Was a physical inventory count carried out at the Statement
of Financial Position date?
 If no, please provide details of the methods used by the
company to verify inventory at the Statement of Financial
Position date and the audit procedures performed.
 If yes, was a comparison made between inventory records
and quantities counted, were differences investigated,
explained, and adjusted on the records, and did you test
such comparisons? If no, please provide details.
 Did you attend the physical inventory count(s)?
 If yes, please give details of the locations visited.

FURTHER
INFORMATION
 If no, please provide details as to how you have satisfied
yourself as to the physical quantities existing at the Statement
of Financial Position date.
 Did you satisfy yourselves, by observations during the
physical inventory count, that the company's methods were
satisfactory?
 Did you perform test counts and check the results with
final inventory listings, to establish the reliability of the
company's counting? If not, provide details of the alternative
 If the year-end inventory figures are determined wholly or in
part from perpetual inventory records, did your procedures
include:
a. Observation of cycle counts and appropriate testing?
b. Checking of test counts to the records to determine
that the records have been adjusted to agree with the
physical counts?
c. Substantiation of the quantities on hand of selected
items at year-end by physical inspection and checking
with records?
d. Determining that a proper cut-off was made?
e. Testing arithmetic accuracy and compilation of records
from receiving and delivery documents relating to the
receipt and transfer of goods?
 If not, provide details of the alternative procedures
performed.
 Were any inventories held by third parties at the Statement
of Financial Position date?
 If yes, have you obtained direct confirmation of inventories
held by third parties at the Statement of Financial Position
date, or, if material, did you observe the counting of such
inventory?
 If no confirmation obtained, provide details of the alternative
 Did you test cut-off with particular reference to sales and
purchases, work in progress transfers, and intercompany or
interdepartmental transfers?
o If not, provide details of the alternative procedures
performed.
 Have you tested the arithmetical accuracy of final inventory
figures, including computations, footings, checking from
original count sheets, and reconciliation with the general
ledger?

AUDIT AND ASSURANCE
FURTHER
INFORMATION
o If not, provide details of the alternative procedures
performed.
 Are the bases of inventory valuation (i.e., raw materials,
work in progress, and finished goods):
 Consistent with the prior year?
 In accordance with Accounting Standards?
 Have full details of these bases been supplied to us?
 If not, provide details, including the audit procedures
performed.
 Were there any areas where you have difficulty establishing
whether the value of inventory is fairly stated and in
accordance with Accounting Standards? If yes, provide
further details.
 Do costs include an appropriate proportion of manufacturing,
but not administrative or selling overhead, and is the
allocation of expense between manufacturing overhead,
administration, and selling expenses on a reasonable and
consistent basis?
 Does the inventory valuation exclude research and
development expenditure? If not, provide details, including
the audit procedures performed.
 If standard costs are used:
 Have they been updated to reflect current operations?
 Is an adjustment to “actual” made where variances appear
to require it?
 Have you tested computations from product specifications?
performed.
 If job order or process costs are used, have you tested the
build-up of costs from records of expenditure on labour,
materials, and overhead?
performed.
 Have you tested to ascertain that inventories have been
valued at the lower of cost or market?
 Market should not exceed the net realizable value (i.e.,
estimated selling price in the ordinary course of business
less reasonably predictable costs of completion and disposal)
and
 Market should not be less than net realizable value reduced
by an allowance for an approximately normal profit margin.
 Please provide details of all provisions made against
inventory, including any general provisions.

FURTHER
INFORMATION
 Have satisfactory explanations been given to you regarding
material fluctuations in rates of gross profit, inventory levels,
and differences between book and physical quantities? If not,
provide details, including the audit procedures performed.
 Are you satisfied that long term contracts related to sales/
purchase of inventory and any resulting provisions have
been properly accounted for under Accounting Standards If
not, please provide details, including the audit procedures
performed
 Are you satisfied that inventory has been correctly classified
between raw materials, work in progress and finished
goods? If no, provide further details
E. RECEIVABLES
 Are you satisfied with the procedures for cut off and have
you tested for periods just before and after year-end? If not,
provide details of alternative procedures performed.
 Have you performed an accounts receivable confirmation?
If yes, please provide a summary of the results of the
confirmation. If no, please provide details of the alternative
procedures performed to satisfy yourself as to the validity of
accounts receivable.
 If confirmation procedures were carried out at other than the
Statement of Financial Position date, please provide details
of the rollforward procedures undertaken?
 How have you satisfied yourself that the company has
a satisfactory procedure for identification, control, and
recovery of past due accounts?
 Does the company have a consistent policy of providing
allowances for uncollectible and doubtful debts, and do you
consider the provision adequate, but not excessive? If not,
provide details of alternative procedures performed.
 Have you obtained reasonable explanations of trends in the
ages of the receivables, and ratios of sales to receivables,
allowances, and bad debts? If not, provide details of
 If any receivables have arisen other than as a result of normal
operations, provide details as to how have you adequately
satisfied yourself as to their validity and collectability?
 Have you obtained third party confirmation in instances
where material amounts have been factored? If not, provide
details of alternative procedures performed.

AUDIT AND ASSURANCE
FURTHER
INFORMATION
 How have you satisfied yourself that the provision for
credits issued post year end and other write-offs is adequate
at the Statement of Financial Position date?
 Are any goods sold on approval or on a sale or return basis?
If yes, how have you satisfied yourself that these transactions
have been accounted for correctly under Accounting
Standards, including any resulting provisions.
 Have you determined through normal audit procedures
that no receivables are pledged or hypothecated except as
disclosed? If not, provide details of alternative procedures
performed.
 Have long-term loans been confirmed by the borrower? If
not, provide details of alternative procedures performed.
 If any receivables are the result of sales on instalment
agreements, have details been provided in the financial
statements.
 Have you obtained third party confirmation in instances
where material amounts have been factored?
 Have receivables and sales for goods in the hands of
customers on a contingent basis (e.g., on approval, on sale
or return) at year-end been eliminated from the receivables
and sales and has the value of such goods been included in
inventories?
 If the company bills customers before delivery the
merchandise: Have you ascertained that billings for
unshipped goods at year-end have been eliminated from
receivables and sales and has the inventory value of such
goods been included in inventories?
 In those unusual cases under "bill and hold" arrangements
with customers where title has passed to the customer for such
unshipped goods, have you ascertained that such "bill and
hold" accounting is appropriate and have been confirmed?
 Please provide details of any other receivables in the financial
statements, along with details of the audit procedures
performed.
F. CASH & BANK
 Have you obtained direct confirmation of all bank balances,
bank facilities and related guarantees and that there was
no other information contained in the bank's reply which
should be brought to our attention. If no, please provide
further details.

FURTHER
INFORMATION
 Provide details of the audit procedures performed to ensure
that bank cut-off procedures have been performed correctly.
 Have any large or unusual transfers between bank accounts,
affiliates, subsidiaries, or other unusual transactions,
occurring just before or after year-end, been adequately
explained. Please give brief summary of your verification
procedure.
 Where material cash in hand balances existed at the
Statement of Financial Position date, were such balances (or
a sample of them) were counted by you at that date. Please
give details of the locations visited and the results obtained.
If no physical counts were undertaken, please give details of
the verification work carried out.
 Please give details of any right of set-off in respect of the
company's balances with those of other members of the
group.
 Are you satisfied with daily cash balances Please explain the
reason for any unusual balance during the year
 Are you aware of any restrictions, which might limit the
company's ability to remit funds to the country in which
its parent company is registered? If yes, please give further
details.
 Are cash balances, overdrafts and loans are correctly
classified and full disclosure of any security given has also
been disclosed in the financial statements. If no, please give
further details.
 Have bank balances been verified and have other related
matters confirmed by the banks been properly reflected
in the financial statements If no, please provide details of
alternative procedures performed
G. LIABILITIES AND PROVISIONS
 How have you verified accounts payable?
 How have you satisfied yourself that there are no recorded
liabilities or provisions that are materially less than or in
excess of requirements?
 Have you made tests of un-entered invoices, cash
disbursements, and unmatched receiving reports for the
period after the Statement of Financial Position to determine
that adequate accruals were provided? If no, provide details
of alternative procedures performed.

AUDIT AND ASSURANCE
FURTHER
INFORMATION
 Have all liabilities or contingent liabilities relating to
employee benefits (e.g., termination pay, etc.) been recorded
or disclosed in the financial statements? If no, provide
further details.
 Are all material liabilities and accruals recorded disclosed in
the financial statements? If no, provide further details.
 Is the basis of deferring income in compliance with
Accounting Standards, reasonable and consistent with the
prior year? If no, provide details.
 With respect to provisions established for specified purposes,
have you ascertained that charges against those provisions
are in accordance with the intent of the account and should
not have been charged directly against income?
 Have costs associated with exit from or disposal of activities
been properly accounted for and recorded in accordance
with Accounting Standards? If no, provide details.
 If the company has received any government grants in
purchasing fixed assets, are you satisfied that no event
has occurred which could render such grants liable to
repayment? If no, please provide further details.
 Where the company has assets held under finance leases,
please give details of how such assets and the related
liabilities have been treated in the accounts.
 Please give details of any creditors which are secured and
the nature of the security.
 Please include items covered by reservation of title clauses.
 Does the client have any debt? If yes, have confirmations
been obtained from lenders for material loans? If no
confirmations have been obtained, please provide details of
alternative procedures.
 Have you agreed new debt transactions to authorizations
and cash receipts? If no, provide details of alternative
 Have you confirmed debt paid off or otherwise extinguished
during the period? If no, provide details of alternative
 If debts have been extinguished, have any resulting gains
and been properly accounted for and recorded in accordance
with Accounting Standards? If no, provide details.
 How have you satisfied yourself as to un-issued debentures,
bonds, notes, etc.?

FURTHER
INFORMATION
 Has the company complied with restrictions or covenants
imposed either by regulations or by the terms of the lending
agreements? If no, provide details of any breaches, including
any resulting action taken by the company.
 Are you satisfied that the company have not breached any
borrowing restrictions contained in their [Memorandum
and Articles of Association/other documents]? If no, please
give further details.
 Is all debt adequately disclosed in accordance with
Accounting Standards in the financial statements. If no,
provide details.
 Does the company's financial statements provide full details
of:
o Interest rates?
o Repayment terms?
o Security and guarantees?
o Restrictive covenants? If no, provide details.
 Does the company make regular provision for costs of
repairs and replacements required under the terms of any
long-term leases?
 Please provide details of any other liabilities or provisions
in the financial statements, along with details of the audit
procedures performed
H. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS
 Does the client have any derivative transactions as defined
by Accounting Standards? If yes, how have you satisfied
yourself that all derivative transactions, as defined by
Accounting Standards?, including embedded derivatives,
were identified and captured in the accounting system?
 Did you obtain-
(a) an understanding of the client’s control environment
and the specific controls surrounding derivative
transactions and
(b) any written client policy statement? If no, please provide
details of the alternative procedures performed.
(c) Are all derivatives recorded as assets or liabilities at their
fair values and has the client’s methods of valuing
derivative instruments been evaluated? If no, provide
details.
 For derivatives accounted for as hedges under Accounting
Standards, is there adequate contemporaneous
documentation and has a quarterly reassessment been
made? If no, provide details.

AUDIT AND ASSURANCE
FURTHER
INFORMATION
 Have appropriate derivative disclosures been made, as
required by Accounting Standards If no, provide details
I. INTERCOMPANY/RELATED PARTY TRANSACTIONS
 Have all group balances been shown separately within
debtors and creditors? If no, please give further details.
 Please give details of balances due from related/connected
parties that are not part of the group.
 Please give details of any right of set-off in respect of the
company's balances with those of other members of the
group.
 Are there:
o Emoluments paid or credited to directors who are also
directors of the parent company and/or;
o Capital commitments with group companies. If yes,
please give further details.
 Does the company require financial support from the
holding company or another group company to continue
trading? If yes, please confirm that you have received the
necessary confirmation of financial support in writing and
name the company giving the support.
 Is this sufficient to enable you to issue an unqualified audit
report in respect of this matter?
J. TAXATION
 Please provide copies of:
 The tax computations for the current year;
 The taxation account; and
 The reconciliation of the actual tax charge to the profit before
taxation.
 Have the tax provisions been audited by the audit
engagement team?
 If no, provide details of alternative procedures performed.
 Has adequate, but not excessive, provision been made
for taxes payable, and in particular in relation to profits,
distributions, and capital gains? If no, provide details.
 Has the company complied with regulations of the taxing
authorities that could have a material effect on its financial
statements? If no, provide details.
 Have previous years' liabilities been agreed to returns filed
with the taxing authorities?
 Have you reviewed correspondence with the taxing
authorities, returns filed with them, and payments made
during the year? If no, provide details as to the alternative
procedures performed to satisfy yourself as to the status of
taxation liabilities from prior years.

FURTHER
INFORMATION
 Is the client in dispute with the tax authorities? If yes, please
provide details, including the audit procedures performed
to ensure that all relevant items are accrued or disclosed in
the financial statements.
 Are you satisfied that deferred tax has been provided for in
accordance with Accounting Standards. Provide details of
the procedures performed, including a summary schedule
supporting the deferred tax amounts in the financial
statements.
K. SHAREHOLDER’S EQUITY
 Are the amounts and descriptions of share capital authorized,
issued, and outstanding in accordance with the legal
instruments, that regulate the company, and in accordance
with statutory requirements? If no, provide details.
 Have there been any changes in share capital in the year If
yes, were the changes:
 Properly authorized as required by regulations of the
company and by statute?
 Adequately disclosed in the [financial statements /
consolidation package]?
 Vouched by you with cash proceeds or disbursements, or
other receipts or distributions of property? If no, provide
details.
 Where an independent transfer agent keeps the company’s
share register, have you obtained confirmation of shares
issued and outstanding? If no, provide details of the
 If share capital has been issued for consideration other than
cash,
 How have you been able to satisfy yourselves that a fair
value has been attributed to the shares and that additional
paid-in capital has been appropriately treated?
 If shares or share options have been issued to employees,
have these transactions been accounted for and adequately
disclosed in accordance with Accounting Standards, as
applicable?
 Has the company complied with and disclosed in its financial
statements any restrictions imposed by the directors,
company by-laws, statute, or third parties regarding the
classification of reserves, the creation of special reserves,
or restrictions on the application of such reserves? If no,
provide details.

AUDIT AND ASSURANCE
FURTHER
INFORMATION
 Have the tax consequences of any changes in reserve
balances been appropriately treated? If no, provide details.
 With respect to special reserves set up through appropriation
of retained earnings, have you ascertained that they are still
required?
 If reserves are no longer required, provide details of the
procedures performed to ensure that this movement in
reserves has been correctly accounted for and disclosed
under Accounting Standards.
 Are there any dividends in arrears? If yes, provide details
along with the audit work performed.
 In the case of dividends accrued but not paid at the date of the
Statement of Financial Position, have you supplied us with
particulars of the dates or anticipated dates of authorization,
declaration, and payment? If no, provide details
 If applicable, have financial instruments with both
characteristics of liabilities and equity been appropriately
accounted for and disclosed in the financial statements in
accordance with Accounting Standards? If no, provide
details
L. INCOME STATEMENT
 Have you, after an analysis of the income statement accounts,
received satisfactory explanations of unusual variations as
compared to previous years and expectations? If no, provide
details of alternative procedures performed.
 Have extraordinary items or exceptional charges and credits
been disclosed in the financial statements.
 Provide details as to the procedures performed to satisfy
yourself as to the completeness and validity of the amounts
and disclosures.
 Please summarise the approach you adopted to verify the
completeness and accuracy of turnover and cost of sales.
M. PENSIONS
 Please give details of any pension schemes operated by the
company.
 Have all amounts relating to the company’s pension
scheme(s) been correctly accounted for and disclosed
in accordance with Accounting Standards? If no, please
provide further details.

FURTHER
INFORMATION
 Have you placed reliance on an actuarial valuation? If so,
provide details as to how you have verified the professional
standing of the actuary and how you have understood the
basis on which the valuation was prepared and the scope of
the work performed.
N. COMMITMENTS AND CONTINGENCIES
 Have loss contingencies been provided and/or has
appropriate disclosure been made in accordance with
Accounting Standards?
 Have you determined that contingent liabilities have
been properly accounted for and disclosed, including, for
example, the following-
 Current or imminent litigation, including written inquiry
and response from the company's legal counsel as to the
nature of the matter and the expected outcome?
 Guarantees given to third parties?
 Financial instruments (foreign exchange transactions)?
 Long-term contracts for purchases or sales?
 Product guarantees and warranties?
 Claims for back compensation by employees?
 Possible additional taxes for prior periods?
 Sale, pledge, or assignment of accounts receivable with
recourse?
 Endorsement, discount, sale, or transfer of notes, trade, or
bank acceptances?
 Employment agreements?
 Inadequacy of the company's insurance? Can you confirm
that all material capital and expense commitments disclosed
in the financial statements. If no, provide details.

AUDIT AND ASSURANCE
Question 1: Explain the guiding points for verification of assets.
Question 2: How will you verify Petty Cash Account?
Question 3: Explain the procedure to verify the Assets located at remote Branch office?
Question 4: As an auditor explain the steps to verify the following:
• Provision for Tax
• Contingent Liabilities
• Land and Building

CHAPER 7 : COMPANY AUDIT
CHAPTER 7
COMPANY AUDIT
 Understand qualification and disqualification of an auditor
 Know the procedures of appointment of auditor
 Understand power and duties of auditor

AUDIT AND ASSURANCE
7.1 GENERAL CONSIDERATIONS IN COMPANY AUDIT
These have to be determined on a consideration of:
a. Objectives of audit;
b. Various provisions in the Companies Act, 2063 (First amendment 2074), especially those
concerning accounts and audit; and
c. The scope of the report that the auditor of a company is required to make in pursuance
of the provisions contained in Section 115 of the Companies Act, 2063.
The objectives of an audit are:

i To obtain reasonable assurance about whether the financial statements as a whole are
ii To report on the financial statements, and communicate as required by the NSAs, in

accordance with the auditor’s findings.
In traditional audits, prevention and detection of error and fraud was considered as objective of
an audit. However, it is not a primary responsibility of the auditor to prevent and detect fraud.
Companies Act, 2063 (hereinafter referred to as ‘the Act’ unless otherwise mentioned) also does
not contemplate that an auditor is responsible for the detection of errors and frauds, except when
they are so material as to vitiate the opinion expressed by him that statements of account exhibit
a fair view of state of affairs.
Detection and prevention of frauds and errors were originally regarded as the main objectives of
an audit. It was because the auditor, at that time, was looked upon as the watchdog over the assets
that the business possessed as well as over its functioning in general. Such a concept of duties of
auditors has its origin in the natural distrust that exists among human beings, especially where
the course of business dealings involve several persons entrusting their monies or properties to
others. So deep rooted is this belief that whenever, on a company being wound up, a fraud or error
is discovered, even today there is a public outcry that the auditors should be held responsible for
it.
Though the broad objectives of an audit, to this day, continue to be the same as aforementioned,
the emphasis has shifted from the detection of frauds and prevention of occurrence of errors
to the verification of the statements of account. It is because in the context of present system of
management of companies, it is of greater importance that the annual statement of account should
exhibit a fair view of state of affairs of their working instead of auditor's time and energy being
devoted to tracking down petty frauds and error in accounts, which the internal audit team or staff
of the company can be entrusted to detect or guard against. The function of an audit primarily,

therefore, has come to be regarded as verification of statements of account and expressing an

opinion thereon. The expression of opinion lends credibility to financial statements.
However, while conducting the audit, the auditor is expected to bear in mind the possibility of
existence of a fraud or other irregularity in accounts. Nonetheless, Auditor is not expected to
conduct the audit with the objective of discovering all frauds or irregularities, for if that is to be
done, the audit would take an unduly long time and the cost of it would be quite out of proportion
to its benefit. The auditor is also not expected to perform duties which fall outside the scope of his
competence. For example, the professional skill required of an auditor does not include that of a
technical expert for determining physical condition of specialized assets.
Nevertheless, it is expected that the auditor would be vigilant and watchful and whenever Auditor
comes across a circumstance which arouses his suspicion, Auditor should find out whether a
fraud, or irregularity, in fact does exist and, if so, whether it is sufficiently material to necessitate
qualifications of the audit report.
The auditor, thus, is principally responsible for carrying out his duties by exercising due care and
skill in consonance with the professional standards. If, despite the fact, any fraud or irregularity in
accounts remains undetected, Auditor cannot be held liable for the failure to detect it. Moreover,
since the management is primarily responsible for safeguarding the assets and property of the
company, the auditor, while framing his audit programme, is entitled to rely upon the internal
controls in this regard instituted by the management based on a proper evaluation.
7.2 ACCOUNTS AND RECORDS OF COMPANY
a. Specific Provisions with Regards to Maintenance and Distribution of Accounts

and Financial Reports in the Companies Act, 2063
The provisions regarding the matter of books of account which a company is required to
maintain are specifically contained in Section 108 and 109 of the Act. Related provisions,
including these, are discussed below:
Section 20 - Article of Association

To achieve objective of the company stipulated in Memorandum of Association and to
operate company's affairs in smoothly manner, company is required to frame its Article of
Association and such article should include, along with matters required therein, the matters
about accounts, books of accounts and audit of the company. [Section 20 (1), (2)(t)]
Section 25 - Duplicate copies to be issued: If any shareholder or any concerned person

demands for a duplicate copy of the memorandum of association, prospectus, annual accounts
and audit or directors report or any document submitted by the company to the Company
Registrar Office, the concerned company shall be liable to provide a duplicate copy of such
document by collecting the fees prescribed in the articles of association.

AUDIT AND ASSURANCE
Provided that any person may demand for such document in the case of a public company.
Section 26 - Seal of company and its use:

(1) A company which intends to use a seal in its transactions shall make the seal in its name
in clear legible letters.
(2) The company using the seal referred to in Sub-Section (1), shall use it in any reports and
records to be submitted on its behalf, business letters to be used in its name, statements
of accounts, bills, invoices, requisition order forms, notices and official publications,
negotiable instruments, bills of exchange, promissory notes, and official documents
signed or issued on its behalf.
Section 84 - Providing abstract of financial statements to shareholders:

(1) Notwithstanding anything contained elsewhere in the Act, a company listed in the stock
exchange shall not be required to send the annual financial statements and director’s
report to its shareholders or debenture-holders
Provided that an abstract of financial statements prepared pursuant to Sub-Sections (2)

and (3) is sent to every shareholder along with the notice of annual general meeting.
(2) The abstract shall be prepared on the basis of the annual financial statements of the
company and the director’s report. The format of such statements shall be specified by
the Company Registrar Office based on the suggestions of the competent institutional
body authorized to prescribe accounting standards under the prevailing law.
(3) The abstract of financial statements shall contain, inter alia, the flowing matters:
(a) Matter indicating that the abstract details are only an abstract of the annual financial
statements of the company and their director’s report,
(b) An opinion of the company’s auditor as to whether or not the abstract of annual
financial statements is in consonance with the annual financial statements of the
company and the director’s report and whether or not the abstract is consistent
with the format specified pursuant to this Section,
(c) Matter as to whether or not the auditor has made any remarks about the annual
financial statements of the company and, if such remarks have been made, full
details of such remarks and such materials required to understand such remarks,
(d) In cases where the auditor has mentioned in his report anything about the inadequacy
of the accounts and accounting returns or about the company’s accounts not being
verifiable with the records and returns maintained by the company or about the
non-receipt of any such information and explanation as sought, full details thereof.
(4) Instead of sending the abstract of annual financial statements to the shareholders at their
personal addresses pursuant to Sub-Section (1), the company may publish it along with
the notice of meeting, at least twice in a national daily newspaper.

(5) In the event of publication of the abstract of annual financial statements pursuant to
Sub-Section (4), it shall not be required to send the abstract at the personal addresses of
shareholders.
Section 108 Accounts of company:

1. Every company shall duly maintain its books of accounts in Nepali or English language.
2. The books to be maintained under Sub-Section (1) shall be maintained according to the
double entry system of accounting and in consonance with the accounting standards
enforced by the competent body under the prevailing law and with such other terms and
provisions required to be observed pursuant to this Act, in such a manner as to clearly
reflect the actual affairs of the company.
3. The books of account of a company shall not be kept at any place other than its registered
office, except with the approval of the Company Registrar Office.
4. The cash balance of a company, other than the amount specified by the board of directors,
shall be deposited in a bank and transaction shall be done through the bank.
5. Subject to the provisions contained in this Chapter, the directors or other officers shall
have the final responsibility to maintain books of account and records of the company.
6. Where there is a default in complying with the provisions made in this Act in respect of
the preparation of books of account and annual financial statements of a company, the
director or officer him/herself, during whose tenure the annual financial statements and
other reports have been prepared, shall be responsible under this Act.
Section 109 Annual financial statements and report of board of directors:

(1) The following annual financial statements shall be prepared by the board of directors
of a public company every year, at least thirty days prior to the holding of its annual
general meeting, and in the case of a private company, within six months of the expiry of
its financial year:
(a) Statement of Financial Position as at the last date of the financial year.
(b) Statement of Profit or Loss of the financial year.
(c) Statement of cash flow of the financial year.
(2) The annual financial statement prepared pursuant to Sub-Section (1) shall give true and
fair view of the state of affairs of the company as at the last day of the financial year
concerned and also state the account of profit and loss and description of cash flow
made in that financial year. Such financial statements shall be prepared in the format
prescribed by the prevailing law.
(3) The annual financial statements as referred to in Sub-Section (1) shall have to be audited
and approved by the board of directors.

AUDIT AND ASSURANCE
(4) The board of directors of every public company and every private company with the
paid –up capital of ten million rupees or above or with an annual turnover of hundred
million rupees or above shall also prepare, in addition to the annual financial statements
required to be prepared pursuant to Sub-Section (1), a separate report related to that
period stating the following matters,:
(a) Review of the transactions of the related financial year;

(b) Impacts, if any, caused on the transactions of the company from national and
international situation;
(c) Achievements in the current year as at the date of report and opinions of the board
of directors on matters to be done in the future;
(d) Industrial or professional relations of the company;
(e) Alterations in the board of directors and the reasons therefore;
(f) Major things affecting the transactions;
(g) Comments of the board of directors on any remarks in the audit report;
(h) Amount recommended for payment by way of dividend (Proposed Dividend);
(i) In the event of forfeiture of shares, details regarding the number of forfeited shares,
face value of such shares, total amount received by the company for such shares
prior to the forfeiture thereof, proceeds of sale of such shares after the forfeiture
thereof, and refund of amount ,if any, made for such forfeited shares;
(j) Progress of transactions of the company and of its subsidiary company in the
previous financial year and review of the situation existing at the end of the related
financial year;
(k) Major transactions completed by the company and its subsidiary company in the
current financial year and any material changes taken place in the transactions of
the company during that period;
(l) Disclosures made by the substantial shareholders of the company to the company in
the related financial year;
(m) Details of shareholding by the directors and officers of the company at the financial
year and, in the event of their involvement in share transaction of the company,
details of information received by the company from them;
(n) Disclosures about the personal interest of any director and his/her close relative in
any agreements related with the company during the related financial year;
(o) In the event that the company has bought its own shares (buy-back), the reasons
for such buy-back, number and face value of such shares, and amount paid by the
company for such buy-back;

(p) Whether there is an internal control system in place or not; and details of such
system, if it is in place;
(q) Details of total management expenses during the related financial year;
(r) Name-list of the members of audit committee, remuneration, allowances and

facilities received by them, details of the functions performed by that committee,
and details of suggestions, if any, made by that committee;
(s) Amount, if any, outstanding and payable to the company by any director, managing
director, chief executive, substantial shareholder or his/her close relative or by any
firm company, corporate body in which he/she is involved;
(t) Amount of remuneration, allowances and facilities paid to the director, managing
director, chief executive and officer;
(u) Amount of unclaimed dividends;
(v) Details of sale and purchase of properties pursuant to Section 141;
(w) Details of transactions carried on between the associated companies pursuant to

Section 175;
(x) Any other matters required to be set out in the report of board of directors under
this Act and the prevailing law;
(y) Other necessary matters.
(5) While preparing the annual financial statements pursuant to Sub-Section (1), such
statement shall also contain, in the case of the year of incorporation of the company,
the accounts from the date of its incorporation to the last day of that financial year, and
thereafter, the accounts of the previous financial year.
(6) The annual financial statements prepared pursuant to this Section shall be kept open for
inspection by any shareholder, if he/she so desires.
(7) The annual financial statements and the report of board of directors prepared pursuant
to this Section shall be approved by the board of directors and signed by the Chairperson
of the board of directors and at by at least one director.
(8) The books of accounts and annual financial statements prepared by a company pursuant
to this Chapter shall be kept safely for at least five years after the end of financial year.
(9) The officers who prepare any false annual financial statements, reports of board of
directors and other returns and reports required to be prepared pursuant to this Act and
the directors who approve the same shall be liable to punishment under this Act.

AUDIT AND ASSURANCE
b. Specific Provisions with Regards to Audit and Auditors in the Companies

Act, 2063
Chapter 8 of the Companies Act, 2063 specifies the provisions, inter alia, related to appointment
and disqualification of auditors.
Section 110 - Company to appoint auditor:

(1) Every company shall appoint an auditor under this Act to have its accounts audited.
(2) In cases where any company has a branch office outside Nepal, the auditor appointed
pursuant to Sub-Section (1) may also audit the accounts of that branch office except
as otherwise provide in the prevailing law of the country where such branch office is
situated.
Section 111 - Appointment of auditor:

(1) The auditor of accompany shall be appointed, from amongst the auditors licensed to
carry out audit under the prevailing law, by the general meeting, subject to Chapter-18
in the case of a public company, and, in accordance with the provision as contained in
the memorandum of association, articles of association or consensus agreement, if any
failing such provision, by the general meeting in the case of a private company; and his/
her name shall be forwarded to the Company Registrar Office within fifteen days from
the date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the
holding of the first annual general meeting,
(2) The auditor appointed pursuant to Sub-Section (1) shall hold office only until the next
annual general meeting.
(3) No auditor or his/her partner or ex-partner or employee or ex-employee shall be

appointed as auditor for more than three consecutive terms to perform the audit of a
public company.
Provided, however, that this restriction shall not apply to any partner who ended partnership
or any employee who left the service of such auditor three years before.
Section 112 - Disqualifications of auditor:

(1) None of the following persons or the firms or companies in which such persons are
partners shall be qualified for appointment as auditor and shall, despite appointment as
auditor, continue to hold office:
(a) Any director, any advisor appointed with entitlement to regular remuneration or
cash benefit, any person or employee or worker involved in the management of the
company or a partner of any of them and/or employee of any of such partners or a
close relative of a director or partner, and/or employee of such relative;

(b) A debtor who has borrowed money from the company in any manner, or a person
who has failed to pay any dues payable to the company within the time limit and is
in such arrears or close relative of such person;
(c) A person who has been sentenced to punishment for an offense pertaining to audit
and a period of three years has not elapsed thereafter;
(d) A person who has been declared insolvent;
(e) A substantial shareholder of the company or a shareholder holding one percent or

more of the paid up capital of the company or his close relative;
(f) A person who has been sentenced to punishment for an offense of corruption, fraud
or a criminal offense involving moral turpitude and a period of five years has not
elapsed thereafter;
(g) A person referred to in Sub-Section (3) of Section 111;
(h) In the case of a public company, any person who works, whether full time or
part time, for any governmental body or anybody owned fully or partly by the
Government of Nepal or any other company or a partner of such person or a person
who is working as an employee of such partner or a person who is authorized to
sign any documents or reports to be prepared by the management of the company;
(i) A company or corporate body with limited liability;
(j) A person having interest in any transaction with the company or his/her close
relative or a director, officer or substantial shareholder of another company
having any interest in any transaction with the company.
(2) The auditor shall, prior to his/her appointment, give information in writing to the
company that he/she is not disqualified pursuant to Sub-Section(1).
(3) Where any auditor becomes disqualified to audit the accounts of a company or there
arises a situation where he/she becomes disqualified for appointment or can no longer
continue to act as an auditor of the company, he/she shall immediately stop performing
audit which is required to be performed or is being performed by him/her and give
information thereof to the company in writing.
(4) An audit performed by an auditor who has been appointed in contravention of this
Section shall be invalid.
Section 113 - Power of Office to appoint auditor: Where the annual general meeting of a
company fails to appoint an auditor for any reason or where the annual general meeting itself
cannot be held or where the auditor appointed pursuant to this Act ceases to continue his/
her office for any reason, the Company Registrar Office may, at the request of the board of
directors of the company, appoint another auditor.

AUDIT AND ASSURANCE
Section 114 - Accounts and records to be furnished: The books of accounts and records of a
company shall be furnished to the auditor on his/her demand, at any time during office hours
for the purposes of audit; and the concerned director or employee shall also forthwith give
oral explanations on such matter as may be asked by him/her, within a reasonable period of
time.
Section 115 - Functions and duties of auditor:

(1) The auditor shall submit his/her report to the company, addressing to the shareholders
or the appointing authority, certifying the Statement of Financial Position, Statement
of Profit or Loss and cash flow statement based on the books of account, records and
accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall
disclose the matters to be set out prescribed under this Act.
(3) The audit report as referred to in Sub-Section (2) shall also indicate the following matters,
inter alia:
(a) Whether such information and explanations have been made available as required
for the completion of audit;
(b) Whether the books of account as required by this Act have been properly maintained
by the company in a manner to reflect the real affairs of its business;
(c) Whether the Statement of Financial Position, Statement of Profit or Loss and cash
flow statements received have been prepared in compliance with the accounting
standards prescribed under the prevailing law and whether such statements are in
agreement with the books of account maintained by the company;
(d) Whether, in the opinion of the auditor based on the explanations and information
made available in the course of auditing, the present balance sheet properly reflects
the financial situation of the company, and the Statement of Profit or Loss and cash
flow statement for the year ended on the same date properly reflect the profit and
loss, cash flow of the company, respectively;
(e) Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any loss
or damage to the company or not;
(f) Whether any accounting fraud has been committed in the company
(g) Suggestion, if any.

Section 116- Audit report to bear auditor’s signature:

(1) An audit report, prepared by the auditor appointed by any company under this Act,
shall be signed and dated by the auditor him/herself.
(2) Whether any company has appointed any accounting institution licensed under the
prevailing law to carry out audit, the member who has been authorized by decision of
the partners of a such institution shall sign and date the audit report.
Section 117- Information to be provided: The Company shall, subject to the provisions
contained in this Act, send a copy of the report made by the auditor to the shareholders.
Whether there is a provision of formal trade union in such company, the company shall, at the
request in writing of such trade union, provide one copy of such report to that trade union.
Section 118- Remuneration of auditor: The remuneration of an auditor shall be as prescribed

by the appointing authority; and such remuneration shall be borne by the company.
Section 119- Provision relating to removal of appointed auditor:

(1) No auditor appointed pursuant to this Chapter shall be removed pending the completion
of audit of accounts of any financial year for which he/she was appointed as the auditor.
(2) Notwithstanding anything contained in Sub-Section (1) , if any auditor breaches the code
of conduct of auditors or does any act against the interest of the company which has
appointed him as the auditor or commits any act contrary to the prevailing law, such
auditor may be removed through the same process whereby he/she was appointed as
auditor, by giving prior information to the Institute of Chartered Accountants of Nepal,
and with the approval of the regulatory authority, if any authorized by the prevailing
law for the regulation of business of the company concerned, and failing such authority,
with the approval of the Company Registrar Office.
(3) While removing an auditor pursuant to Sub-Section (2), the auditor shall be provided
with a reasonable opportunity to defend him/herself.
Section 160 - Punishment with fine not exceeding fifty thousand rupees or with
imprisonment for a term not exceeding two years or with both: Under this provision,
auditor if commits the following offense shall be punished with a fine from twenty thousand
rupees to fifty thousand rupees or with imprisonment for a term not exceeding two years or
with both punishments:
• where the auditor of a company states a false matter in his/her report in the course of
carrying out his/her duty or omits necessary comments while making audit, with mala
fide intention or malicious recklessness, such auditor;
• An auditor who knowingly carries out auditing of the concerned company even after
that he/she is not qualified to carry out auditing of any company;

AUDIT AND ASSURANCE
Section 161- Punishment with fine not exceeding fifty thousand rupees: Under this provision,
auditor if commits the following offense shall be punished with a fine not exceeding fifty
thousand rupees:
• An auditor who does not present a report as specified in the Act;
• An company, director, auditor, officer and employee who violate the provision contained
in Chapter-18 Audit Committee or who fail to fulfill the duty and obligations specified in
that Chapter;
7.3 AUDIT OF SHARE CAPITAL AND TRANSFER OF SHARES
a. Audit of Share Capital

Almost the first function of a company is to raise capital. Section 11 of the Companies Act,2063
provides that paid up capital of public company shall be a minimum of ten million rupees,
except as otherwise provided in the prevailing law or in a notification by the Government
of Nepal in the Nepal Gazette that the paid up capital of any particular company shall be in
excess of the said required minimum. Section 27 of the Act provides that face value of shares
of a private company shall be as specified in its articles of association and the face value of
shares of a public company shall be fifty rupees per share or shall be equivalent to such amount
exceeding fifty rupees as is divisible by the figure ten, as provided in the memorandum of
association and articles of association. This however has been made redundant by the Section
42 of Securities Registration and Issuance Regulation, 2073 and face value of share is kept at
hundred rupees.
Section 28 - Allotment of Shares:

(1) Where a public company invites the general public to apply for the subscription of
its shares, it shall allot the shares and give the shareholders a notice in the format as
prescribed, within a maximum period of three months after the date of closure of share
issuance.
Provided that in cases where at least fifty percent of the total shares issued publicly
cannot be sold failing a underwriting agreement on the subscription of at least fifty
percent of the publicly issued shares, no shares shall be allotted.
(2) If the company makes an application, explaining the reasons for failure to allot shares
within the time-limit set forth in Sub-Section(1), owing to the circumstance mentioned in
the proviso to that Sub-Section within seven days after the expiration of that time-limit,
the Company Registrar Office may extend the time limit for up to three months for the
allotment of shares. If the shares cannot be allotted even within such extended time limit,
the company may allot such shares through negotiations or any other methods.

(3) If the allotment of shares cannot be made even within the time -limit as referred above,
the amount received for the subscription of shares as well as an interest thereon, as
prescribed, from the day of expiration of such time-limit to the day of refund of such
amount shall be refunded.
(4) If the funds are insufficient to refund the amount required to be refunded pursuant
to Sub-Section (3), the shortfall amount shall be borne by the promoters and directors
personally.
Section 29 - Issue of share at Premium:

(1) Listed public companies can issue shares at premium. But unlisted public companies
or private companies can issue shares at premium through their general meeting only
when their net worth exceed their total liabilities.
(2) Where the shares are sold at a premium pursuant to above, a sum in excess of the face
value, out of the proceeds thereof, shall be deposited in a premium account.
(3) The company may use the moneys in the account as referred to above in the following
acts:
 Paying up unissued share capital to be issued to the shareholders as fully paid

bonus shares,
 Providing for the premium payable on redemption of any redeemable preference

shares,
 Writing off the preliminary expenses made by the company,
 Bearing or reimbursing the expenses of, or the commission paid or discount allowed
on, any issue of shares of the company.
Section 30 - Shares with different rights:

(1) The company may, by making provisions to that effect in its memorandum of association
and articles of association, issue various classes of shares with different rights attached
thereto.
(2) Except as otherwise provided in the articles of association of a company, approval of the
shareholders of any particular class shall be required to make any alteration in the rights
of those shareholders of that class. However, no alteration may be made in the rights of
the shareholders of any particular class to adversely affect the rights of the shareholders
of any other class.
(3) If the shareholders representing at least ten percent share of any particular class who
are not satisfied with a decision to make alteration in the rights attached to the shares of
that class pursuant to above file a petition in the court to have the decision to make such
alteration void, the decision made to make alteration in the rights of the shareholders

AUDIT AND ASSURANCE
of such class shall not be enforced unless and until otherwise decided or ordered by the
court.
(4) A petition shall be made pursuant to Sub-section (3) within thirty days after the decision
made to make alteration in the rights attached to the shares of any particular class; and
any decision as referred to in Sub-section(2) shall not be enforced pending the expiration
of that time limit.
(5) If it appears that alteration in the rights conferred to the shareholders of the class
concerned is prejudicial to the rights of the petitioner shareholders, the court may quash
the decision made on the alteration in the rights of the shareholders of that class.
(6) The board of directors shall submit a proposed resolution on the alteration in the rights
of the shareholders of any particular class pursuant to Sub-Section (2) to the general
meeting of the shareholders of the concerned class; and such resolution has to be adopted
as a special resolution by the general meeting.
(7) Notwithstanding anything contained elsewhere in this Section, in privatizing a company

fully or partly owned by the Government of Nepal, as a shareholder, in accordance
with the prevailing law on privatization, the Government of Nepal may have special
voting right in making decision on the following matters, as provided in the articles of
association, so long as the investment to the Government of Nepal is retained in such
company:
 In making decision on a resolution to relinquish the title to an undertaking pursuant

to clause (a) of Sub-Section (1) of Section 105,
 In making decision on voluntary liquidation of the company,
 In making decision to amalgamate the company into another company.
Section 31 – Return of Shares to be filed with Company Registrar Office:

(1) A company shall file with the Office a return of allotments stating the number of shares
issued and allotted, total amount of the shares, the names and addresses of the allotters,
and the amount paid or due and payable on each share, within thirty days after the
allotment of shares.
(2) If any shares have been allotted as fully or partly paid up otherwise than in cash, the
company shall file with the Company Registrar Office a deed constituting the title of
the allotter to the shares together with any contract of sale or a contract for services or
other consideration in respect of which that allotment was made, and a return stating the
number and nominal amount of shares so allotted and the extent to which they are to be
treated as paid- up.

Section 32: Dealing in Securities:

(1) While issuing its securities to the general public, a public company shall deal in the
securities only through a securities dealer recognized to perform securities related
transactions including all acts such as the sale, allotment and recovery of amounts of
such securities.
(2) A public company shall file with the Company Registrar Office a copy of an agreement
made by it on the dealing of securities through any body, within seven days after the
date of making of such agreement.
Section 33: Share Certificate:

(1) A share certificate in the prescribed format shall be issued to every shareholder in respect
of each share subscribed by him/her, within two months after the allotment of shares; the
share certificate shall bear the signature of any two out of a director or chief executive of
the company or the company secretary, in the case of a public company, and the signature
of the person as mentioned in the articles of association or consensus agreement, in the case
of a private company, and also bear the seal of the company, if any.
(2) While issuing a share certificate in respect of any shares held jointly by two or more
persons, the share certificate may be issued to any one of them, by mentioning their
names in the certificate. However, the names of all shareholders shall be mentioned in
the shareholder register.
(3) If a share certificate is lost or destroyed because of a divine act or otherwise, the shareholder
shall give information thereof to the registered office the company immediately when
he/she knows that the share certificate has been so lost or destroyed because of the
divine act or otherwise.
(4) If any application made pursuant to Sub-Section (3), the company shall, if the matter
contained in the application seems to be reasonable after inquiring into all necessary
matters relating thereto, issue another share certificate to the applicant, by collecting
the duplicate fees for duplicate copy as prescribed in the articles of association; and this
matter shall also be recorded in the shareholder register.
(5) Notwithstanding anything contained elsewhere in this Section, if a listed company has
caused a register to be maintained, pursuant to Sub-Section (6) of Section 46, by the
securities registrar authorized to provide securities deposit service under the prevailing
law, provision may be made to issue to the shareholder a securities deposit passbook or
any other certificate certifying him/her to be a shareholder, instead of a share certificate.
(6) A certificate issued by a company, signed by its competent officer and under the seal of
the company, if any, to be used by it, specifying the number of shares or debentures held
by any shareholder or debenture-holder shall be prima facie evidence of his/her title to
such shares or debentures.

AUDIT AND ASSURANCE
(7) If any company allots any shares or debentures or transfers such shares or debentures
to a representative of a body licensed under the prevailing law to carry on securities
dealings, the provision of Sub-Section(1) shall not apply to such shares or debentures.
Section 57 - Reduction of share capital:

(1) If a company intends to reduce its share capital , it may, by adopting a special resolution
to that effect at its general meeting, reduce its share capital by obtaining approval of
the Court and making necessary amendment to or alteration in the memorandum of
association and articles of association, accordingly.
(2) On receipt of approval of the Court as above, the company may reduce its share capital
as follows:
 By reducing the capital to such amount as has been paid up where calls for payment
of amount on shares are not fully paid up,
 By paying back any paid-up share capital,
 By devaluating the face value of shares where the company has sustained a big loss
or suffered a natural calamity.
(3) However, a company which has already become insolvent in accordance with the
prevailing law shall not reduce its capital pursuant to this Section.
Section 58 - Procedure for obtaining approval of Court to reduce share capital:

(1) Where a company has adopted a special resolution for reducing its share capital pursuant
to Section 57, it shall make a petition to the Court for an order confirming the reduction.
(2) Where a petition is made pursuant to Sub-Section (1), the concerned company shall,
prior to the hearing of such petition, publish a public notice in a daily newspaper of
national circulation for at least three times, setting out the venue and date of hearing on
the reduction of share capital of the company.
(3) Every person who is entitled to any debt or claim under the prevailing law at the time of
commencement of the winding up or insolvency of a company shall be entitled to submit
his claim and objection to the reduction of share capital of the company.
(4) The director or company secretary of a company shall, as ordered by the Court, submit
to the Court a real and true list of creditors of the company, if any, setting out, inter
alias, their names, addresses and amount of debt repayable to each of them, at the
commencement of hearing of the petition for reducing the capital of the company.
(5) Irrespective of whether the creditors whose debts are yet to be discharged or determined,
out of the creditors whose names are entered on the list submitted, do or do not consent
to the reduction of capital in the case where the company admits the full amount of
the debts or claims made by the creditors, or though not admitting it, agrees to make

provision of moneys required to pay such amount and makes required provision for the
same by executing a bond undertaking to pay the full amount within a certain date, then
the Court may issue order confirming the reduction of the share capital .
(6) In taking action for approval on a proposed reduction of share capital which involves
either the diminution of any liability in respect of unpaid share capital or paying back to
any shareholder of any amount paid for shares, the Court may, if, having regard to the
circumstances and available evidence, direct that the provisions of Sub-Section (3) or (4)
shall not apply to any specific creditor.
(7) If the list of creditors submitted pursuant to Sub-Section (4) is found to contain any false
statement or omission, the director of the company who submits such list and the officer
who signs such list shall be liable to punishment under this Act.
Provided, however, that if the officer who signs such list proves that any omission or
mistake was made without his/her knowledge or immediately when he/she knew such
omission or mistake, Auditor gave information to the Court for the rectification of such
omission or mistake, prior to the making of an order by the Court under this Section or
Auditor exercised all reasonable care to avoid such omission or mistake, Auditor shall
not be liable to that punishment.
(8) If the Court is satisfied, with respect to the creditors who under Sub-Section (1) are
entitled to object to the resolution on reduction of capital, that either their consent to the
reduction has been obtained or their debts or claim have been discharged or have been
determined and are at the state of discharge, or have been secured, it may make an order
confirming the reduction, specifying appropriate alters and conditions.
(9) Where the Court makes an order pursuant to Sub-Section (8), it may order directing that
the concerned company, of which resolution to reduce capital has been co confirmed,
shall, for a specified periods, add to its names the last words thereof the words "capital
reduced" and publish necessary notice with a view to giving information to the general
public about the reasons and causes for such reduction and other important information
in regard thereto.
(10) Where a company is ordered to add to its name the words "capital reduced" pursuant
to Sub-Section (9), those words shall, until the expiration of the period specified by the
Court be deemed to be an integral part of the name of the company.
(11) The contents of the terms contained in an order issued by the Court, pursuant to this
Section, in the course of confirming a resolution for the reduction of capital shall be
deemed to have ipso facto been incorporated in the memorandum of association and
articles of association of the company; and the memorandum of association and articles
of association shall be deemed to have been amended to that extent.

AUDIT AND ASSURANCE
(12) Any director who knowingly conceals, hides or holds back the name of any creditor
who, under this Section, is entitled to object to the resolution for reducing capital or
knowingly prepares or submits a false statement on the amount of loan or clam or
liability or conceals, hides or holds back such loan or liability or prepares or causes to
prepare a false statement or any officer or employee of the company who abets to such
act shall be liable to punishment under this Act.
(13) Where the share capital of a company is reduced pursuant to this Section, the director or
company secretary of that company shall mention and authenticate that matter in each
share certificate issued by such company.
Section 59 - Liability of shareholders in respect of reduced share capital:

(1) Except as otherwise provided for in this Section, a shareholder of the company, past or
present, shall not be liable, in respect of any share mentioned in the order issue by the Court
confirming the reduction of share capital, to pay any amount exceeding the difference
between the amount actually paid on the share or the reduced amount, if any, which is
deemed to have been paid thereon, as the case may be, and the fixed amount of such share.
Provided that where the list of creditors entitled to object to the reduction of share
capital submitted to the Court omits any such creditor and, after an order confirming the
reduction of capital of the company has been made, the company is unable to pay the
amount of debt of such creditor, the shareholder of the company shall be bound to pay
the amount as mentioned in Sub-Section (3) or (4).
(2) Notwithstanding anything contained in the proviso to Subsection (1), where the List
submitted to the Court omits the name or any claim of a creditor because of a fault or
negligence of his own, the shareholders shall not be bound to pay such amount.
(3) A person who was a shareholder of a company at the date of issue by the Court of an
order confirming the resolution for reducing the capital of the company shall be liable
to pay an amount not exceeding the amount which he would have been liable to pay if
the company had undergone insolvency and commenced insolvency proceedings on the
day immediately before the said date.
(4) If a company is insolvent, and where an application is made by a creditor whose name is
said to be omitted from the list of creditors submitted to the Court , along with the proof
of omission of his name, the Court may, if it thinks fit, settle a list of shareholders who
are liable to pay to the company the amount required for the repayment of loan of such
creditor and issue an order to make calls on shares held by the shareholders settled on
such list as if they were ordinary contributors in an insolvency process of the company.
(5) Notwithstanding anything contained elsewhere in this Section, no shareholder shall be

liable to pay an amount in excess of the face value of a share at the time of the subscription
of such share by him.

Section 61 - Prohibition on purchase by company of its own shares:

(1) No company shall purchase its own shares (buy-back) or lend money against security of
its own shares.
(2) Notwithstanding anything contained in Sub-Section (1), in the following circumstances,

a company may buy back its shares out of its free reserves available for being distributed
as dividends, by giving information to the Office:
a. Where the shares issued by the company are fully paid up;
b. Where the shares issued by a public company have been listed in the Securities
Board;
c. Where the buy-back of shares is authorized by the articles of association of the

concerned company;
d. Where a special resolution has been adopted at the general meeting of the concerned
company authorizing the buy-back;
e. Where the ratio of the debt owed by the company is not more than twice the capital
and general reserve fund after buy-back of shares;
Explanation: For the purposes of this Clause, "debt" means all amounts of secured
or unsecured debts borrowed by a company.
f. Where the value of shares to be bought back by a company is not more than twenty
percent of the total paid up capital and general reserve fund of that company;
g. Where the buy-back of shares is not in contravention of the directives issued by the
Company Registrar Office in this respect.
(3) A resolution to be presented at the general meeting pursuant to Clause (d) of Sub-Section
(2) shall state the following matters:
a. The reason and necessity for the buy-back of shares;
b. A statement of the evaluation of possible impacts of the financial situation of the

concerned as a result of the buy-back of shares,
c. The class and number of shares intended to be bought back;
d. The maximum or minimum amount required to buy back shares as referred to in

Clause (c) and financial source of such amount;
e. The time limit for the buy-back of shares;
f. The mode of the buy-back of shares;
g. Such other necessary matters as specified by the Office and as required to be

disclosed under the prevailing law, in respect of the buy-back of shares.

AUDIT AND ASSURANCE
(4) Where a special resolution as referred to in Sub-Section (3) is adopted by the general
meeting, the concerned company may buy back its shares in any of the following
manners within a period of twelve months of the adoption of that resolution:
a) Purchasing from the stock exchange;
b) Purchasing from the concerned employee of the company the shares allotted to
him/her,
c) Purchasing from the existing shareholders on a proportionate basis.
(5) Where a company buys back its own shares pursuant to Sub-Section (4), it shall file with
the Company Registrar Office a return containing the number of shares bought back,
amount paid for the same and other necessary details within thirty days of the date of
such buy-back.
(6) There shall be established a separate capital redemption reserve fund, to which a sum
equal to the nominal value of the shares bought back pursuant to Sub-Section (4) shall
be transferred; and the amount of such fund shall be maintained as if it were the paid-up
capital .
(7) Where a company buys back its shares pursuant to Sub Section (4),it shall cancel the
shares so bought back within one hundreds twenty days of the date of such buy-back .
(8) Once a company buys back any class of shares pursuant to this Section, the company
shall not re-issue the shares of that class prior to the expiration of two years after such
buy-back, except for the issue of bonus shares or payment of its liability.
(9) Notwithstanding anything contained elsewhere in this Section, no public company shall
buy back its shares in a manner that such minimum number of shareholders or minimum
paid-up capital as required to be maintained by that company becomes less or lower.
(10) Other conditions where a company cannot buy back its shares and other terms required
to be complied with in the buying back of its shares shall be as prescribed.
Shares Transfer Audit

Frequently, big companies require auditors to undertake audit of share transfer recorded by
the company during the previous year. The objective of such an audit is detection of mistakes
in the registration of transfers which may have the effect of saddling the company with the
liability for damages claimed by a shareholder on account of losses suffered in consequence
thereof. The various steps which are considered necessary for carrying out such an audit are
given below:
1. Ascertain whether notices were sent in every case to the transferors and, in case of joint-
holders, to each of the holders and the objections, if any, raised by them were taken into
consideration before the transfers were registered.

2. Verify that in the case of partly paid shares, where the application for registration was
made by the transferor, a notice invariably was sent to the transferee and the transfer was
registered only when "no objection" had been received from him, within prescribed time
from service of notice on him.
Section 64 - Prohibition on issue or sale of shares at a discount:

(1) A company shall not issue or sell its shares at a discount.
(2) Notwithstanding anything contained in Sub-Section(1), a company may, on the

following conditions, issue or sell shares at a discount by adopting a special resolution
at the general meeting to that effect, not being less than the percentage specified in that
resolution:
(a) In issuing or selling shares pursuant to a capital restructuring scheme of the

company,
(b) In issuing or selling shares pursuant to a scheme of converting loans borrowed by

the company into shares with the consent of creditors;
(c) In issuing or selling shares pursuant to an employee share scheme;
(d) In issuing shares on such other conditions as approved by the Company Registrar
Office.
Section 65 - Issue of Preference shares:

(1) A company may issue preference shares as provided for in this Act, memorandum of
association or articles of association.
(2) Except as provided in the articles of association, no shares issued pursuant to Sub-Section
(1) shall be converted into ordinary shares.
(3) In issuing preference shares pursuant to Sub-Section (1), the following maters, inter alia,
shall be disclosed:
a. Whether preference is given to receive dividends against ordinary shares;
b. Percentage of dividends receivable by preference shareholders;
c. Whether dividends get cumulated every year (cumulative) or profits are distributed
only in a year wherein profit is made(non-cumulative);
d. Whether preference is given while paying amount of share in the event of liquidation
of company;
e. Whether voting right is attached there to; and if voting right is attached, whether
such right is available only in the case of preference share or also in other matters;

AUDIT AND ASSURANCE
f. Whether voting right is available also in other matters pursuant to Clause (e) , the
proportion to which such right is exercisable;
g. Whether preference shares can be converted into ordinary shares;
h. Whether the amount of preference shares can be redeemed (redeemable ) or cannot
be redeemed (irredeemable) after a certain period;
i. Whether, in redeeming preference shares, premium is payable on redemption.
(4) Where any redeemable shares are issued, the shares shall not be redeemed unless they
are fully paid.
(5) No amount of preference shares shall be redeemed except out of profits which would
otherwise be available for dividend or out of the proceeds of a fresh issue of shares made
by the company for the purposes of the redemption.
(6) Where a premium is payable on the redemption of any redeemable preference shares,
there shall be provided for a separate fund out of the profits of the company or out of the
company's shares premium account, for the purposes of redemption of such shares.
(7) Except in cases where any redeemable preference shares are redeemed out of the proceeds
of a fresh issue of shares pursuant to sun-Section (5), while redeeming preference shares
pursuant to this Act, a capital redemption reserve account shall be established and a sum
equal to the nominal amount of the shares redeemed shall be transferred to that account,
out of profits which would otherwise have been available for dividend.
(8) The capital redemption reserve account established pursuant to Sub-Section (7) shall be
maintained as if it were the paid -up capital.
(9) After the completion of the redemption of any preference shares redeemed pursuant to
this Section, such shares shall be deemed to have, ipso facto, been cancelled.
(10) A company shall while redeeming any preference shares, follow such terms and
procedures as provided by the articles of association of the company, subject to this
Section; and such redemption of preference shares shall not be taken as reducing the
amount of authorized share capital of the company.
(11) Where a company has redeemed or is about to redeem any preference shares, it shall
have power to issue new shares up to the nominal amount of the shares so redeemed or
to be redeemed.
(12) Where a company has redeemed any preference shares, the company shall give
information thereof to the Office within one month of such redemption; and on receipt
of such information, the Office shall record such information in the company register.
(13) Notwithstanding anything contained elsewhere in this Section, a company may issue
new shares to its shareholders as fully paid bonus shares, out of the capital redemption
reserve funds established pursuant to Sub-Section (7).

7.4 OTHER ISSUES IN COMPANY AUDIT
Verification of the constitution and powers

A company can function within the limits prescribed by the documents on the basis of which
it has been registered. It raises its capital from the public on certain conditions, specified in the
Prospectus before commencing business, to purchase a property or to have subscription to its
capital underwritten. Hence, it is essential that the auditor, prior to starting the audit of a company,
shall examine:
(a) The Memorandum of Association.
(b) The Articles of Association.
(c) Contracts entered into with vendors and other persons relating to purchase of property,
payment of commission, etc.
A contract made prior to the incorporation of a company shall be a proposed contract only, and
such contract shall not be binding on the company. Moreover, a public company cannot commence
business until the certificate of commencement of business has been granted by the Company
Registrar Office. It is, therefore, the duty of the auditor to take into account, while examining the
transaction entered into by the company, the dates when these were entered into for confirming
the validity. With a view to carrying out the audit effectively, it is necessary that the auditor should
know the authority structure of the company.
Power of Board of Directors

The Board of Directors of a company is entitled to exercise all such powers, and to do all such acts
and things, as the company is authorised to do. However, the Board shall not exercise any power
or do any act or thing which is directed or required by any legislation (including the Companies
Act) or by the memorandum or articles of the company, to be exercised or done by the company,
in general meeting.
Section 95 of the Act confers the following powers and responsibilities to board of directors:
(1) To manage all transaction, exercise of powers and perform duties of the company through the
board of directors collectively subject to the provisions contained in this Act and the articles
of association and the decisions of the general meeting.
(2) Except in accordance with a decision of the general meeting no director of a public company
shall do anything yielding personal benefit to him/her through the company. Provided,
however, that a private company may make a reasonable provision on the benefit which the
director may derive thought the company, as mentioned in the memorandum of association
and articles of association or consensus agreement.

AUDIT AND ASSURANCE
(3) Except as otherwise provided in this Act, the memorandum of association and articles of
association or the consensus agreements in case of a private company, the board of directors
may appoint any director from amongst themselves or any employee of the company as its
representative and delegate to him/her any or all of its powers, inter alia, to do any act or thing,
make correspondences or sign bills of exchange or cheques etc. on behalf of the company, to
be exercised individually or jointly. In delegating the powers, at least one director and their
company secretary, if any, shall certify such delegation, pursuant to a decision of the board of
directors.
(4) A company may recover damages from a person acting in the capacity of director or
representative of the company for any loss or damage caused to the company from any act or
action done by such person beyond his jurisdiction.
(5) If any person enters into any transaction with the director or with a representative as referred
to in Sub-Section (3) despite the knowledge or having reason to believe that such director or
representative is dealing with any transaction for his/her personal interest or for causing loss
or damage to the company, such person shall not be entitled to make any claim against the
company in respect of such transaction.
(6) Notwithstanding anything contained in Sub-Section (3), the board of directors shall not
delegate the following powers conferred to the company and shall exercise such powers only
by means of resolutions passed at meetings of the board of directors :
(a) The power to make calls on shareholders in respect of amount unpaid on their shares;
(b) The power to issue debentures;
(c) The power to borrow funds other than through debentures;
(d) The power to invest the funds of the company;
(e) The power to provide loans.
(7) The provision of Clause(e) of Sub-Section(6) shall not apply to loans to be let and deposits
to be received in the ordinary course of business transaction by the companies carrying on
banking and financial business.
(8) If the board of directors considers necessary to form a sub-committee for the discharge of any
specific business, it may form one or more than one sub-committee as required and get such
business discharged.

7.5 SPECIAL CONSIDERATIONS INVOLVED IN THE EXAMINATION

OF CERTAIN DOCUMENTS
a. Memorandum of Association
It is a charter containing particulars of business activities that the company can undertake
and the powers it can exercise in regard thereto. Only on a consideration thereof it is possible
for the auditor to determine whether a transaction which has been entered into by the
company is intra vires, i.e. the company is authorised to enter into it. If a company enters
into a transaction which is ultra vires, the shareholders, though entitled to claim the profit
arising on such a transaction, may restrain the management from charging the loss, if it has
been suffered thereon, to the company. If the auditor fails to detect and report the transactions
which are ultra vires the company, Auditor would be guilty of negligence.
Generally the Memorandum of Association of company is drawn up comprehensively in

order that the company may be able to enter into a wide variety of transactions which it
may be required to do for carrying out one or more of its objects. Nevertheless, sometimes
occasions arise when a company, inadvertently, or deliberately, enters into a transaction
which is ultra vires objects to powers. In such a case, the shareholders may decide to restrain
the management from charging to the company the losses suffered by the company in respect
of such a transaction.
Section 18 of the Act provides the following matters relating to Memorandum of Association.
(1) the Memorandum of Association of a company shall incorporate following matters:
(a) The name of company,
(b) The address of the registered office of the company,
(c) The objectives of the company,
(d) The acts to be carried out to accomplish the objectives of the company,
(e) The figure of the authorized capital of the company and the figure of the share
capital to be issued by the company for time being and the figure of undertaken to
be paid by the promoter of the company,
(f) Types of shares of the company, the rights and powers inherent in such shares,
value of each share and number of shares of different types,
(g) Restrictions, if any, in the purchase or transfer of shares,
(h) Number of shares which the promoters have undertaken to subscribe for the time
being,

AUDIT AND ASSURANCE
(i) Terms of payments of share amounts,
(j) Statements that the liability of shareholders shall be limited,
(k) The maximum number of shareholders in case of a private company,
(l) Other necessary matters.
(2) If any of the following matters shall be done or provided, in addition to those mentioned
in Sub-Section(1), the memorandum of association shall also state such matters:
(a) If the promoter or any other person is entitled to subscribe shares or acquire title
thereto in any manner other than by making payment in cash, such matter,
(b) If the company is to acquire any property in any manner from the promoter or any
other person at the time of commencement of its transactions such matter,
(c) If the company itself to bear the expenses incurred on its incorporation, such matter,
(d) If the promoter or any other person is entitled to any special privilege or right from
the company, such matter.
(3) While subscribing shares or acquiring title thereto by the promoter or any other person
in consideration other than cash as mentioned in Clause (a) of Sub- Section (2) and
in the case if a public company, while acquiring any property by the company from
the promoter or any other person at the time of commencement of its transactions as
mentioned in cause (b), such consideration other than cash and such property shall be
evaluated by certified engineer or accountant holding certificate to conduct valuation
work under the prevailing law.
(4) The criteria for the valuation of any property pursuant to Sub-Section (3) shall be as
prescribed; and unless such criteria are prescribed, the person valuating such property
shall mention the criteria employed by him/her to evaluate the property.
(5) If the memorandum of association is inconsistent with this Act it shall ipso facto be void
to the extent of such inconsistency.
(6) The format of memorandum of association shall be as prescribed.
b. Articles of Association
These are rules and regulations for the internal management of the company; and they define
the rights of different classes of shareholders, conditions under which calls can be made, the
maximum and minimum number of directors the company can have, their qualifications,
disqualifications and removal, etc. The terms and conditions of these provisions have
relevance to the examination of transaction that the auditor is required to carry out. Auditor
should, therefore, study the Articles and include extracts from them in his permanent audit
file. The auditor, who fails to take note of the provisions in the Articles in the verification

of statements of accounts, would be guilty of professional negligence. While delivering

judgment in the case, Leeds Estate Building and Investment Co. v. Shepherd, Starling J. said,
"It is the duty of the auditor to see that the Statement of Financial Position is a true and correct
representation of the company's affairs. It was no excuse that the auditor had not seen the
articles when Auditor knew of their existence."
The auditor must, therefore, acquaint himself with the provision of the Articles of the company
and should apply this knowledge in the verification of the transactions of the company.
Section 20 of the Act provides the following matters relating to the Articles of association:
(1) A company shall frame the articles of association in order to attain the objectives set forth
in its memorandum of association and carry out its activities in a well -managed manner.
(2) The articles of association shall state the following matters:
a. Procedures for convening the general meeting of the company and notice to be
given for such meeting,
b. Proceedings of general meeting,
c. Number of directors, provision of alternate director, if any, and tenure of directors,
d. Provisions relating to the minutes of decisions of the general meeting and the board
of directors, and duplicate copies and inspection thereof,
e. If a person has to subscribe shares to become a director of a company, minimum

number of shares,
f. In the case of a public company, qualifications and number of independent director,
g. Where any professional persons, other than shareholders, are to be appointed as

directors, provisions relating to the number, tenure, qualifications and procedures
of appointment of such persons,
h. Powers and duties of the board of directors and the managing director,
i. Authority of directors and delegation of authority,
j. Quorum for a meeting of the board of directors, notice of meeting and proceedings
of meeting,
k. Lien on shares,
l. Different classes of shares and the rights, powers and restrictions attached to such
shares,
m. Provisions relating to calls on shares and forfeiture of shares,
n. Provisions relating to the transfer of shares,

AUDIT AND ASSURANCE
o. Matters on alteration in share capital,
p. Matters on buying back of shares by the company, if the company is to buy back its
shares,
q. Appointment of a company secretary,
r. Provisions relating to remuneration, allowances and facilities of directors,
s. Use of the company's seal in its transactions, if it is to be used,
t. Accounts, books of accounts and audit of the company,
u. Provisions on powers to raise loans or debentures,
v. Amalgamation of the company,
w. Such matters, if any, as required by the prevailing law to be mentioned in the articles
of association of a company carrying on any specific business,
x. Such other necessary matters as required to be mentioned in the articles of

association.
(3) If any provision contained in the articles of association of the company, inclusive of
a provision on the saving of its directors or officers, is inconsistent with this Act and
the memorandum of association, such provision shall be void to the extent of such
inconsistency.
(4) The format of articles of association shall be as prescribed.
c. Prospectus
It is a formal document which a public company must issue before it makes the allotment
of shares. It must contain all the terms and conditions on which subscription to the shares is
sought to be obtained from the public e.g. the company may stipulate, that it would obtain
a quotation for its shares at a Stock Exchange or that it shall purchase a property which is
considered valuable for the company or that it has obtained the services of technical experts
whose services will be valuable for setting up the factory. In case the company fails to carry
out any of these undertakings or if any statement made by it ultimately is proven to be false,
the shareholder has the option to claim refund of the amount paid by him. The auditor should,
therefore, study carefully all the conditions and stipulations made in the prospectus and, in
case any of them has not been carried out, to draw the attention of shareholders thereto. It
may be noted that the right to claim refund is restricted to such of the shareholders who
subscribed for shares on the basis of prospectus. A shareholder who has purchased the shares
from stock exchange or otherwise cannot claim refund.
Section 23 of the Act provides the following matters relating to the Prospectus to be published:

(1) A public company shall publish its prospectus prior to issuing its securities publicly.
(2) Prior to the publication of prospectus under Sub-Section(1), the prospectus signed by all
directors of the company has to be submitted, along with a written application made to
the Securities Board for approval, under the prevailing laws on securities.
(3) Unless and until the Securities Board approves and gives permission for the public issue
under Sub-Section (2) and a copy of such prospectus is registered with the office, no
company or no person, on behalf of such company, shall publish, or cause to be published
, the prospectus of such company.
(4) If it appears that the prospectus submitted pursuant to Sub-Section(2) omits any
important matter or contains any unnecessary matter the Securities Board shall cause
such prospectus to be amended or altered as required and grant approval to publish it in
accordance with law.
(5) If the prospectus submitted pursuant to Sub-Section (2) is approved by the Securities
Board, the concerned company shall give to the Company Registrar Office information
thereof, in writing, accompanied by a copy of the approval letter of the Securities Board;
and on receipt of that information, the Office shall register the prospectus pursuant to
this Section.
Provided, however, that if it appears that any matter contained in this Act has not been
complied with, the Company Registrar Office may refuse to register it.
(6) If any person demands for a copy of the prospectus registered pursuant to Sub-Section
(5), the Company Registrar Office shall provide such copy by collecting the prescribed
fees.
(7) In publishing the prospectus pursuant to Sub-Section (1), the company shall also mention
that the prospectus has been approved by the Securities Board and registered with the
Company Registrar Office, and the date thereof.
(8) The covering page of each prospectus shall also mention that such prospectus has been
registered pursuant to this Section and that the Securities Board or the Office shall not be
liable to bear any kind of responsibility in respect of the matters mentioned therein.
(9) Prior to the approval by the Securities Board of the prospectus of any company, the
concerned company shall make a declaration before the Securities Board that the
provisions of this Act have been complied with; and the Securities Board may, if it deems
necessary, seek opinion of the Office on that matter.
(10) Other procedures to be fulfilled in publishing the prospectus and the matters to be set
out in the prospectus shall be as mentioned in the prevailing law on securities.

AUDIT AND ASSURANCE
Section 35 - Procedures for issuing debentures:

(1) A public company shall, in issuing debentures pursuant to this Act, issue debentures after
making provision of a debenture trustee. Such debenture trustee has to be a debenture
trustee licensed by the Securities Board.
(2) The matters relating to the creditor and the borrower, in issuing debentures with a
debenture trustee, shall be as mentioned in an agreement to be concluded between such
trustee and the company.
(3) If the memorandum of association or the articles of association provides that debentures
can be converted into shares or such term has been specified prior to the issuance of
debentures, debentures may be converted into shares, subject to the share capital related
provisions of this Act.
(4) If any debentures are to be converted into shares pursuant to Sub-Section (3), it has to be
clearly disclosed in the prospectus.
(5) Notwithstanding anything contained in the prevailing law, the court may issue an order
of specific performance as per the contract concluded between a public company and a
person in respect of the subscription of the debentures issued by that company.

Question 1 Explain Buy-back of shares by the company.
Question 2 Explain the provision relating to maintenance of books in branch office.
Question 3 Can a company issue or sale of shares at a discount?
Question 4 How the share premium balance should be utilized?
Question 5 MIN Limited has transferred the right to borrow the money required for the company
to Manager. Comment.
Question 6 Max limited wishes to issue prospectus in its own format. Comment and explain the
process.

AUDIT AND ASSURANCE

CHAPER 8 : AUDIT OF SPECIAL SECTORS
CHAPTER 8
AUDIT OF SPECIAL SECTORS
 Understand the auditing procedures of not for profit organizations

like NGOs and charitable organizations
 Understand the auditing procedures of educational institutions,

hospitals, clubs
 Understand the auditing procedures of hire purchase and leasing

companies
 Understand the auditing procedures of co-operative societies and

joint venture

AUDIT AND ASSURANCE
8.1 AUDIT OF NON-GOVERNMENTAL ORGANISATIONS (NGOS)
NGOs can be defined as non-profit making organisations which raise funds from members, donors
or contributors apart from receiving donation of time, energy and skills for achieving their social
objectives like imparting education, providing medical facilities, economic assistance to poor,
managing disasters and emergency situations. Therefore, this definition of NGO would include
religious organisations, voluntary health and welfare agencies, charitable organisations, hospitals,
old age homes, research foundations etc. The scope of services rendered by NGOs is extremely
wide and as such cannot be covered in a small definition.
NGOs are generally registered under Institution Registration Act, 2034. NGOs can also be
registered as “company not distributing profits” under section 166 of Companies Act, 2063 on
conditions that it shall not be entitled to distribute or pay to its members any dividends or any
other moneys out of the profits earned or savings made for the attainment of any objectives. NGOs
are affiliated with the Social Welfare Council. The Social Welfare Council monitors the activities
of such NGOs. NGOs registered under Companies Act, 2063 must maintain their books of account
under the actual basis as required by provisions of section 108 of the said act.
Sources and applications of funds of NGOs

The main sources of funds include grants and donations, fund raising programmes, advertisements,
fees from the members, technical assistance fees / fee for services rendered, subscriptions, gifts,
sale of produce or publications, etc.
Donations and grants received in the nature of promoter's contribution are in the nature of capital
receipts and shown as liabilities in the Statement of Financial Position of NGO. These may either
be in the form of corpus contribution or a contribution towards revolving fund. A contribution
made towards the capital or the corpus of an NGO is known as corpus contribution. The donors
are generally required to specify whether the donation/grant given by him shall form part of
the corpus of the NGO. Such contributions are generally given with reference to the total funds
required by an NGO. The objective of a contribution or grant towards a Revolving Fund is to
rotate the amount by giving temporary loans from the fund to other NGO or beneficiaries for their
projects and then recover the loan so as to give temporary loans again and so on. However, any
interest earned from the beneficiary on such temporary loans from the revolving fund could be
either added back to the fund or credited to the Income and Expenditure Account depending on
restrictions laid down by the authority providing the contribution (for the revolving fund) or by
the rules and regulations laid down by the concerned NGO in this regard.
Donations and grants received for acquisition of specific fixed assets are those grants whose
primary condition is that an NGO accepting them should purchase, construct or otherwise acquire
the assets for which the grant is given. Many a times NGOs receive contributions in kind. These
contributions include assets such as land, buildings, vehicles, office equipment, etc. and articles

related to programmes / projects such as food, books, building materials, clothes, beds, and raw
material for training purposes, e.g., wool, reeds, cloth, etc.
The areas of application of funds for an NGO include Establishment Costs, Office and
Administrative Expenses, Maintenance Expenses, Programme / Project Expenses, Charity,
Donations and Contributions given, etc.
Audit of an NGO
The auditor of an NGO registered under Institution Registration Act 2034 is normally appointed
by the Management Committee. The auditor of the NGO registered under Companies Act, 2063 is
appointed by the members of the company. Some of the statutes like Institution Registration Act,
2034, Companies Act, 2063, Social Welfare Council Act 2049 and Income Tax Act 2058 require that
the accounts of NGOs be audited and submitted to prescribed authorities within prescribed time
limit and failure to do so may lead to forfeiture of certain exemptions and benefits.
While planning the audit, the auditor may concentrate on the following:
i Knowledge of the NGO's work, its mission and vision, areas of operations and
environment in which it operate.
ii Updating knowledge of relevant statutes especially with regard to recent amendments,

circulars, judicial decisions viz. Income Tax Act 2058 etc. and the Rules related to the
statutes.
iii Reviewing the legal form of the Organisation and its Memorandum of Association,
Articles of Association, Rules and Regulations.
iv Reviewing the NGO's Organisation chart, then Financial and Administrative Manuals,
Project and Programme Guidelines, Funding Agencies Requirements and formats,
budgetary policies if any.
v Examination of minutes of the Board/Managing Committee/Governing Body/

Management and Committees thereof to ascertain the impact of any decisions on the
financial records.
vi Study the accounting system, procedures, internal controls and internal checks existing
for the NGO and verify their applicability.
vii Setting of materiality levels for audit purposes.
viii The nature and timing of reports or other communications
ix The involvement of experts and their reports.
x Review the previous year's Audit Report.

AUDIT AND ASSURANCE
Audit Programme of NGO

The audit programme should include in a sequential order for all assets, liabilities, income and
expenditure ensuring that no material item is omitted for each of the following items:
i Corpus Fund: The contributions/grants received towards corpus are vouched with
special reference to the agreements/letters from the donor(s). The interest income is
checked with Investment Register and Physical Investments titles documents in hand.
ii Reserves: Vouch transfers from projects / programmes with donors' letters and board
resolutions of NGO. Also check transfer of gross value of asset sold from capital reserve
to general reserve and adjustments during the year.
iii Ear-marked Funds: Check requirements of donor institution’s, board resolution of NGO,
rules and regulations of the schemes of the ear-marked funds.
iv Project/Agency Balances: Vouch disbursements and expenditure as per agreements
with donors for each of the balances.
v Loans: Vouch loans with loan agreements, receipt counter-foil issued.
vi Fixed Assets: Vouch all acquisitions/sale or disposal of assets including depreciation
and the authorisations for the same. Also check donor's letters/agreements for the grant.
In the case of immovable property check title, etc.
vii Investments: Check Investment Register and the investments physically ensuring that
investments are in the name of the NGO. Verify further investments and disinvestments
for approval by the appropriate authority and reference in the bank accounts for the
principal amount and interest.
viii Cash in Hand: Physically verify the cash in hand and imprest balances, at the close of the
year and whether it tallies with the books of account.
ix Bank Balance: Check the bank reconciliation statements and ascertain details for old
outstanding and unadjusted amounts.
x Stock in Hand: Verify stock in hand and obtain certificate from the management for the
quantities and valuation of the same.
xi Programme and Project Expenses: Verify agreement with donor/contributor(s)
supporting the particular programme or project to ascertain the conditions with respect
to undertaking the programme / project and accordingly, in the case of programmes/
projects involving contracts, ensure that income tax is deducted at source, deposited and
returns filed and verify the terms of the contract.
xii Establishment Expenses: Verify that provident fund, gratuity, life insurance premium,
employee’s insurance as per employee’s byelaws and their administrative charges are
deducted, contributed and deposited within the prescribed time. Also check other office
and administrative expenses such as postage, stationery, travelling, etc.

The receipt of income of NGO may be checked on the following lines:

i Contributions and Grants for projects and programmes: Check agreements with donors and
grants letters to ensure that funds received have been accounted for. Check that all foreign
contribution receipts are deposited in the foreign contribution bank account as notified under
the Social Welfare Council Act and Rule.
ii Receipts from fund raising programmes: Verify in detail the internal control system and
ascertain who are the persons responsible for collection of funds and mode of receipt. Ensure
that collections are counted and deposited in the bank daily.
iii Membership Fees: Check fees received with Membership Register. Ensure proper
classification is made between entrance and annual fees and life membership fees. Reconcile
fees received with fees to be received during the year.
iv Subscriptions: Check with subscription register and receipts issued. Reconcile subscription
received with printing and dispatch of corresponding magazine/circulars/periodicals. Check
the receipts with subscription rate schedule.
v Interest and Dividends: Check the interest and dividends received and receivable with
investments held during the year.
8.2 AUDIT OF EDUCATIONAL INSTITUTIONS (SCHOOL, COLLEGE,

UNIVERSITY ETC.)
Educational institutions can be run as trust or as company

The audit procedures involved in the audit of an educational institution are the following:
i. Examine the Trust Deed or MOA/AOA or regulations in the case of school and note
all the provision affecting accounts. Refer to the respective Act of Legislature and the
Regulations framed there under, for example provisions relevant in Education Act, and
Regulation in case of audit of schools.
ii. Read through the minutes of the meetings of the Managing committee or Governing Body,
noting resolutions effecting accounts to see these have been duly complied with, specially
the decisions as regards the operation of bank accounts and sanctioning of expenditure.
iii. Check names entered in the students’ Fee Register for each month or term, with the
respective class register showing names of students on rolls and test amount of fees
charged, and verify that there operates a system of internal check which ensures that
demands against the students are properly raised.
iv. Check fees received by comparing counterfoils of receipts granted with entries in the
cash book and tracing the collections in the Fee Register to confirm that the revenue from
this source has been duly accounted for.

AUDIT AND ASSURANCE
v. Totals of the various columns of the Fees Register for each month or term to ascertain that
fees paid in advance have been carried forward and the arrears that are irrecoverable
have been written off under the sanction of an appropriate authority.
vi. Check admission fees with admission slips signed by the head of the institution and
confirm that the amount had been credited to a capital funds, unless the Managing
committee has taken a decision to the contrary.
vii. See that scholarship and concessions have been granted by a person authorized to do
so, having regard to the prescribed rules.
viii. Confirm that fines for late payment or absence etc. have either been collected or remitted
under proper authority.
ix. Confirm that hostel dues were recovered before student’s accounts were closed and
their deposits of caution money refunded.
x. Verify rental income from landed property with the rent rolls etc.
xi. Vouch income from endowments and legacies, as well as interest and dividends from
in investment; also inspect the securities in respect of investments held.
xii. Verify any Government or local authority grant with the relevant papers of grant. If
any expenses have been disallowed for purposes of grant, ascertain the reasons and
compliance thereof.
xiii. Report any old heavy arrears on account of fees, dormitory rents etc. to the managing
committee.
xiv. Confirm that caution money and other deposits paid by students on admission have been
shown as liability in the Statement of Financial Position and not transferred to revenue.
xv. See that the investments representing endowment funds for prized are kept separate
and any income in excess of the prizes has been accumulated and investment along
with the corpus.
xvi. Verify that the provident fund money of the staff has been invested in appropriate
securities.
xvii. Vouch donations, if any, with the list published with the annual report. If some
donations were meant for any specific purpose, see that the money was utilized for the
purpose.
xviii. Vouch all capital expenditure in the usual way and verify the same with the sanction
for the committee as contained in the minute book.
xix. Vouch in the usual manner all establishment expenses and enquire into any unduly
heavy expenditure under any head.
xx. See that increase in the salaries of the staff have been sanctioned and minuted by the
committee.

xxi. Ascertain that the system ordering inspection on receipt and issue of provisions,
foodstuffs, clothing and other equipment is efficient and all bills are duly authorized
and passed before payment.
xxii. Verify the inventories of furniture, stationery, clothing, provision and all equipment,
etc. These should be checked by reference to stock register and values applied to various
items should be test checked.
xxiii. Confirm that the refund of taxes deducted from the income from investment (interest
on securities, etc) has been claimed and recovered since the institutions are generally
exempted from the payment of income-tax.
xxiv. Verify the annual statements of accounts and while doing so see that separate statements
of account have been prepared as regards poor students fund, Games fund, hostel and
provided fund of staffs etc.
8.3 AUDIT OF HOSPITALS AND CLINICS
Hospitals can be run as sole proprietorship or partnership or trust and even as company etc.
Auditor should ascertain the legal status and study applicable statute and regulation.
The special steps involved in carrying out the audit of Hospital are stated below:
i. Examine the trust or partnership deed or MOA/AOA as per the legal status of the
hospital.
ii. Read through the minutes of the meetings of the Managing committee or Governing
Body, noting resolutions effecting accounts to see these have been duly complied with,
specially the decisions as regards the operation of bank accounts and sanctioning of
expenditure.
iii. Evaluate the internal control system and obtain the list of accounting records and
accounting policy adopted by management.
iv. Vouch the Register of patients with copies of bills to them. Verify bills for a selected
period with the patient’s attendance record to see that the bills have been correctly
prepared. Also see that bills have been issued to all patients’ form that an amount was
recoverable according to the rules of the hospital.
v. Check cash collection as entered in the cash book with the receipts, counterfoils and
other evidence for example, copies of patients bills counterfoils of dividend and other
interest warrants, copies rent bills , etc.
vi. See by reference to the property and investment register that all income that should have
been received by of rent of properties, dividends, and interest on securities settled on the
hospital, has been collected.

AUDIT AND ASSURANCE
vii. Ascertain that legacies and donations received for a specific purpose have been applied
in the manner agreed upon.
viii. Trace all collections of subscription and donations from the cash book to the respective
registers. Reconcile the total subscription due as shown by the subscription register and
the amount collected and that still outstanding.
ix. Vouch all purchases and expenses and verify that the capital expenditure was incurred
only with the prior sanction of the Trustee or the Managing committee and that
appointments and increments to staff have been duly authorized.
x. Verify that grants, if any, received from Government or local authorities have been duly
accounted for. Also, that refund in respect of taxes deducted at source has been claimed.
xi. Compare the totals of various items of expenditure and income with the amount
budgeted for them and report to the trustee or the Managing committee significant
variations which have taken place.
xii. Examine the internal check as regards the receipt and issue of stories: medicines, linen,
apparatus, clothing, property, instruments, etc. So as to ensure that purchases have been
properly recorded in the stock Register and that issued have been made only against
proper authorization.
xiii. See that depreciation has been written off against all the assets at the appropriate rates.
xiv. Inspect the bonds, share scripts, title deeds of properties and compare their particulars
with those entered in the property and investment registers.
xv. Obtain inventories, especially of stocks and stores as at the end of the year and check a
percentage of the items physically; also compare their total values with their total values
with respective ledger balances.
8.4 AUDIT OF CLUBS AND RECREATIONAL CENTER
The special steps involved in an audit of clubs are stated below:
i. Study the provision of applicable statute as per legal status of the club.
ii. Study the meeting minutes of the governing body to gain the knowledge of any important
decision, which may affect the accounts.
iii. Evaluate the internal control system and obtain the list of accounting records and
accounting policy adopted by management.
iv. Vouch the receipt on account of entrance fees with members' applications, counterfoils
issued to them, as well as on a reference to minutes, of the Managing Committee.

v. Vouch member's subscriptions with the counterfoils of receipt issued to them, trace
receipts for a selected period to the Register of Members; also reconcile the amount of
total subscriptions due with the amount collected and that outstanding.
vi. Ensure that arrears of subscriptions for the previous year have been correctly brought
over and arrears for the year under audit and subscriptions received in advance have
been correctly adjusted.
vii. Check totals of various columns of the Register of members and tally them across.
viii. See the Register of Members to ascertain the Member's dues which are in arrear and
enquire whether necessary steps have been taken for their recovery; the amount
considered irrecoverable should be mentioned in the Audit Report.
ix. Verify the internal check as regards members being charged with the price of foodstuffs
and drinks provided to them and their guests as well as with the fees chargeable for the
special services rendered, such as billiards, tennis, etc.
x. Trace debits for a selected period from subsidiary registers maintained in respect of
supplies and services, to members to confirm that the account of every member has been
debited with amounts recoverable from him.
xi. Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into the
respective stock registers.
xii. Vouch purchases of foodstuffs, cigars, wines, etc., and test their sale price so as to confirm
that the normal rates of gross profit have been earned on their sales. The stock of unsold
provisions and stores, at the end of year, should be verified physically and its valuation
checked.
xiii. Check the stock of furniture, sports material and other assets physically with the
respective stock registers or inventories prepared at the end of the year.
xiv. Inspect the share scrips and bonds in respect of investments, check their current values
for disclosure in final accounts; also ascertain that the arrangements for their safe custody
are satisfactory.
xv. Examine the financial powers of the secretary and, if these have been exceeded, report
specific care for confirmation by the Managing Committee.

AUDIT AND ASSURANCE
8.5 AUDIT OF HIRE PURCHASE AND LEASING COMPANIES
Hire purchase agreement means an agreement under which goods are let on hire and under
which the hirer has an option to purchase them in accordance with the terms of the agreement and
includes an agreement under which:
a. Possession of goods is delivered by the owner thereof to a person on condition that such
person pays the agreed amount in periodical installments,
b. The property in the goods is to pass to such person on the payment of the last of such
installments, and
c. Such person has a right to terminate at any time before the property so passes.
Thus hirer, the person who obtains possession of goods from an owner under a hire-purchase
agreement and owner mean the person who lets or has let, delivers or has delivered of goods to a
hirer under a hire-purchase agreement in order to complete the purchase of, or the acquisition of
the property in, the goods of which the agreement relates, and includes any sum so payable by the
hirer under the hire purchase agreement by way of a deposit or other initial payment.
While checking the hire-purchase transaction, the auditor may examine the following:
i. Hire purchase agreement is in writing and is signed by all parties.
ii. Hire purchase agreement specifies clearly that -
a. The hire purchase price of the goods to which the agreement relates;
b. The cash price of the goods, that is to say, the price at which the goods may be
purchased by the hirer for cash;
c. The date on which the agreement shall be deemed to have commenced.
d. The number of installments by which the hire-purchase price is to be paid, the

amount of each of those installments, and the date, or the mode of determining
the date, upon which it is payable, and the person to whom the place where it is
payable; and
e. The goods to which the agreement relates in a manner sufficient to identity them.
iii. Ensure that payments are being received regularly as per the agreement.
In a lease agreement, a party (called ‘lessee’) acquires the right to use an asset for an agreed period
of time in consideration of payments of rent to another party ( called lessor’). In certain lease
agreements, the legal ownership of the risks and rewards of ownership of the assets are transferred
to the lessee. In other words, the lease, in effect, is a financing arrangement. Such leases are termed
as finance leases. An operating lease, on the other hand, is a simple arrangement where, in return
for rent, the lessor allows the lessee to use the asset for a certain period.

A normal financial lease transaction usually goes through the following modality:
The lessees select the equipment and satisfy himself about its functional fitness and specifications,
the lessor has no participation at this stage. Having chosen the equipment, the lessee approaches a
lessor, either directly or through a lease broking agency. The lease agreement is broadly negotiated
and rates are finalized. The lessor places an order on the manufacturer as chosen by lessee.
The manufacturer delivers the equipment at the site of the lessee, and the latter gives notice of
acceptance to the lessor. The lease agreement giving detailed terms of contract is signed between
the parties. Leases will normally be full pay out, with term varying as per requirements.
During the lease period, the lessee:

- Pays rentals regularly at periods agreed-upon, which are usually each calendar month,
- Keeps the equipment in good repair and working condition, etc &
- Will be entitled to manufacturer’s warranties or after-sales services.
In respect of leasing transactions entered into by a leasing company involved in the leasing capital
goods, the auditor should check/verify the following:
1. The object of the leasing company to see that the goods like capital goods, consumer
durables etc. In respect of which the company can undertake such activities. Further,
whether company can undertake financing activities or not.
2. Whether there exists a procedure to ascertain the credit analysis of lessee like lessee’s
ability to meet the commitment under lease, past credit record, capital strength,
availability of collateral security etc.
3. The lease agreement should be examined and the following points may be noted-
a. The description of the lessor, the lessee, the equipment and the location where the
equipment is to be installed. (The stipulated time that the equipment shall not be
removed from the described location except for repairs. For the sake of identification,
the lessor may also require plates or markings to be attached to the equipments).
b. The tenure of lease dates of payment lease charges, deposits or advance etc. should
be noted.
c. Whether the equipment shall be returned to the lessor on termination of the

agreement and the cost shall be borne by the lessee.
d. Whether the agreement prohibits the lessee from assigning or subletting the
equipment and authorizes the lessor to do so.
4. Examine the lease proposal form submitted by the lessee requesting the lessor to provide
him the equipment under lease.

AUDIT AND ASSURANCE
5. Examine the lease proposal form submitted by the lessee requesting the lessor to provide
him on lease the equipment.
6. Ensure that the invoice is retained safely as the lease is a long term contract.
7. Examine the acceptance letter obtained from the lessee indicating that the equipment is
received in order and is acceptable to the lessee,
8. Check the Board resolution authorizing a particular director to execute the lease
agreement has been passed by the lessee.
9. See that the copies of the insurance policies have been obtained by the lessor for his
records.
8.6 AUDIT OF CO-OPERATIVE SOCIETY
Cooperatives are formed and in operation based on the mutual support and cooperativeness for
the economic and social development of the general public consumers by the farmers, craftsperson
(Kaligadh), class of people with low capital and low income, labors, landless and unemployed
people or social workers of the country. The various provisions contained with respect to accounts
and audits are as under:
The Co-operatives Act 2074, a Central Act, provides the fundamental law regarding the formation
and operation of the co-operative societies in Nepal and is applicable in many provinces with
or without amendments. The co-operative societies are under the regulation and supervision of
local government authorities, thus specific local acts/rules/regulation if any shall govern them.
Hence an auditor of co-operative society shall be familiar with the provisions of particular local act
governing the co-operative society under audit.
Section 48 of the Cooperative Act 2074 provides that Accounts Supervision Committee shall be
formed and following duties shall be performed:
(1) The general meeting of every association may elect and form one accounts committee
consisting of three members including one coordinator.
(2) The accounts committee may perform the trimester wise internal audit of the association
in a regular basis and give suggestions to the board.
(3) The accounts committee has to submit its accounts related report to the general meeting.
Further, Section 74 of the Cooperative Act 2074 provides that every association or society has to
maintain records of accounts of all transactions carried on by it on double entry book keeping
system and other necessary prescribed records.

Section 75: Audit of accounts

(1) That every association or society has to get its accounts of every fiscal year examined by any
registered auditor recognized by the Registrar or official designated by him/her within three
months after the expiration of that fiscal year.
(2) Notwithstanding anything contained in Sub-section (1), the general meeting of the concerned
association or society may, with the approval of the Registrar, appoint a registered auditor
and cause the accounts of that association or society to be examined by such auditor.
(3) In appointing an auditor pursuant to Sub-section (2), the same person or company may not be
appointed for more than three consecutive times.
(4) A report on examination of accounts has to be submitted to the general meeting and got
endorsed.
(5) If the general meeting does not endorse the report on examination of accounts submitted to
the general meeting pursuant to Sub-section (4), the general meeting may appoint another
auditor and have an inquiry held or accounts re-examined.
(6) The remuneration and facilities of auditor shall be as determined by the General Meeting.
Special features of Co-operative Audit

There are certain special features of co-operative audit to be borne in mind other than general
process of audit involved in audit work (such as checking of posting, ascertainment of arithmetical
accuracy, vouching, verification of assets and liabilities and final scrutiny of financial statements).
Some of the special features are:
a) Examination of overdue debts, whether classified properly as loan not overdue, loan
overdue within 12 months and loan overdue for more than 12 months and whether
proper provision for doubtful debts has been made.
b) Ensure whether overdue interest has not been capitalized in outstanding loan.
c) Regarding valuation of assets and liabilities, there are no specific provisions or

instructions under the Act and Rules and thus general principles of accounting and
auditing standards shall be adopted.
d) Adherence to cooperative principles shall be ascertained by the auditor in general, how

far the objects, for which co-operative organization is established, have been achieved.
The assessment should not necessarily be in terms of profit but in terms of bestowing
benefits to the members.
e) Observations of provisions of acts and rules and point out the infringement with
provisions therein. The financial implications of such infringements should be properly
assessed and reported by the auditor.

AUDIT AND ASSURANCE
f) Verification of member’s register and examination pass books.
g) Creation of statutory and voluntary reserves or fund and operation of such reserves or
funds
h) Verification of implementation and compliance with directives of Anti-money laundering

for co-operative society and procedures prepared by the co-operative there under and
reporting.
8.7 AUDIT OF JOINT VENTURE
Joint Venture audits review operator activities, procedures and costs over a defined scope period.
Non-operating partners schedule and fund a review of detail transactions and related supporting
documentation to ensure their individual ownership interests are productive and are being
protected.
Why conduct a Joint Venture Audit?
a. Confirm that all transactions and billed charges are in compliance with agreement;
b. Ensure unrelated costs have not been billed incorrectly to the Joint Account;
c. Perform a vendor audit review to confirm credits for deposits, refunds and returns have
been appropriately reflected;
d. Provide valuable insight about the Operator transactions to the Non-Operator investors;
&
e. Increase profitability by disqualifying and recovering any overcharges.
Overview of Joint Venture audits

Objectives of typical Joint Venture audits are-
• Ensure billed charges are in compliance with the operating agreement and supported by
adequate documentation.
• Ensure unrelated costs have not been charged to the project.
• Determine whether all vendor credits for deposits, refunds and returns have been
appropriately reflected in net project costs.
• Ensure the operator activities are in compliance with the agreement, including
maintaining adequate insurance coverage and timely regulatory reporting.
• Ensure goods, services and applicable taxes are paid in a timely manner.
• Ensure project assets and costs are adequately managed, controlled and reported.

• Analyze the cash call process and ensure funding adequately matches the operation
needs without material surplus.
Audit Planning and Execution

Joint Venture audits are traditionally conducted in the following manner:
i. Preliminary work, including notification to operator, data acquisition and transaction

request.
ii. On site testing at Operator location.
iii. Development and Communication of Findings.
iv. Summarization of Findings and Audit Close meeting.
v. Preparation and Presentation of the Final Report.
vi. Operator Response to Final Report.
vii. Resolution and Settlement of Audit Issues.

AUDIT AND ASSURANCE
Question 1 Mention any ten special points to be examined by you in the audit of Income and
Expenditure of a charitable institution running a hospital.
Question 2 Define a comprehensive Audit Programme for auditing the receipt of fees from the
students of a school run by a religious Trust.
Question 3 KR, an NGO operating in Kathmandu, had collected large scale donations for flood
victims. The donations so collected were sent to different NGOs operating in remote
places for relief operations. This NGO being operating in KTM has appointed you to
audit its accounts for the year in which it collected and remitted donations for Flood
victims.
Draft an audit programme for audit of receipts of donations and remittance of

the collected amount to different NGOs. Mention six points each, peculiar to the
situation, which you will like to incorporate in your audit programme for audit of
said receipts and remittances of donations.
Question 4 Prepare a comprehensive Audit Programme for audit of Co-operative Societies.

CHAPER 9 : GOVERNMENT AUDIT
CHAPTER 9
GOVERNMENT AUDIT
 Identify the audit procedures of government including local

bodies
 Understand the concept of propriety audit and performance audit
 Impart the knowledge of audit of public sector companies

AUDIT AND ASSURANCE
9.1 GOVERNMENT AUDIT
Government audit is as old as history of organised government of country. The concept and scope
of government audit has developed in tune with political, social and economic development of the
countries. Government audit aims to promote good governance through an independent, efficient
and effective audit services. To carry out audit in an independent manner, some independent
institutions are set up through constitutional or legal provisions. Such institution is empowered
to carry out audits of all receipts, expenditure and other matters as specified in mandate from
various aspects such as regularity, economy, efficiency, and effectiveness, and propriety.
In Nepal, government audit is performed by an independent constitutional body, i.e. Office of

Auditor General (OAG). The Constitution of Nepal, gives a special status of constitutional body to
the OAG and contains provisions to safeguard their independence. According to Article 240 of the
Constitution, on the recommendation of the Constitutional Council, the President shall appoint
the Auditor General.
History
The office of the Auditor General of Nepal was established on 2016/03/15 B.S. (June 29, 1959 A.D.)
after the appointment of Auditor General pursuant to the then Constitution.
Prior to establishment of OAG, the institution named Kumari Chowk Adda used to review the
government accounts. It is assumed that Kumari Chowk was established in the year 1769 with the
aim of strengthening administrative system after the unification of Nepal. It is also anticipated that
there was also existence of audit institution prior to unification.
Office of the Auditor General of Nepal

As per Article 241 of Constitution of Nepal, the accounts of all Federal and State Government
Offices including the Office of the President, Office of the Vice-President, Supreme Court, Federal
Parliament, State Assembly, State Government, Local level, Constitutional Bodies and Offices
thereof, Courts, Office of the Attorney General, Nepal Army, Nepal Police and Armed Police
Force, Nepal shall be audited by the Auditor-General in accordance with law, having regard to,
inter alia, the regularity, economy, efficiency, effectiveness and the propriety thereof.
The Auditor General shall be consulted in the matter of appointment of an auditor to carry out the
audit of a corporate body of which the Government of Nepal or State Government owns more than
fifty percent of the shares or assets.
The Auditor General may also issue necessary directives setting forth the principles for carrying
out the audit of such corporate body.

The Auditor General shall, at all times, have power to examine any books of accounts for the purpose
of carrying out the functions. It shall be the duty of the concerned chief of office to provide all such
documents and information as may be demanded by the Auditor General or any of his or her
employees.
The accounts to be audited pursuant to clause (1) shall be maintained in the form prescribed by the
Auditor General, as provided for in the Federal law.
In addition to the accounts of the offices mentioned in clause (1), the Federal law may also require
the accounts of any other offices or bodies to be audited by the Auditor General.
Audit Act, 2075 provides various provisions regarding governmental audit. It discusses about
scope of audit, approaches to audit, matters to be examined, aspects of audit, audit from propriety
aspect, audit of fully state owned enterprises and appointment of auditors of substantially
government owned enterprises, reporting etc.
Audit Objectives and Policies

To fulfill constitutional mandate, OAG has set its objectives and policies as below:
• To promote public accountability and transparency
• To bring forth economy in the mobilization of public resources and enhance efficiency
• To enhance effectiveness of public entities
• To improve and assure clean practices in the working system of administrative, financial
and managerial system;
• To assist in compliance of the existing laws;
• To encourage abandonment of the discretionary work-style
• To recommend practical suggestions for improvement by identifying weaknesses and

lacunae in the existing approaches, processes, practices and legal provisions; and
• To encourage the practice of taking actions against delinquents and rewarding the
excellent performers.
Standards and other guiding document

OAG has developed and put into effect the various standards, Code of ethics and other guiding
Documents which provide basis for how governmental audit is to be carried out. Such documents
include:
(1) Policy Guideline,
(2) Operational Guideline,

AUDIT AND ASSURANCE
(3) Government Auditing Standards,
(4) Code of Ethics for Government Auditors,
(5) Administrative Expenditures Audit Guide,
(6) Guidelines for the Audit of Public Sector Enterprises,
(7) Performance Audit Guide,
(8) Procurement Audit Guide,
(9) Project Financial Statements Audit Guideline,
(10) Revenue Audit Guideline
Provision of Legal Compliance

Section 4 of Audit Act 2075: Methods of audit:
The Auditor General may conduct final audit of the financial activities and other activities relating
thereto of the offices, bodies or organizations under its jurisdiction, either in detail or sporadically
or a random basis and present the facts obtained there from, make critical comments thereon and
submit its reports.
Section 5 of Audit Act 2075: Audit of financial and other matter

1) The Auditor General may carry out the audit of others subjects other than financial audit like
Information Technology, performance, gender, methodology science, environment of the
offices, bodies or organizations under its jurisdiction on the basis of sampling.
2) The methods, procedures, scope, period, examination and reporting of audit of various
subjects as mentioned in subsection (1) shall be as prescribed by Auditor General.
Section 6 of Audit Act 2075: Periodic Audit

1) The Auditor General may conduct periodic audit of the offices, bodies or organizations under
its jurisdiction before the end of fiscal year or after completion of transactions.
2) The methods, procedures, scope, period, examination and reporting of periodic audit shall be
as prescribed by Auditor General.
3) The report of periodic audit shall be made public by delivering to concerned offices.
Section 7 of Audit Act 2075: Audit of Grants and Assistance

1) The Auditor General may audit the any grants. assistance received or provided by Nepal
government, State government and Local Level as per federal laws.
2) The methods, procedures, scope, period, examination and reporting of such audit shall be as
prescribed by Auditor General.

Section 8 Audit Act 2075 : Matters to Be Audited:The Auditor General, with due regard to
the regularity, economy, efficiency, effectiveness and propriety, shall audit following matters to
ascertain whether:
1) the amount appropriated in the concerned heads and sub- heads by the Appropriation Act for
respective services and activities have been expended for the specified purposes of designated
services or activities within the approved limit;
2) the accounts have been maintained in the prescribed forms and such accounts fairly represent
the position of the transactions;
3) the central accounts have been prepared by compilation of all financial transactions including
sanction, revenue, deposits by constitutional body, ministry, department and equivalent
central level offices of their underlying offices; by provincial ministry and other province
level offices of their underlying officer and thereby whether those accounts portrait actual
financial transactions
4) the accounts of central, provincial and local accumulated fund and emergency fund and other
government funds are accurate
5) timely sanction of budget by concerned government offices
6) financial statements have portrayed accurate and realistic picture of financial transactions
7) the income and expenses are supported by adequate documents
8) physical progress reports are available with accounts and reports
9) the expenditure authorization is approved to officers
10) timely payments of outstanding amounts and payables
11) proper utilization of inventory of cash and available resources and assets
12) recording of government assets as per prevailing laws
13) The available resources, means and assets are properly utilized and the maintenance and
perspiration thereof against any loss or damage has been properly arranged;
14) the arrangements for accounts relating to public debts and amount receivables and payables
there from and paid principal, interest, dividend are adequate and accurate
15) The legal provisions against mis-utilization of expenditure accounts are adequate and
monitoring and control of these are adequate
16) Effective establishment of internal control system and its implementation
17) Satisfactory conduction of internal audit function and if so, are they followed;
18) the accounts of revenue, all other incomes and deposits are correct and the rules relating to
evaluation, realization and methods of book keeping are adequate and if so, are they followed;

AUDIT AND ASSURANCE
19) the provisions related to security deposit are adequate and if so they are observed
20) The accounts of income and expenditure of industrial and business services, and their balance
of cash and kind, and the arrangements and rules relating to their financial transactions are
adequate and if so, are they observed;
21) The organization, management and job allocation of the office are sufficient and proper and
are that operating accordingly;
22) Any function is being unnecessarily performed in duplication by any employee or agency or
any essential function is being omitted;
23) The progress has been achieved within scheduled time and the quality and quantity of the
work is satisfactory;
24) The objective and policy of the Office is explicit and the program is delineated conforming to
the specified objective and policy;
25) The program is being implemented within the limits of approved cost estimate and the
proceeds received in comparison to the cost is reasonable;
26) The arrangements for maintaining data relating to target, progress and cost are adequate and
reliable.
27) Monitoring activities are carried out as provided by prevailing laws and if so the monitoring
reports are implemented.
28) Attempt to covert the financial transactions and records and reporting system into information
technology based system has been made.
29) The revenue, grants and royalty that have been distributed among Nepal government, State
government and local level have been used and operated effectively.
30) Reimbursements are sought on time.
31) Records of irregularities and settlement are updated and attempts to settle the irregularities
have been made.
PROPRIETY AUDIT
According to propriety audit, the auditors try to bring out cases of improper, avoidable, or
infructuous expenditure even though the expenditure has been incurred in conformity with the
existing rules and regulations. With the passage of time, it was felt that regularity audit alone was
not sufficient to protect properly the public interest in the spending of money by the executive
authorities. A transaction may satisfy all the requirements of regularity audit insofar as the various
formalities regarding rules and regulations are concerned, but may still be highly wasteful. A
building may be constructed for installing a telephone exchange but may not be used for the same
purpose resulting in infructuous expenditure or a school building may be constructed but used
after five years of its completion, a case of avoidable expenditure.

Audit should, therefore, try to secure a reasonably high standard of public financial morality by
looking into the wisdom, faithfulness and economy of transactions. These considerations have led
to the evolution of audit against propriety which is now being combined by the audit authorities
with their routine function of regularity audit. It is hard to frame any precise rules for regulating
the course of audit against propriety. Such an objective of audit depends for its acceptance on
its appeal to the common sense and straight logic of the auditors and of those whose financial
transactions are subjected to propriety audit. However, there are some general principles, legally
or otherwise, which have for long been recognised as standards of financial propriety. Audit
against propriety seeks to ensure that expenditure conforms to following principles:
(1) The expenditure should not be prima facie more than the occasion demands.
(2) Every public officer is expected to exercise the same vigilance in respect of
expenditure incurred from public moneys as a person of ordinary prudence would exercise
in respect of expenditure of his own money.
(3) No authority should exercise its powers of sanctioning expenditure to pass an order
which will be directly or indirectly to its own advantage.
(4) Public moneys should not be utilised for the benefit of a particular person or section of
the community unless :
(i) the amount of expenditure involved is insignificant; or
(ii) a claim for the amount could be enforced in a Court of law; or
(iii) the expenditure is in pursuance of a recognised policy or custom; and
(iv) the amount of allowances, such as travelling allowances, granted to meet expenditure
of a particular type should be so regulated that the allowances are not, on the whole,
sources of profit to the recipients.
Section 9 of Audit Act, 2075 requires the Auditor General to audit following matters considering
the propriety thereof:
a) On the propriety of any expenditure and its authorization, if in the opinion of the Auditor
General such expenditure is a reckless one or is an abuse of national property, whether
movable or immovable, despite that the expenditure confirms to the authorization, and
(a) On the propriety of all authorizations issued in respect of any grant of national property
whether movable or immovable, fixed or current, or underwriting of any revenue, or any
contract, license or permits relating to mining, forest, water resources, etc. and any other
act of abandoning movable or immovable, assets of the nation.
(b) On propriety of public construction, repair and maintenance, procurement and supply,
contracts related to consultancy services, services flow, public expenditure, government
revenue operation and other financial transactions

AUDIT AND ASSURANCE
The Auditor General may audit financial accountability of any officer within his scope if felt
necessary as per the accepted audit principles However, the Auditor General may not include
in the report minor items of discrepancy and other items deemed as insignificant in view of their
property which were observed during the audit of income and expenditure.
PERFORMANCE AUDIT
The scope of audit has been extended to cover an economy, efficiency and effectiveness (3Es)
aspects which are commonly known as performance audit or Value for money audit.
International Organisation of Supreme Audit Institutions (INTOSAI) describes performance

audit as an independent examination of the economy, efficiency and effectiveness of government
undertakings, programmes or organisations, with due regard to economy, and the aim of leading
to improvements.
“Economy” means the acquisition of the appropriate quality and quantity of human, financial,
physical and information resources at the appropriate times and at the lower cost. It is minimising
the cost of resources used for an activity (input), having due regard to appropriate quality.
“Efficiency” means the use of human, financial, physical and information resources such that
the output is maximised for any given set of resource inputs, or input is minimised for any given
quantity and quality of output.
“Effectiveness” means the achievement of the objectives or other intended effects of activities. It
addresses whether policy objectives or goals have been met and whether this can be attributed to
the policy pursued.
Performance audit is the outcome of the important efforts directed to improve the system of
management to ensure genuine output from resources employed. The concept of performance
auditing emerged in response to:
• increasing demand for information on efficiency and economy in managing resources

and the effectiveness with which objectives are met;
• need to determine whether :
 the operations of audit entities were conducted in a way that ensures the best
possible use of resources or considering the 3Es;
 officials in the public sector have met their accountability obligations;
 reporting on performance is credible and adequate.

9.2 AUDIT OF LOCAL BODIES
Local Government Operation Act 2074 defines Local Bodies as the Rural Municipality and
Municipality. As per this law and related regulations, these local bodies are given specific
responsibilities. To discharge such responsibilities, they are given certain authorities to raise local
taxes. In addition to such local taxes collected by them, they receive financial grants (conditional/
unconditional) from government and supports from donors/ development partners. Funds so
received by the local bodies is spent for the services and works included in development plans as
passed by the respective councils of the local bodies. Local self-governance Regulation and Local
Bodies Financial Administration Regulation 2064 contains various provisions relating to financial
management, accounts and audits of local bodies.
The objectives of audit of local bodies are:
a) Reporting on the fairness of the content and presentation of financial statements
b) Reporting upon the strengths and weakness of systems of financial controls
c) Reporting on the adherence to legal and administrative requirements
d) Reporting upon whether value is being fully received on money spent
e) Detection and prevention of error, fraud and misuse of resources.
After introduction of new Audit Act 2075, Section 20 provides for annual audit of Rural Municipality
and Municipality shall be done by Office of Auditor General. The audit of local bodies requires the
similar matters to be audited as mentioned in government audit.
9.3 AUDIT OF PUBLIC SECTOR COMPANIES
The International Standards of Supreme Audit Institutions (ISSAIs) developed by the International
Organization of Supreme Audit Institutions (INTOSAI) aim to promote independent and effective
auditing by supreme audit institutions (SAIs). The ISSAIs encompass public-sector auditing
requirements at the organizational (SAI) level, while on the level of individual audits they aim
to support the members of INTOSAI in the development of their own professional approach in
accordance with their mandates and with national laws and regulations.
INTOSAI’s Framework of Professional Standards has four levels:
• Level 1 contains the framework’s founding principles.
• Level 2 sets out prerequisites for the proper functioning and professional conduct of
SAIs in terms of organizational considerations that include independence, transparency
and accountability, ethics and quality control, which are relevant for all SAI audits.

AUDIT AND ASSURANCE
• Levels 3 elaborate on Level 1 and Level 2 and provide an authoritative international

framework of reference defining public-sector auditing
• Level 4 translates the Fundamental Auditing Principles into more specific and detailed
guidelines.
Purpose and Authority of ISSAI

ISSAI 100 establishes fundamental principles which are applicable to all public-sector audit
engagements, irrespective of their form or context. ISSAIs 200, 300 and 400 build on and further
develop the principles to be applied in the context of financial, performance and compliance
auditing respectively. They should be applied in conjunction with the principles set out in ISSAI
100. The principles in no way override national laws, regulations or mandates or prevent SAIs
from carrying out investigations, reviews or other engagements which are not specifically covered
by the existing ISSAIs.
The fundamental Principles form the core of the General Auditing Guidelines at Level 4 of ISSAI
framework. The principle can be used to establish authoritative standard in three ways:
• As a basis on which SAIs can develop standard
• As a basis for the adoption of consistent national standard
• As a basis for adoption of General Auditing Guidelines as standard
SAIs should declare which standard they apply when conducting audits and such should be
accessible to the user either as a part of audit reports or any other general form of communication.
SAI may declare that the standards it has developed or adopted are based on or are consistent
with the Fundamental Auditing Principles only if the standards fully comply with all relevant
principles. Such reference may be made by stating in audit report:
… We conducted our audit in accordance with [standards], which are based on [or consistent
with] the Fundamental Auditing Principles (ISSAIs 100-999) of the International Standards of
Supreme Audit Institutions.
SAIs may choose to adopt the General Auditing Guidelines as their authoritative standards.
In such cases the auditor must comply with all ISSAIs relevant to the audit. Reference to the
ISSAIs applied may be made by stating:
… We conducted our audit[s] in accordance with the International Standards of Supreme Audit
Institutions.
In order to enhance transparency, the statement may further specify which ISSAI or range
of ISSAIs the auditor has considered relevant and applied. This may be done by adding the
following phrase:

….The audit[s] was [were] based on ISSAI[s] xxx [number and name of the ISSAI or range of
ISSAIs].
SAI will exercise its public-sector audit function within a specific constitutional arrangement
and by virtue of its office and mandate, which ensure sufficient independence and power of
discretion in performing its duties. The mandate of a SAI may define its general responsibilities
in the field of public-sector auditing and provide further prescriptions concerning the audits
and other engagements to be performed.
Objective of Public-Sector Auditing

The public-sector audit environment is that in which governments and other public-sector
entities exercise responsibility for the use of resources derived from taxation and other sources
in the delivery of services to citizens and other recipients. These entities are accountable for
their management and performance, and for the use of resources, both to those that provide the
resources and to those, including citizens, who depend on the services delivered using those
resources. Public-sector auditing helps to create suitable conditions and reinforce the expectation
that public-sector entities and public servants will perform their functions effectively, efficiently,
ethically and in accordance with the applicable laws and regulations.
Public sector auditing can be described as a systematic process of objectively obtaining and
evaluating evidence to determine whether information or actual conditions conform to the
established criteria. It is essential in that it provides legislative and oversight bodies, those
charged with governance and the general public with information and independent and objective
assessments concerning the stewardship and performance of government policies, programmes
or operations.
All public-sector audits start from objectives, which may differ depending on the type of audit
being conducted. However, all public-sector auditing contributes to good governance by:
• Providing an independent, objective and reliable information, conclusion or opinions

based on sufficient and appropriate evidence relating to public entities;
• Enhancing the accountability and transparency, encouraging continuous improvement

and sustained confidence in the appropriate use of public funds and assets and the
performance of public administration;
• reinforcing the effectiveness of those bodies within the constitutional arrangement

that exercise general monitoring and corrective functions over government, and those
responsible for the management of publicly-funded activities;
• Creating incentives for change by providing knowledge, comprehensive analysis and

well-founded recommendations for improvement.

AUDIT AND ASSURANCE
Provision of Legal Compliance

Section 10 of Audit Act 2075: Audit of corporate body fully owned by Government of Nepal, State
Government, And Local Level:
a) The audit of the corporate bodies wholly owned by Government of Nepal, State
Government and Local Level shall be audited by the Auditor General.
b) If the Auditor General is constrained by time and resources to audit the corporate bodies
wholly owned by Government of Nepal pursuant to Sub-section (1) he/she may appoint
license holder auditors under the prevailing laws an assistant.
c) The auditor appointed pursuant to Sub-section (2) shall act under the direction,
supervision and control of the Auditor General.
d) The powers, functions, duties and responsibilities of the auditors appointed pursuant to
Sub-section (2) and the procedures to be followed by them in course audit and provisions
relating to their report shall be as prescribed by the Auditor General.
e) The remuneration to be paid by the concerned organization to the auditors appointed

pursuant to Sub-section (2) shall be fixed by the Auditor General keeping in view the
volume of financial transactions, status of accounts, number of branches and sub-
branches, work load and work progress of the concerned organization.
Section 11 of Audit Act 2075 : Audit of corporate body substantially owned by Government of
Nepal:
a) The audit of corporate body partially owned by Government of Nepal shall be done in
under the principles prescribed by Auditor General.
b) The Auditor General shall be consulted while appointing an auditor for such corporate
bodies.
c) The concerned organization shall deliver at the Office of the Auditor General a copy of
the report submitted by the auditor appointed in consultation with the Auditor General
pursuant to Sub-section (2).
d) The Auditor General may issue directives to the concerned organization and the auditor
in respect of the irregularities observed in the report received pursuant to Sub-section
(4) and it shall be the duty of concerned organization and the auditor to abide by such
directives.
e) The concerned organization shall deliver the progress report of implementation of

directives issued in respect of the irregularities observed in the report submitted by the
auditor within prescribed time limit.

Types of Public-Sector Audit

In general, public-sector audits can be categorized into one or more of three main types:
• Audits of financial statements;
• Audits of compliance with authorities and
• Performance audits.
a. Audits Of Financial Statements

Financial audit focuses on determining whether an entity’s financial information is presented
in accordance with the applicable financial reporting and regulatory framework. This is
accomplished by obtaining sufficient and appropriate audit evidence to enable the auditor to
express an opinion as to whether the financial information is free from material misstatement
due to fraud or error.
ISSAI 200 provides the fundamental principles for an audit of financial statements prepared
in accordance with a financial reporting framework. The principles also apply when SAI
is engaged or has responsibility to audit single financial statements and specific elements,
accounts or items of a financial statement, or financial statements prepared in accordance with
special-purpose financial frameworks, or summary financial statements. Where reference is
made in ISSAI 200 to audits of financial statements, this includes responsibilities of this nature.
The subject matter of a financial audit is financial position, performance, cash flow or other
elements which are recognized, measured and presented in financial statements. The subject
matter information is the financial statement. A complete set of financial statements for a
public-sector entity, when prepared in accordance with a financial reporting framework for
the public sector, normally consists of:
• a statement of financial position;
• a statement of financial performance;
• a statement of changes in net assets/equity;
• a cash flow statement;
• a comparison of budget and actual amounts – either as a separate additional financial

statement or as a reconciliation;
• notes, comprising a summary of significant accounting policies and other explanatory

information.
• In certain environments a complete set of financial statements may also include other
reports, such as reports on performance and appropriation reports.

AUDIT AND ASSURANCE
Pre-conditions for an Audit of Financial Statements in Accordance with the ISSAIs

A financial audit conducted in accordance with the ISSAIs is premised on the following
conditions:
• The financial reporting framework used for preparation of the financial statements is
deemed to be acceptable by the auditor.
• The management of the entity acknowledges and understands its responsibility:
o For preparation of the financial statements in accordance with the applicable

financial reporting framework, including, where relevant, their fair presentation;
o For such internal control that management deems necessary for the preparation of
financial statements that are free from material misstatement, whether due to fraud
or error; and
o To provide the auditor with unrestricted access to all information of which it is

aware and that is relevant to the preparation of the financial statements.
The auditor should access whether the preconditions for an audit of financial statement have
been met.
Frameworks prescribed by law or regulation will often be deemed acceptable by the auditor.
However, even if deemed unacceptable, such a framework may be allowable if:
• the management agrees to provide the necessary additional disclosures in the financial
statements to avoid their being misleading; and
• the auditor’s report on the financial statements includes an Emphasis of Matter paragraph
drawing users’ attention to such additional disclosures.
Acceptable financial reporting framework normally exhibits certain attributes which ensures
that the information provided in the financial statement is of value to intended users:
• Relevance
• Completeness
• Reliability
• Neutrality and objectivity
• Understandability
In some public-sector audit environments, financial audits are referred to as budget execution
audits, which often include the examination of transactions against the budget for compliance
and regularity issues. Such audits may be undertaken on a risk basis or with the aim of
covering all transactions. In such audit environments there is often no acceptable financial

reporting framework. The results of financial transactions may be presented as a comparison

between expenditure amounts and budgetary amounts. In environments where such audits
are undertaken and there are no financial statements presented in accordance with an
acceptable financial reporting framework, the auditor may conclude that the preconditions
for an audit established by the ISSAIs on financial audit are not in place. Auditors may thus
consider developing standards using the Fundamental Principles of Financial Auditing as
guidance to suit their specific needs. Where the audit mandate refers to financial audit but
does not link this to financial statements prepared in accordance with a financial reporting
framework, it is proposed that the ISSAIs be considered best available practice and the spirit
of the ISSAIs be implemented through standards devised for the specific environment.
Where the audit mandate refers to audits of single financial statements and specific elements,
accounts or items of a financial statement, ISSAI 1805 may be relevant.
Audits of Financial Statements Prepared In Accordance With Special-Purpose Frameworks

The principles of ISSAI 200 are applicable to audits of financial statements prepared in
accordance with both general-purpose and special-purpose frameworks. Financial statements
prepared for a special purpose are not appropriate for the general public. Auditors should,
therefore, carefully examine whether the financial reporting framework is designed to meet
the financial information needs of a wide range of users (general-purpose framework) or of
specific users, or the requirements of a standard-setting body.
Special-purpose frameworks relevant to the public sector may include:
• the cash receipts and disbursements basis of accounting for cash flow information that
an entity may be required to prepare for a governing body;
• the financial reporting provisions established by an international funding organization

or mechanism;
• the financial reporting provisions established by a governing body, the legislature or other
parties that perform an oversight function to meet the requirements of that body; or
• the financial reporting provisions of a contract, such as a project grant.
Audits of Single Financial Statements and Specific Elements, Accounts or Items of a

Financial Statement
The principles of ISSAI 200 are also applicable to audits of public-sector entities that prepare
financial information, including single financial statements or specific elements, accounts or
items of a financial statement, for other parties (such as governing bodies, the legislature
or other parties with an oversight function). Such information may come under the audit
mandate of the SAI. Auditors may also be engaged to audit single financial statements, or
specific elements, accounts or items – such as projects financed by the government –although
they are not engaged to audit the complete set of financial statements of the entity concerned.

AUDIT AND ASSURANCE
SAIs may also find it useful to consider the requirements and guidance in ISSAI 1805 when
developing or adopting standards based on the principles in ISSAI 200. ISSAI 1805 deals
with special considerations in the application of the requirements of the ISAs to an audit of
a single financial statement or of a specific element, account or item of a financial statement.
The single financial statement or the specific element, account or item of a financial statement
may be prepared in accordance with a general-purpose or special-purpose framework.
b. Audits of compliance with authorities

ISSAI 400 – Fundamental Principles of Compliance Auditing builds on and further develops
the fundamental principles of ISSAI 100 to suit the specific context of compliance auditing.
Compliance auditing is the independent assessment of whether a given subject matter is in
compliance with applicable authorities identified as criteria. Compliance audits are carried
out by assessing whether activities, financial transactions and information comply, in all
material respects, with the authorities which govern the audited entity. These authorities may
include rules, laws and regulations, budgetary resolutions, policy, established codes, agreed
terms or the general principles governing sound public-sector financial management and the
conduct of public officials.
The subject matter in the compliance audit is defined by the scope of the audit. It may be
activities, financial transactions or information. For attestation engagements on compliance
it is more relevant to focus on the subject matter information, which may be a statement of
compliance in accordance with an established and standardized reporting framework?
Compliance auditing is often an integral part of an SAI’s mandate for the audit of public-sector
entities. This is because legislation and other authorities are the primary means by which
legislatures exercise control of income and expenditure, management and the rights of citizens
to due process in their relations with the public sector. Public-sector entities are entrusted with
the sound management of public funds. It is the responsibility of public-sector bodies and their
appointed officials to be transparent about their actions and accountable to citizens for the funds
with which they are entrusted, and to exercise good governance over those funds.
Compliance auditing promotes transparency by providing reliable reports as to whether

funds have been administered, management exercised and citizens’ rights to due process
honored as required by the applicable authorities. It promotes accountability by reporting
deviations from and violations of authorities, so that corrective action may be taken and those
accountable may be held responsible for their actions. It promotes good governance both by
identifying weaknesses and deviations from laws and regulations and by assessing propriety
where there are insufficient or inadequate laws and regulations. Fraud and corruption are,
by their very nature, elements which counteract transparency, accountability and good
stewardship. Compliance auditing therefore promotes good governance in the public sector
by considering the risk of fraud in relation to compliance.

The different perspectives of compliance auditing

Compliance audit can be part of a combined audit that may also include other aspects.
Compliance audit is generally conducted either in relation with financial audit or in
combination with performance audit. When compliance auditing is part of a performance
audit, compliance is seen as one of the aspects of economy, efficiency and effectiveness. Non-
compliance may be the cause of, an explanation for, or a consequence of, the state of the
activities that are the subject of the performance audit.
Compliance audit may also be planned performed and reported on separately from the audit
of financial statements and from performance audits. ISSAI 4100 provides guidance in this
regard. Compliance audits may be conducted separately on a regular or an ad hoc basis, as
distinct and clearly-defined audits each related to a specific subject matter.
c. Performance Audit
ISSAI 300 - Fundamental Principles of Performance Auditing builds on and further develops
the fundamental principles of ISSAI 100 to suit the specific context of performance auditing.
Performance auditing is an independent, objective and reliable examination of whether
government undertakings, systems, operations, programmes, activities or organizations are
operating in accordance with the principles of economy, efficiency and effectiveness and
whether there is room for improvement.
Performance auditing seeks to provide new information, analysis or insights and, where
appropriate, recommendations for improvement. Performance audits deliver new
information, knowledge or value by:
• providing new analytical insights (broader or deeper analysis or new perspectives);
• making existing information more accessible to various stakeholders;
• providing an independent and authoritative view or conclusion based on audit evidence;
• providing recommendations based on an analysis of audit findings.
The subject matter of a financial audit is defined by the audit objective and audit questions.
The subject matter may be specific programmes, entities or funds or certain activities (with
their output, impact and outcomes), existing situation (including causes and consequences)
as well as financial and non-financial information about any of these elements. The auditor
measures and evaluates the subject matter to access the extent to which the established criteria
have or have not been met.

AUDIT AND ASSURANCE
Economy, efficiency and effectiveness

The principles of economy, efficiency and effectiveness can be defined as follows:
• The principle of economy means minimizing the costs of resources. The resources used
should be available in due time, in and of appropriate quantity and quality and at the
best price.
• The principle of efficiency means getting the most from the available resources. It is
concerned with the relationship between resources employed and outputs delivered in
terms of quantity, quality and timing.
• The principle of effectiveness concerns meeting the objectives set and achieving the
intended results.
Performance audits often include an analysis of the conditions that are necessary to ensure that
the principles of economy, efficiency and effectiveness can be upheld. These conditions may
include good management practices and procedures to ensure the correct and timely delivery
of services. Where appropriate, the impact of the regulatory or institutional framework on the
performance of the audited entity should also be taken into account.
Performance auditing promotes accountability by assisting those with governance and

oversight responsibilities to improve performance. It does this by examining whether
decisions by the legislature or the executive are efficiently and effectively prepared and
implemented, and whether taxpayers or citizens have received value for money. It also
promotes transparency by affording parliament, taxpayers and other sources of finance,
those targeted by government policies and the media an insight into the management and
outcomes of different government activities
9.4 ELEMENTS OF PUBLIC SECTOR AUDITING
All public-sector audits have the same basic elements: the auditor, the responsible party, intended
users (the three parties to the audit), criteria for assessing the subject matter and the resulting
subject matter information. They can be categorized as two different types of audit engagement:
attestation engagements and direct reporting engagements.
I) The Three Parties

Public sector audit includes at least three separate parties: the auditor, a responsible party
and intended user.
• The auditor: In public sector auditing the role of the auditor is fulfilled by the Head of the
SAI and the persons to whom the task of conducting the audits is delegated. The overall
responsibility of public sector auditing remains as defined by SAI’s mandate.

• The responsible party: In public sector auditing the relevant responsibility are determined
by constitutional and legislative arrangement. The responsible party is responsible
for the subject matter information, for managing the subject matter or for addressing
recommendations, and may be individuals or organizations.
• Intended users: The individuals, organizations or classes thereof for whom the auditor
prepares the audit report. The intended user may be the legislative or oversight bodies,
those charged with governance or the general public.
II) Subject Matter, Criteria and Subject Matter Information

The subject matter refers to the information, condition or activity that is measured or
evaluated against certain criteria. It can take many forms and have different characteristics
depending on the audit objective. An appropriate subject matter is identifiable and capable
of consistent evaluation or measurement against the criteria, such that it can be subjected
to procedures for gathering sufficient and appropriate audit evidence to support the audit
opinion or conclusion.
The criteria are the benchmarks used to evaluate the subject matter. Each audit should have
criteria suitable to the circumstances of that audit. In determining the suitability of criteria the
auditor considers their relevance and understandability for the intended users, as well as their
completeness, reliability and objectivity (neutrality, general acceptance and comparability
with the criteria used in similar audits). They should be made available to the intended users
to enable them to understand how the subject matter has been evaluated or measured.
The subject matter information refers to the outcome of evaluating or measuring the subject
matter against the criteria. It can take many forms and have different characteristics depending
on the audit objective and audit scope.
9.5 TYPES OF ENGAGEMENT
There are two types of engagement:
• In attestation engagements the responsible party measures the subject matter against the
criteria and presents the subject matter information, on which the auditor then gathers
sufficient and appropriate audit evidence to provide a reasonable basis for expressing a
conclusion.
• In direct reporting engagements it is the auditor who measures or evaluates the subject
matter against the criteria. The auditor selects the subject matter and criteria, taking
into consideration risk and materiality. The outcome of measuring the subject matter
against the criteria is presented in the audit report in the form of findings, conclusions,
recommendations or an opinion. The audit of the subject matter may also provide new
information, analyses or insights.

AUDIT AND ASSURANCE
Financial audits are always attestation engagements, as they are based on financial information
presented by the responsible party. Performance audits are normally direct reporting engagements.
Compliance audits may be attestation or direct reporting engagements, or both at once.
Confidence and Assurance In Public-Sector Auditing

The intended users will wish to be confident about the reliability and relevance of the information
which they use as the basis for taking decisions. Audits provide information based on sufficient
and appropriate evidence, and auditors should perform procedures to reduce or manage the risk
of reaching inappropriate conclusions. The level of assurance that can be provided to the intended
user should be communicated in a transparent way. Due to inherent limitations, however, audits
can never provide absolute assurance.
Depending on the audit and the users’ needs, assurance can be communicated in two ways:
• Through opinions and conclusions which explicitly convey the level of assurance. This
applies to all attestation engagements and certain direct reporting engagements.
• In other forms. In some direct reporting engagements the auditor does not give an
explicit statement of assurance on the subject matter. In such cases the auditor provides
the users with the necessary degree of confidence by explicitly explaining how findings,
criteria and conclusions were developed in a balanced and reasoned manner, and
why the combinations of findings and criteria result in a certain overall conclusion or
recommendation.
Reasonable assurance is high but not absolute. The audit conclusion is expressed positively,
conveying that, in the auditor's opinion, the subject matter is or is not compliant in all material
respects, or, where relevant, that the subject matter information provides a true and fair view, in
accordance with the applicable criteria.
When providing limited assurance, the audit conclusion states that, based on the procedures
performed, nothing has come to the auditor’s attention to cause the auditor to believe that the
subject matter is not in compliance with the applicable criteria. The procedures performed
in a limited assurance audit are limited compared with what is necessary to obtain reasonable
assurance, but the level of assurance is expected, in the auditor's professional judgement, to be
meaningful to the intended users. A limited assurance report conveys the limited nature of the
assurance provided.

9.6 PRINCIPLES OF PUBLIC SECTOR AUDITING
Auditing is a cumulative and iterative process. However, for the purposes of presentation the
fundamental principles are grouped by principles related to the SAI’s organizational requirements,
general principles that the auditor should consider prior to commencement and at more than one
point during the audit and principles related to specific steps in the audit process.
a. General Principles
Ethics and Independence
Auditors should comply with the relevant ethical requirements and be independent. The
SAIs should have policies addressing ethical requirements and emphasizing the need for
compliance by each auditor. Auditors should remain independent so that their reports will be
impartial and be seen as such by the intended users. Guidance on the key ethical principles of

AUDIT AND ASSURANCE
integrity, objectivity, professional competence and due care, confidentiality and professional
behavior are defined in ISSAI 30 – Code of Ethics.
Professional Judgement, Due Care and Skepticism

Auditors should maintain appropriate professional behavior by applying professional
skepticism, professional judgment and due care throughout the audit The auditor’s attitude
should be characterized by professional skepticism and professional judgement, which are to
be applied when forming decisions about the appropriate course of action. Auditors should
exercise due care to ensure that their professional behavior is appropriate.
Professional skepticism means maintaining professional distance and an alert and questioning
attitude when assessing the sufficiency and appropriateness of evidence obtained throughout
the audit. It also entails remaining open-minded and receptive to all views and arguments.
Professional judgement implies the application of collective knowledge, skills and experience
to the audit process. Due care means that the auditor should plan and conduct audits in a
diligent manner. Auditors should avoid any conduct that might discredit their work.
Quality Control
Auditors should perform the audit in accordance with professional standards on quality
control. SAI’s quality control policies and procedures should comply with professional
standards, the aim being to ensure that audits are conducted at a consistently high level.
Quality control procedures should cover matters such as the direction, review and supervision
of the audit process and the need for consultation in order to reach decisions on difficult or
contentious matters. Auditors can find additional guidance in ISSAI 40 – Quality Control for
SAIs.
Audit Team Management and Skills

The individuals in the audit team should collectively possess the knowledge, skills and
expertise necessary to successfully complete the audit. This includes an understanding and
practical experience of the type of audit being conducted, familiarity with the applicable
standards and legislation, an understanding of the entity’s operations and the ability and
experience to exercise professional judgement. Common to all audits is the need to recruit
personnel with suitable qualifications, offer staff development and training, prepare manuals
and other written guidance and instructions concerning the conduct of audits, and assign
sufficient audit resources. Auditors should maintain their professional competence through
ongoing professional development.
Some SAIs use the work of other auditors at state, provincial, regional, district or local level,
or of public accounting firms that have completed audit work related to the audit objective.
Arrangements should be made to ensure that any such work was carried out in accordance
with public-sector auditing standards.

Audits may require specialized techniques, methods or skills from disciplines not available
within the SAI. In such cases experts may be used to provide knowledge or carry out specific
tasks or for other purposes.
Audit Risk
Auditors should manage the risks of providing a report that is inappropriate in the
circumstances of the audit. The auditor performs procedures to reduce or manage the risk
of reaching inappropriate conclusions, recognizing that the limitations inherent to all audits
mean that an audit can never provide absolute certainty of the condition of the subject matter.
When the objective is to provide reasonable assurance, the auditor should reduce audit risk
to an acceptably low level given the circumstances of the audit. The audit may also aim to
provide limited assurance, in which case the acceptable risk that criteria are not complied
with is greater than in a reasonable assurance audit. A limited assurance audit provides a
level of assurance that, in the auditor’s professional judgment, will be meaningful to the
intended users.
Materiality
Auditors should consider materiality throughout the audit process. A matter can be judged
material if knowledge of it would be likely to influence the decisions of the intended users.
Determining materiality is a matter of professional judgement and depends on the auditor’s
interpretation of the users’ needs. This judgement may relate to an individual item or to a
group of items taken together. Materiality is often considered in terms of value, but it also
has other quantitative as well as qualitative aspects. The inherent characteristics of an item or
group of items may render a matter material by its very nature. A matter may also be material
because of the context in which it occurs.
Materiality considerations affect decisions concerning the nature, timing and extent of audit
procedures and the evaluation of audit results. Considerations may include stakeholder
concerns, public interest, regulatory requirements and consequences for society.
Documentation
Auditors should prepare audit documentation that is sufficiently detailed to provide a clear
understanding of the work performed, evidence obtained and conclusions reached.
Audit documentation should include an audit strategy and audit plan. It should record the
procedures performed and evidence obtained and support the communicated results of the
audit.
Documentation should be sufficiently detailed to enable an experienced auditor, with

no prior knowledge of the audit, to understand the nature, timing, scope and results of
the procedures performed, the evidence obtained in support of the audit conclusions and

AUDIT AND ASSURANCE
recommendations, the reasoning behind all significant matters that required the exercise of
professional judgement, and the related conclusions.
Communication
Auditors should establish effective communication throughout the audit process. It is essential
that the audited entity be kept informed of all matters relating to the audit. This is key to
developing a constructive working relationship. Communication should include obtaining
information relevant to the audit and providing management and those charged with
governance with timely observations and findings throughout the engagement. The auditor
may also have a responsibility to communicate audit-related matters to other stakeholders,
such as legislative and oversight bodies.
b. Principles Related to the Audit Process

Planning an Audit
Auditors should ensure that the terms of the audit have been clearly established. Audits
may be required by statute, requested by a legislative or oversight body, initiated by the
SAI or carried out by simple agreement with the audited entity. In all cases the auditor,
the audited entity’s management, those charged with governance and others as applicable
should reach a common formal understanding of the terms of the audit and their respective
roles and responsibilities.
Auditors should obtain an understanding of the nature of the entity/programme to

be audited. This includes understanding the relevant objectives, operations, regulatory
environment, internal controls, financial and other systems and business processes, and
researching the potential sources of audit evidence. Knowledge can be obtained from
regular interaction with management, those charged with governance and other relevant
stakeholders. This may mean consulting experts and examining documents (including earlier
studies and other sources) in order to gain a broad understanding of the subject matter to be
audited and its context.
Auditors should conduct a risk assessment or problem analysis and revise this as necessary in
response to the audit findings. The auditor should consider and assess the risk of different types
of deficiencies, deviations or misstatements that may occur in relation to the subject matter. Both
general and specific risks should be considered. This can be achieved through procedures that
serve to obtain an understanding of the entity or programme and its environment, including the
relevant internal controls. The auditor should assess the management’s response to identified
risks, including its implementation and design of internal controls to address them. In a problem
analysis the auditor should consider actual indications of problems or deviations from what
should be or is expected. This process involves examining various problem indicators in order
to define the audit objectives. The identification of risks and their impact on the audit should be
considered throughout the audit process.

Auditors should identify and assess the risks of fraud relevant to the audit objectives.
Auditors should make enquiries and perform procedures to identify and respond to the risks
of fraud relevant to the audit objectives. They should maintain an attitude of professional
skepticism and be alert to the possibility of fraud throughout the audit process.
Auditors should plan their work to ensure that the audit is conducted in an effective and
efficient manner. Planning for a specific audit includes strategic and operational aspects.
Strategically, planning should define the audit scope, objectives and approach. The objectives
refer to what the audit is intended to accomplish. The scope relates to the subject matter
and the criteria which the auditors will use to assess and report on the subject matter, and
is directly related to the objectives. The approach will describe the nature and extent of the
procedures to be used for gathering audit evidence. The audit should be planned to reduce
audit risk to an acceptably low level.
Operationally, planning entails setting a timetable for the audit and defining the nature,
timing and extent of the audit procedures. During planning, auditors should assign the
members of their team as appropriate and identify other resources that may be required, such
as subject experts.
Audit planning should be responsive to significant changes in circumstances and conditions.

It is an iterative process that takes place throughout the audit.
Conducting an Audit
Auditors should perform audit procedures that provide sufficient appropriate audit evidence
to support the audit report. The auditor’s decisions on the nature, timing and extent of audit
procedures will impact on the evidence to be obtained. The choice of procedures will depend
on the risk assessment or problem analysis. Evidence should be both sufficient (quantity) to
persuade a knowledgeable person that the findings are reasonable, and appropriate (quality)
– i.e. relevant, valid and reliable. The auditor’s assessment of the evidence should be objective,
fair and balanced. Preliminary findings should be communicated to and discussed with the
audited entity to confirm their validity.
Auditors should evaluate the audit evidence and draw conclusions. After completing the
audit procedures, the auditor will review the audit documentation in order to determine
whether the subject matter has been sufficiently and appropriately audited. Before drawing
conclusions, the auditor reconsiders the initial assessment of risk and materiality in the light
of the evidence collected and determines whether additional audit procedures need to be
performed.
Based on the findings, the auditor should exercise professional judgement to reach a
conclusion on the subject matter or subject matter information.

AUDIT AND ASSURANCE
Reporting and Follow-Up

Auditors should prepare a report based on the conclusions reached. The audit process
involves preparing a report to communicate the results of the audit to stakeholders, others
responsible for governance and the general public. The purpose is also to facilitate follow-up
and corrective action. In some SAIs, such as courts of audit with jurisdictional authority, this
may include issuing legally binding reports or judicial decisions.
The form and content of a report will depend on the nature of the audit, the intended users,
the applicable standards and legal requirements. The SAI’s mandate and other relevant laws
or regulations may specify the layout or wording of reports, which can appear in short form
or long form.
Long-form reports generally describe in detail the audit scope, audit findings and conclusions,
including potential consequences and constructive recommendations to enable remedial
action. Short-form reports are more condensed and generally in a more standardized format.
Attestation engagements
In attestation engagements the audit report may express an opinion as to whether the subject
matter information is, in all material respects, free from misstatement and/or whether the
subject matter complies, in all material respects, with the established criteria. In an attestation
engagement the report is generally referred to as the Auditor’s Report.
Direct engagements
In direct engagements the audit report needs to state the audit objectives and describe how
they were addressed in the audit. It includes findings and conclusions on the subject matter
and may also include recommendations. Additional information about criteria, methodology
and sources of data may also be given, and any limitations to the audit scope should be
described.
The audit report should explain how the evidence obtained was used and why the resulting
conclusions were drawn. This will enable it to provide the intended users with the necessary
degree of confidence.
Opinion
When an audit opinion is used to convey the level of assurance, the opinion should be in a
standardized format. The opinion may be unmodified or modified. An unmodified opinion is
used when either limited or reasonable assurance has been obtained. A modified opinion may be:
• Qualified (except for) – where the auditor disagrees with, or is unable to obtain sufficient
and appropriate audit evidence about, certain items in the subject matter which are, or
could be, material but not pervasive;

• Adverse – where the auditor, having obtained sufficient and appropriate audit evidence,
concludes that deviations or misstatements, whether individually or in the aggregate,
are both material and pervasive;
• Disclaimed – where the auditor is unable to obtain sufficient and appropriate audit
evidence due to an uncertainty or scope limitation which is both material and pervasive.
Where the opinion is modified, the reasons should be put in perspective by clearly explaining,
with reference to the applicable criteria, the nature and extent of the modification. Depending
on the type of audit, recommendations for corrective action and any contributing internal
control deficiencies may also be included in the report.
Follow-up
SAIs has a role in monitoring action taken by the responsible party in response to the matters
raised in an audit report. Follow-up focuses on whether the audited entity has adequately
addressed the matters raised, including any wider implications. Insufficient or unsatisfactory
action by the audited entity may call for a further report by the SAI.

AUDIT AND ASSURANCE
Question 1 In carrying out audit of Government expenditure, what are the basic standards that
you will examine and consider?
Question 2 What are the primary types of audit in public sector?
Question 3 Explain the difference between-
- Efficiency, economy and effectiveness.
- Propriety audit and performance audit

CHAPER 10 : COMPLETING AND REPORTING ON AN ASSURANCE ENGAGEMENT
CHAPTER 10
COMPLETING AND REPORTING ON

AN ASSURANCE ENGAGEMENT
To be able to understand-
 Concept of hot and cold review
 The concept of forming an opinion on financial statements
 Knowledge of modifications to audit opinion
 Concept of Emphasis of Matter
 Communicating key audit matters in the independent auditor’s

report
 Consideration of subsequent events

AUDIT AND ASSURANCE
2.1 QUALITY CONTROL AND REVIEW PROCEDURE
As per Nepal Standard on Quality Control, it is the objective of the firm to establish and maintain
a system of quality control to provide it with reasonable assurance that:
- The firm and its personnel comply with professional standards and applicable legal and
regulatory requirements; and
- Reports issued by the firm or engagement partners are appropriate in the circumstances.
Beside NSQC there can be local quality control standards as well by the bodies regulating the
auditor’s work in specific jurisdiction with almost similar objectives to be achieved.
Although there are many elements and aspects of audit firm and auditor’s work get included but
the foremost is the auditor’s report to ensure whether objectives of the audit have been achieved
or not. There are techniques called Peer Review, hot file review (also known as hot review), cold
file review (also known as cold review) and quality assurance review.
a. Peer Review
This is a critical independent review of one public accounting firm practices by another public
accounting firm. It is a review of the firm’s accounting and auditing practices. It is intended
that the review be done by practitioners upon fellow practitioners.
Such an external review offers a more objective evaluation of the quality of performance than
could be done by self review.
Peer review study the adequacy of the firms established quality control policies and tests to
determine the extent of the firms compliance to these policies.
Suggestions for improvement to the system are outlined in a letter of comments issued by
peer reviewers to the reviewed firm. If a firm fails to take appropriate corrective action,
various actions may be imposed e.g. suspension from membership.
In carrying out the review it is limited to:-
• Professional aspects of the practice.
• The overall total quality control policies.
• Professional aspect of the firms accounting and auditing practices like maintenance of
working papers and work products such as report to the financial statements.

b. Hot file review

Hot file review or hot review is conducted usually conducted during the audit and/or audit
work is completed but before the auditor’s report is issued. This in nature is a detailed review
that is conducted with an aim to find out if there is any weakness in application of audit
procedures or if the results have been misinterpreted. Hot reviews are usually carried out
usually by the senior the audit team or someone with the same authority who is not connected
with the engagement. Such reviews mostly include meetings with audit team personnel and
their individual work so that both work and the skills of members are improved by pointing
out discrepancies and providing recommendations.
The purpose of a hot review is to identify any key areas that need to be addressed prior to
signing the report. The categories for review which may be undertaken can be described as
follows:
• Comfort reviews
Number of firms, for their largest clients (not necessarily high risk clients), feel a little
exposed and want someone else to review the work before the job is complete.
• High risk reviews
One off review may be required on files in circumstances where, for example, the company
is being sold and the firm feels that having a review undertaken by an independent party
will help to decrease their risk.
• Training reviews
Where key audit staff have left, a manager-style review on files may be undertaken in
order to train a new manager or partner.
• Independence reviews
Some sole practitioners require an outside review to ensure that it is reasonable for them
to maintain an audit assignment when independence might be called into question. This
is particularly the case where individuals have been an audit partner for more than seven
years.
• NSQC reviews
The NSQC1: “Quality control for firms that perform audits and reviews of historical
financial information, and other assurance and related services engagements”, requires
an independent hot review for all listed work and certain other high profile or high risk
work.

AUDIT AND ASSURANCE
To summarize, hot review is conducted during the audit work is conducted but before the
auditor’s report is issued with a prime objective to ensure compliance with relevant auditing
standards and achieving engagement’s objectives
c. Cold file review:

Cold file review or cold review is an objective evaluation on the date of auditor’s report and is
performed by the auditor i.e. partner himself when all the audit work has been concluded and
the required sufficient appropriate audit evidence has been obtained and conclusions drawn
and reported. This review usually takes place when the auditor’s report is signed off. The
purpose of this review is to ensure compliance with relevant auditing standards and to analyze
weaknesses in the way whole audit work is conducted and how it can be improved for next
similar assignments by updating firm’s quality control standards, training the staff etc.
Normally the cold file review would aim to:
• Identify whether the disclosure requirements had been properly met - incorrect
disclosures are the largest subject of complaints to the Institute.
• Identify whether the Auditing Standards and Regulations have been properly complied
with - each audit would be "scored" using a comprehensive file review checklist.
• Assess the effectiveness of any independent manager review and the partner review,
looking for any points that should have been picked up by a manager but had not been,
and likewise with the partner.
To summarize, cold review is conducted with a view to check for the weaknesses in the firm’s
quality control procedures and system, proficiency of audit team members and how they can
be improved to make later audit assignment more effective and efficient.
2.2 CONSIDERATION OF SUBSEQUENT EVENTS
During the course of audit, many events may be identified and known even after completion of
audit. Such events those that are identified after the audit (whether existed at balance sheet date
or not) are called subsequent events.
The auditor should consider the effect of subsequent events on the financial statements and on
the auditor’s report. As per NAS 10 Events after the Reporting period deals with the treatment
in financial statements of events, favorable and unfavorable, occurring between the end of the
reporting period and the date when the financial statements are authorised for issue and identifies
two types of events:
(a) Those that provide evidence of conditions that existed at the end of reporting period;
(b) Those that are indicative of conditions that arose subsequent to reporting period.

The objectives of auditor are to:
a) Obtain the sufficient appropriate audit evidence about whether events occurring
between the date of financial statements and the date of the auditor’s report that require
adjustment of, or disclosure in, the financial statements in accordance with the applicable
financial reporting framework; and
b) Respond appropriately to facts that become known to the auditor after the date of
auditor’s report, that, had they been known to the auditor at that date, may have caused
the auditor to amend the auditor’s report.
Events Occurring between the date of financial statements and the Date of the Auditor’s Report
(Auditor has active duty)
The auditor should perform procedures designed to obtain sufficient appropriate audit evidence
that all events up to the date of the auditor’s report that may require adjustment of, or disclosure
in, the financial statements have been identified.
The procedures to identify events that may require adjustment of, or disclosure in, the financial
statements would be performed as near as practicable to the date of the auditor’s report and
ordinarily include the following:
 Reviewing procedures management has established to ensure that subsequent events

are identified,
 Reading minutes of the meetings of shareholders, the board of directors and audit and
executive committees held after period end and inquiring about matters discussed at
meetings for which minutes are not yet available,
 Reading the entity’s latest available interim financial statements and, as considered
necessary and appropriate, budgets, cash flow forecasts and other related management
reports,
 Inquiring, or extending previous oral or written inquiries, of the entity’s lawyers

concerning litigation and claims
 Inquiring of management and where appropriate those charged with governance

as to whether any subsequent events have occurred which might affect the financial
statements.
The auditor shall request written representation from management and where appropriate those
charged with corporate governance, that all events occurring subsequent to the date of financial
statements and for which applicable financial reporting framework requires adjusment or
disclosure have been adjusted or disclosed.

AUDIT AND ASSURANCE
When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for and adequately disclosed
in the financial statements.
Facts discovered after the Date of the Auditor’s Report but Before the Financial Statements are
issued (Auditor has Passive duty)
The auditor does not have any responsibility to perform procedures or make any inquiry regarding
the financial statements after the date of the auditor’s report. During the period from the date of
the auditor’s report to the date the financial statements are issued, the responsibility to inform the
auditor of facts which may affect the financial statements rests with management.
When, after the date of the auditor’s report but before the financial statements are issued, the
auditor becomes aware of a fact which may materially affect the financial statements, the auditor
should consider whether the financial statements need amendment, should discuss the matter
with management and, where appropriate those charged with governance and determine whether
the financial statements need amendment and if so inquire how management intends to address
the matter in the financial statements..
When management amends the financial statements, the auditor would carry out the procedures
necessary in the circumstances and would provide management with a new report on the
amended financial statements. The new auditor’s report would be dated not earlier than the date
the amended financial statements are signed or approved.
When management does not amend the financial statements in circumstances where the auditor
believes they need to be amended and the auditor’s report has not been released to the entity, the
auditor should express a qualified opinion or an adverse opinion.
When the auditor’s report has been released to the entity, the auditor would notify those persons
ultimately responsible for the overall direction of the entity not to issue financial statements and the
auditor’s report thereon to third parties. If the financial statements are subsequently released, the
auditor needs to take action to prevent reliance on the auditor’s report. The action taken will depend
on the auditor’s legal rights and obligations and the recommendations of the auditor’s lawyer.
Facts Discovered After the Financial Statements Have Been Issued (Auditor has passive duty)
After the financial statements have been issued, the auditor has no obligation to make any inquiry
regarding such financial statements.
When, after the financial statements have been issued, the auditor becomes aware of a fact which
existed at the date of the auditor’s report and which, if known at that date, may have caused the
auditor to modify the auditor’s report, the auditor should consider whether the financial statements
need revision, should discuss the matter with management, and inquire how management intends
to address the matter in the financial statements..

When management revises the financial statements, the auditor would carry out the audit
procedures necessary in the circumstances, would review the steps taken by management to
ensure that anyone in receipt of the previously issued financial statements together with the
auditor’s report thereon is informed of the situation, and would issue a new report on the revised
The new auditor’s report should include an emphasis of a matter paragraph referring to a note to
the financial statements that more extensively discusses the reason for the revision of the previously
issued financial statements and to the earlier report issued by the auditor. The new auditor’s report
would be dated not earlier than the date the revised financial statements are approved.
Offering of Securities to the Public
In cases involving the offering of securities to the public, the auditor should consider any legal
and related requirements applicable to the auditor in all jurisdictions in which the securities are
being offered.
2.3 AUDIT FINALIZATION AND FINAL REVIEW
Before the finalization of the audit, the engagement leader shall review the audit evidence obtained
to consider if sufficient appropriate audit evidence was obtained or if additional audit procedures
are needed. On overall review of the audit evidence obtained, if the engagement leader is unable
to obtain sufficient appropriate audit evidence, he or she shall perform appropriate consultation,
starting with the entity assistant auditor general, to evaluate the impact on the audit report.
An engagement designed to provide a high level of assurance, both positive observations and
negative observations, must be able to withstand critical examination. In determining whether
they have gathered evidence of sufficient quantity and appropriate quality, auditors need to
be certain that, in their judgment, there is a low risk of making erroneous observations, faulty
conclusions, or inappropriate recommendations. In considering whether they have obtained
sufficient appropriate audit evidence, auditors consider the level of assurance being provided and
the assessment of significance and risk. For example, audits that provide a high level of assurance
generally have a higher threshold for what is sufficient appropriate evidence than a review
engagement which provides moderate assurance. Similarly, a high-risk or a significant/material
audit component will typically have a higher threshold for what is sufficient appropriate evidence
than a lower risk audit component.
An audit is a cumulative and iterative process. As audit work proceeds, information may come to
the auditor's attention that differs from the information used to plan the audit. Initial findings may
cause the auditor to re-evaluate the planned audit procedures and the level of evidence gathered,
based on a revised consideration of risks. Before the conclusion of the audit, the same principles
apply— the engagement leader needs to ensure the initial or revised risk assessment applied in the

AUDIT AND ASSURANCE
engagement remains valid. This is necessary since the risk assessment helped direct audit strategy,
planned audit procedures, and the level and extent of evidence gathered.
For special audit like performance audit, analysis of audit evidence can be thought of as building
an argument that leads to conclusions that can withstand critical scrutiny. Working from the
evidence presented in the completed audit programs, teams build the argument, step by step,
for their observations, conclusions, and recommendations. At each step, teams should consider
the possibility that their argument could be flawed if they base it on erroneous or incomplete
information, or that the logic is not convincing.
Teams consider all relevant evidence, regardless of whether it appears to corroborate or contradict
the assertions or audit criteria. Teams should approach the analysis of audit evidence not only
with an objective frame of mind, but also with a level of skepticism. While theories or predictions
about what the audit may conclude are essential to planning and conducting the examination,
teams should be aware of the possibility that their preliminary conclusions are incorrect, and
remain open to alternative interpretations of the evidence. Teams should encourage and be open
to having their findings challenged. This is particularly true when the audited entity provides
interpretations of the evidence. Rather than resisting or even dismissing these other views, teams
should examine the evidence from them.
In making overall review of the audit evidence to ensure whether sufficient appropriate audit
evidence has been obtained, the audit team considers the following questions:
• Has the team obtained audit evidence regarding all relevant assertions and/or criteria?
• Has the team, as part of executing the audit procedures, identified instances where
further evidence was required? If yes, has it obtained, documented, and appropriately
linked this further work?
• Has the team considered the impact of identified issues and/or misstatements on the
nature, timing, and extent of further procedures?
• Has the team identified any significant matters and appropriately addressed them?
• Where appropriate, has it consulted and documented the results of these consultations?
• Has the team addressed all required audit procedures?
• Teams also consider whether the resolution of differences of opinion, quality review
procedures, and consultations undertaken may impact decisions around the sufficiency
and appropriateness of audit evidence?
For special audit like performance audit, when the evidence does not point whether a criterion has
been met—for example, if some positive and some negative evidence exists—the team may need
to investigate further in order to gain the required level of assurance.

This may be required, for example, to
• Determine whether an issue is an isolated instance or represents a systemic problem;
• Determine who is affected by the issue (e.g., other units in the entity, central operation,
or third parties);
• Assess the impact or potential impact of an issue;
• Determine whether the issue can be addressed by the audited entity or whether it results
from circumstances beyond its control; and
• Determine whether entity's management is aware of the issue and whether it has taken
corrective action.
If additional evidence needs to be gathered, this may involve additional interviews or review
of additional files. If evidence is not found in an area where the auditor expects to find it, this
could be a finding in itself. The auditor first needs to confirm that the evidence should exist. For
special audit like performance audit, as the audit team gathers and analyzes audit evidence during
the examination phase, it meets with entity officials to communicate emerging findings and seek
confirmation and validation of facts to ensure the accuracy and completeness of the evidence. It is
important that the team does this before providing the draft report to the entity.
Audit teams generally hold a series of meetings with senior entity officials to present and discuss
findings to avoid surprises later in the process. Officials may disagree with findings based on a
different weighting of the evidence or based on new evidence they provided. There may be a
misunderstanding of an issue, or a key factor may have changed since the audit began. In some
cases, the entity may fully agree with a finding and want greater emphasis placed on it. Early
presentation of findings provides the entity with an opportunity to provide evidence that it
believes should be taken into account.
Supervisors, audit project leaders, directors, principals, assistant auditors, and quality reviewers
all have a responsibility for the review of audit working papers. The extent of review by the
engagement leader and quality reviewer is a matter of judgment; however, each should include
evidence of their review and involvement in the audit file.
Planning and reporting sign-offs

The team documents the timing and extent of reviews at appropriate stages of the audit, signing
and dating planning and reporting/completion procedures. Team members, the engagement
leader, engagement assistant auditor general, and quality reviewer must address the applicable
sections within the planning and reporting sign-off steps identified for their consideration.

AUDIT AND ASSURANCE
Use review notes if follow-up actions or modifications to documentation are necessary

If, upon review of the audit working paper or procedure step, reviewers find follow-up actions
or modifications to documentation are necessary, they should document this in a review note, to
which the preparer of the working paper must respond. Auditors should not use review notes to
document audit evidence. Audit working papers should stand alone as a record of work done in
an audit. Auditors should address and document in the working papers matters that have been
raised during file review and coaching.
The engagement leader shall take responsibility for reviews being performed for-
• Review and sign-off of engagement documentation by more junior team members shall
precede those of more senior team members.
• On or before the date of the assurance engagement report, the engagement leader shall
evidence his or her review (i.e., engagement leader sign-off) of critical areas of judgment,
especially those relating to complex or contentious matters identified during the
engagement;
• Evidence obtained and the resulting conclusions relating to areas identified as having
high risk (for example, in a direct reporting engagement, evidence obtained and the
resulting conclusions reached relating to each of the significant criteria used to evaluate
the subject matter);
• Resolution of significant issues raised during the engagement; and any other matters the
practitioner considers significant.
Subject to the minimum requirements being met, the extent of the engagement leader's review,
and evidence of it, is a matter of judgment. Engagement leaders consider whether the evidence on
file provides a proper account of their involvement in the audit, in particular, at key stages and
when significant judgments were made.
Planning and reporting/completion

In signing off on the planning and reporting/completion steps, and reviewing significant matters
and other working papers, the engagement leader confirms that he or she has reviewed sufficient
documentation in the audit file (electronic and hard copy); and held appropriate discussions with
the entity, with the team and, where applicable, the quality reviewer. These sign-offs further
demonstrate-
• audit objectives have been achieved;
• conclusions are consistent with the work done;
• the engagement has been appropriately executed in accordance with professional

standards;

• the engagement leader has taken responsibility for the direction, supervision, and
performance of the audit engagement;
• the overall quality of the audit is satisfactory; and
• the evidence obtained is sufficient and appropriate to support the assurance report.
Significant matters
The engagement leader reviews all significant matters on a timely basis to be satisfied that all matters
considered significant to the audit have been properly recorded as significant matters; there is a
proper trail from identification of each significant matter, through evidence obtained, consultation
as necessary, to the conclusion (i.e., the documentation of significant matters is sufficient for a
reviewer or third party to be able to understand the issue, what audit procedures were performed
and evidence obtained, what consultations took place, and how the final conclusion was reached);
and the documentation of the consulted party's agreement to that final conclusion is included, if
applicable.
Engagement leaders are responsible for the direction, supervision, and review of the audit work
and use professional judgment to decide where their involvement in specific areas is necessary
and how they satisfy themselves with the documentation of their involvement. For example,
when engagement leaders do not perform detailed review of the working papers but would like
to provide evidence of their involvement in the related decision-making process, discussion of
specific matters, etc., they may document that they were involved in team discussions on the
subject(s) included in the working papers without marking them as reviewed. In certain cases
(e.g., lower risk, less complex entities), their involvement in discussion of the matters listed in the
planning and reporting/completion may be sufficient, and evidence of this will be provided by
review of these steps according to office policies.
Similarly, the quality control reviewer shall document the following for the assurance engagement
reviewed:
• that the minimum review procedures from the firm policy concerning quality reviewer
responsibilities have been performed,
• that the engagement quality control review has been completed on or before the date of
the assurance engagement report, and
• that the quality reviewer is not aware of any unresolved matters that would cause the
quality reviewer to believe that the significant judgments the engagement team made
and the conclusions it reached were not appropriate.
The requirements for providing evidence of the quality reviewer's involvement are the same in
principle as the requirements for providing evidence of the engagement leader's review.

AUDIT AND ASSURANCE
Adequate evidence of involvement includes, as a minimum, a record that the-
• Quality reviewer is satisfied with the matters referred to in the minimum review
requirements.
• Quality reviewer involvement also includes timely discussion with the engagement
leader.
• The quality reviewer exercises professional judgement in considering whether a review

of additional documentation is warranted, depending on the circumstances of the
particular engagement.
• Where matters are not resolved to the quality reviewer's satisfaction, the assurance
engagement report should not be dated until the matter is resolved.
• The engagement leader ensures that the assurance engagement file includes sufficient
documentation to demonstrate that all matters raised by the quality reviewer were
resolved before the date of the assurance report.
• Evidence of the quality reviewer's involvement should be clear from the documentation
of the audit procedure steps.
• The review of audit work shall be performed on the basis that more experienced
team members, including the engagement leader, review the work performed by less
experienced team members.
• The engagement leader shall ensure that detailed reviews are conducted on a timely
basis at appropriate stages during the engagement and before the date of the assurance
engagement report.
• Reviewers shall ensure that all necessary work has been carried out and has been
appropriately documented based on the experienced auditor principle.
Principles of review
The auditors prepare audit documentation that is sufficient to enable an experienced auditor,
having no previous connection with the audit, to understand-
• The nature, timing and extent of the audit procedures performed to comply with
professional standards and applicable legal and regulatory requirements;
• The results of the audit procedures performed and the audit evidence obtained; and
• Significant matters arising during the audit (including observations), the recommendations
and conclusions reached thereon, and significant professional judgments made in
reaching those conclusions.

The review process consists of-
• Discussions between a reviewer and the preparer—all or part of the team, including an
individual team member;
• Review of documented evidence, including documents in both electronic and any

external hard copy files; and
• The review and approval of conclusions including the support for those conclusions.
Whether these elements are undertaken at the same or at different times, and regarding particular
areas of the audit or the audit as a whole depends on the engagement circumstances. It is critical
that reviewers do more than just discuss the audit file with the auditor; they must review the file
themselves before signing off. This review helps ensure that auditors recognize the importance of
the requirement to properly document evidence in the file. The aim of review is to determine that-
• The audit work has been performed according to the original or a modified audit plan ;
• The nature, timing, and extent of the procedures performed are consistent with the
tailored audit program (modified if required based on the impact of initial findings);
• Adequate in light of the results obtained;
• Documented in sufficient detail to provide a clear understanding of the purpose, sources,

and conclusions reached (including reasons for these conclusions);
• In annual audits, account balances being tested have been agreed or reconciled to entity
accounting records (as applicable to the engagement);
• The results of audit procedures and evidence obtained, including, where appropriate, any
exceptions noted and their resolution, are clearly reflected in the audit documentation
and the conclusions reached are consistent with the results of the work performed;
• Significant matters have been identified and raised for further consideration;
• Consultations have taken place, where appropriate, and the resulting advice documented
and implemented;
• Documentation is appropriate, clear, and concise and is free of excessive information,

with cross-referencing to other documentation as appropriate;
• The audit file and documentation within is organized in a logical manner to provide a
clear link to the significant findings or issues; &
• The evidence obtained is sufficient and appropriate to support the observations,

recommendations, and conclusions in the report.

AUDIT AND ASSURANCE
The following principles of review are applied to every assurance engagement:
• There is always one level of review, and more experienced team members review work
performed by less experienced team members.
• Higher risk audit areas may require two levels of review.
• All audit documentation, including file attachments and external hard copy files, and
other related documents, is subject to at least one level of review.
• Reviewers use their professional judgment to determine if they are satisfied with the
completeness and appropriateness of the work done and its documentation. The level of
details involved in a review can vary, depending on the audit risk and significance.
• Reviews are conducted on a timely basis.
• Evidence of review (sign-off) is included in the audit file.
Planning reviews
The review process begins with briefing team members and continues with coaching to help team
members do the work correctly the first time. This process covers what needs to be documented,
including who will review what and when.
The audit team needs to schedule and budget time for review, considering the complexity of
the engagement and size of the engagement team to determine how much review planning is
needed and what to record to provide evidence that it has been done. For example, for smaller
engagements with a two-person field team, it may be sufficient simply to record that the plan is to
have audit areas reviewed as soon as practicable upon completion of work, with the engagement
leader reviewing higher risk areas (in particular, significant risks) earlier than others. On other
engagements, the plan may be more detailed and may include a project management element,
with identification of the specific dates by which the audit areas are to be completed and reviewed.
Performing reviews
The review process, the engagement team adopts, is based on the experience and judgment of the
engagement leader and senior team members. Engagement team members perform a critical self-review
of their own work before the assigned reviewer reviews the file. After the team member has completed
the critical self-review and addressed any matters identified for further work and/or documentation,
the team member's audit documentation is ready for review by the designated reviewer.
While the engagement leader is ultimately responsible for the performance of the audit and the
quality of the audit file, team members with the appropriate knowledge and experience to act in
this role are usually assigned review responsibilities. Each file is reviewed by an individual more
experienced than the individual who prepared the file. It must be clear when and how reviewers
are to bring matters to the attention of senior team members and/or the engagement leader.

Where the opportunity exists, performing reviews on-site can result in better development of team
members as well as more immediate access to entity personnel in resolving review questions or
comments.
Discussions with the related parties should be conducted where possible during the reviews
of most audit areas and procedures. Larger team discussions involving either all or part of the
team involved in a work area may also help reviewers form a view of the adequacy of the work
performed, the quality of the documentation, and the appropriateness of the conclusions.
There may be circumstances where face-to-face discussion cannot take place and a remote review
is necessary, which may still achieve the objectives. A remote discussion generally involves the
reviewer speaking to the team member (by phone) while both have access to the audit file. Remote
discussions may not be as efficient as in-person discussions since there may be less access to evidence
if both the preparer and reviewer are off-site or there may be a need for more documentation in
the file to explain what work has been completed to allow the reviewer to understand the work
performed and assess its quality.
At the end of fieldwork, the engagement leader performs an overall final review of the audit file,
for example, in conjunction with the final review of the financial statements, to be satisfied that
all audit work has been reviewed, significant review notes are resolved, and there is sufficient
appropriate audit evidence to support the final conclusions. This does not mean that the entire
audit file will be reviewed; however, the engagement leader considers significant areas, as well as
significant matters, to ensure there is adequate support for the report and to enable sign off of the
reporting and completion steps in team mates.
When a quality reviewer (QR) is appointed, the QR is responsible for objectively evaluating,
before the assurance engagement report is dated, the significant judgments the engagement team
made and the conclusions it reached in formulating the audit report. However, the engagement
leader has overall responsibility for the engagement, including the quality of work done, the
documentation, the significant judgments, and opinion. The QR's review does not reduce the
responsibilities of the engagement leader.
Raising and responding to review notes

The reviewer informs the auditor who prepared the work as well as previous reviewers of any
significant changes to be made, and ensures they understand the corrections needed and reasons
for the corrections. Issues should be discussed with senior team members and/or the engagement
leader as appropriate as soon as they are identified. This allows issues to be appropriately
addressed and documented at an early stage of the process.
Reviewers should provide notes to auditors to identify questions, desired follow-up actions,
documentation concerns, etc. The reviewer is responsible for subsequently following up to
determine that open review notes have been satisfactorily addressed.

AUDIT AND ASSURANCE
The preparer is responsible for-
• promptly and thoroughly responding to these review notes;
• performing additional procedures where needed and updating the documentation as

appropriate;
• communicating audit findings, including adjustments identified and potential

modifications to the audit plan, to more senior members of the engagement team; and
• notifying the reviewer when the review notes have been addressed.
Review notes are documented either in the audit file or in another manner, unless the preparer
can address them during the review and the reviewer can observe evidence that the comment has
been adequately addressed. Review notes should not be used to document audit evidence. Audit
working papers should stand alone as a record of work done in an audit. Matters that have been
raised during review and coaching should be addressed and documented in the working papers.
Evidence of review
When the reviewer has completed the review of each audit area within the file, evidence of the
review should be indicated by signature on the working papers and audit procedures summaries.
Importance of Overall Review of Audit Evidence Obtained

In line with NSA 500 “Audit Evidence”, the objective of the auditor is to design and perform audit
procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence
to be able to draw reasonable conclusions on which to base the auditor’s opinion.
Review of the audit evidence ensures that the work performed supports the conclusions reached,
that the evidence obtained is sufficient and appropriate to support the audit observations and
conclusions.
Sufficient appropriate audit evidence must be obtained to provide a reasonable basis to support
the conclusion(s) expressed in an assurance engagement report.
Sufficient and Appropriate Evidence

The auditor shall design and perform audit procedures that are appropriate in the circumstances
for the purpose of obtaining sufficient appropriate audit evidence. The sufficiency and
appropriateness of audit evidence are interrelated.
Sufficiency
Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed
is affected by the auditor’s assessment of the risks of misstatement (the higher the assessed risks,
the more audit evidence is likely to be required) and also by the quality of such audit evidence (the

higher the quality, the less may be required). Obtaining more audit evidence, however, may not
compensate for its poor quality.
Appropriateness
Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its
reliability in providing support for the conclusions on which the auditor’s opinion is based.
The reliability of evidence is influenced by its source and by its nature, and is dependent on the
individual circumstances under which it is obtained.
Degree of knowledge
The degree of knowledge of the auditor may not be sufficient sometimes to evaluate any audit
evidence. As such, the auditor can take the expertise knowledge from the concerned parties. For
example, in the audit of a Jewelers company, the auditor may require the help of a jewel as auditor
may not have much knowledge on such sector.
Overall review of audit evidence involves rechecking a sample of the computations and transfers of
information. Rechecking of computations consists of testing mathematical accuracy. Rechecking
of transfers of information involves seeing if information is recorded consistently in the accounting
records. The planning, testing and evaluation of audit evidence is necessary because it acts as an
indicium of fraud enabling an auditor to express an opinion.
Effect of Dealing with Uncorrected Misstatements

The auditor should consider materiality and its relationship with audit risk when conducting
an audit. Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends on the
size of the item or error judged in the particular circumstances of its omission or misstatement.
Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.
The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects, in accordance with an
identified financial reporting framework.
If the auditor believes that there is an unacceptably high risk that the current period's financial
statements may be materially misstated when (the) prior period likely misstatements that affect
the current period's financial statements are considered along with likely misstatements arising in
the current period, he (or she) should include in aggregate likely misstatement the effect on the
current period's financial statements of those prior-period likely misstatements.
In evaluating the fair presentation of the financial statements, the auditor should assess whether
the aggregate of uncorrected misstatements that have been identified during the audit is material.

AUDIT AND ASSURANCE
The aggregate of uncorrected misstatements comprises:
(a) specific misstatements identified by the auditor including the net effect of uncorrected
misstatements identified during the audit of previous periods; and
(b) the auditor's best estimate of other misstatements which cannot be specifically identified
(i.e., projected errors).
The auditor should determine whether uncorrected misstatements are material, individually or in
the aggregate. In making this determination, the auditor should consider-
a. the size and nature of the misstatements, both in relation to particular classes of
transactions, account balances, or disclosures and the financial statements as a whole,
and the particular circumstances of their occurrence and
b. the effect of uncorrected misstatements related to prior periods on the relevant classes of
transactions, account balances, or disclosures and the financial statements as a whole.
The auditor's calculation of error in a company's current-period income statement depends upon
his assessment of the likelihood that prior-period errors may materially affect current-period
results.
Procedures for Overall Review of Financial Statements

A financial statement review is a service under which the accountant obtains limited assurance
that there are no material modifications that need to be made to an entity's financial statements
for them to be in conformity with the applicable financial reporting framework. A review does
not require the accountant to obtain an understanding of internal control, or to assess fraud risk,
or other types of audit procedures. Consequently, a review does not provide the accountant with
assurance that he has become aware of all the significant matters that would normally have been
discovered and disclosed in an audit.
In a review, management takes responsibility for the preparation and presentation of the entity's
financial statements, while the accountant should have a sufficient level of knowledge of both the
industry and the entity to review the financial statements.
In a financial statement review, the accountant performs those procedures necessary to provide
a reasonable basis for obtaining limited assurance that no material changes are needed to bring
the financial statements into compliance with the applicable financial reporting framework. These
procedures are more heavily concentrated in areas where there are enhanced risks of misstatement.
The types of procedures that would be reasonable to conduct for a review include:
• Conduct a ratio analysis with historical, forecasted, and industry results,
• Investigate findings that appear to be inconsistent,

• Inquire about the procedures for recording accounting transactions,
• Investigate unusual or complex situations that may impact reported results,
• Investigate significant transactions occurring near the end of the accounting period,
• Follow up on questions that arose during previous reviews,
• Inquire about material events that occurred after the date of the financial statements,
• Investigate significant journal entries,
• Review communications from regulatory agencies,
• Read the financial statements to see if they appear to conform with the applicable
financial reporting framework, and
• Review the management reports of any accountants who reviewed or audited the entity's
financial statements in prior periods.
There are also a number of review steps that can be utilized in specific areas, such as:
• Cash. Are cash accounts being reconciled? Have cheques written but not mailed been
classified as liabilities? Is there a reconciliation of intercompany transfers?
• Receivables. Is there an adequate allowance for doubtful accounts? Are any receivables
pledged, discounted? Are there any non-current receivables?
• Inventory. Are physical inventory counts performed? Were consigned goods considered
during the inventory count? What cost elements are included in the cost of inventory?
• Investments. How are fair values determined for investments? How are gains and losses
recorded following the disposal of an investment? How do you calculate investment
income?
• Fixed assets. How are gains and losses on the disposal of fixed assets recorded? What are
criteria for capitalizing expenditures? What depreciation methods are used?
• Intangible assets. What types of assets are recorded as intangible assets? Is amortization
being appropriately applied? Have impairment losses been recognized?
• Notes payable and accrued expenses. Are there sufficient expense accruals? Are loans
properly classified?
• Long-term liabilities. Are the terms of debt agreements properly disclosed? Is the entity
in compliance with any loan covenants? Are loans properly classified as short-term or
long-term?
• Contingencies and commitments. Are there guarantees to which the entity has committed
itself? Are there any material contractual obligations? Are there liabilities for
environmental remediation?

AUDIT AND ASSURANCE
• Equity. What classes of stock have been authorized? What is the par value of each class
of stock? Have stock options been properly measured and disclosed in the financial
statements?
• Revenue and expenses. What is the revenue recognition policy? Are expenses recorded in
the correct reporting period? Have the results of discontinued operations been properly
reported in the financial statements?
The preceding list represents a sampling of the review activities that an accountant could engage
in.
If the accountant believes that the financial statements are materially misstated, he should perform
additional procedures to obtain a limited assurance that there is no need to make material
modifications to the financial statements. If the statements are materially misstated, the accountant
must choose between disclosing the issue in the report that accompanies the financial statements,
or of withdrawing from the review.
2.4 AUDIT CONCLUSION: REPORTING
The auditor's report is a formal opinion, or disclaimer thereof, issued by an independent auditor
as a result of an audit or evaluation performed on a legal entity or subdivision thereof (called
an "auditee"). The report is subsequently provided to a "user" (such as an individual, a group of
persons, a company, a government, or even the general public, among others) as an assurance
service in order for the user to make decisions based on the results of the audit.
An auditor's report is considered an essential tool when reporting financial information to users,
particularly in business. Since many third-party users prefer, or even require financial information
to be certified by an independent external auditor, many auditees rely on auditor reports to certify
their information in order to attract investors, obtain loans, and improve public appearance. Some
have even stated that financial information without an auditor's report is "essentially worthless"
for investing purposes.
Forming an Opinion on the Financial Statements (NSA 700)

The auditor shall form an opinion on whether the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework. In order to form an
opinion, the auditor shall conclude as to whether the auditor has obtained reasonable assurance
about whether the financial statements as a whole are free from material misstatement, whether
due to fraud or error. That conclusion shall take into account:
(a) The auditor’s conclusion whether sufficient appropriate audit evidence has been
obtained,

(b) The auditor’s conclusion whether uncorrected misstatements are material, individually
or in aggregate; and
(c) The other evaluations as required.
The auditor should evaluate whether the financial statements are prepared, in all material
respects, in accordance with the requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s accounting
practices, including indicators of possible bias in management’s judgments.
In particular, the auditor shall evaluate whether, in view of the requirements of the applicable
financial reporting framework:
(a) The accounting policies selected and applied are consistent with the applicable financial
reporting framework and are appropriate;
(b) The financial statements adequately disclose the significant accounting policies selected
and applied;
(c) The accounting estimates made by management are reasonable;
(d) The information presented in the financial statements is relevant, reliable, comparable,
and understandable;
(e) The financial statements provide adequate disclosures to enable the intended users to
understand the effect of material transactions and events on the information conveyed
in the financial statements; and
(f) The terminology used in the financial statements, including the title of each financial
statement, is appropriate.
The auditor’s evaluation as to whether the financial statements achieve fair presentation shall
include consideration of:
(a) The overall presentation, structure and content of the financial statements; and
(b) Whether the financial statements, including the related notes, represent the underlying
transactions and events in a manner that achieves fair presentation.
The auditor shall evaluate whether the financial statements adequately refer to or describe the
applicable financial reporting framework.
Form of opinion
1) Unmodified opinion: The auditor shall express an unmodified opinion when the auditor
concludes that the financial statements are prepared, in all material respects, in accordance
with the applicable financial reporting framework.

AUDIT AND ASSURANCE
2) Modified opinion : The auditor shall modify the opinion in the auditor’s report in accordance
with NSA 705 (Revised) if the auditor:
(a) concludes that, based on the audit evidence obtained, the financial statements as a whole
are not free from material misstatement; or
(b) is unable to obtain sufficient appropriate audit evidence to conclude that the financial
statements as a whole are free from material misstatement,
2.5 AUDIT REPORT- NEPALESE LAW MANDATE
The objective of audit is to express an opinion on the financial statements. Such opinion is expressed
by way of report. Companies Act, 2063 provides with the following provision with respect to audit
report.
1. It is the duty and function of the auditor to prepare the audit report in accordance with
the prevailing law or in consonance with the audit standards prescribed by the competent
body; and such report shall state the matters to be set out under this Act, as per necessity.
(Section 115(2)).
2. Such audit report shall also indicate the following matters, inter alia:
a. Whether such information and explanations have been made available as were
required for the completion of audit;
b. Whether the books of account as required by this Act have been properly maintained
by the company in a manner to reflect the real affairs of its business;
c. Whether the balance sheet, profit and loss account and cash flow statements received
have been prepared in compliance with the accounting standards prescribed under
the prevailing law and whether such statements are in agreement with the books of
account maintained by the company;
d. Whether, in the opinion of the auditor based on the explanations and information
made available in the course of auditing, the present balance sheet properly reflects
the financial situation of the company, and the profit and loss account and cash flow
statement for the year ended on the same date properly reflect the profit and loss,
cash flow of the company, respectively;
e. Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any loss
or damage to the company or not;
f. whether any accounting fraud has been committed in the company;
g. Suggestion, if any.

The Bank and Financial Institution Act, 2073 provides that the auditor shall forward a report
of audit performed by him or her to the concerned licensed institution and the Rastra Bank
incorporating the following in the report.
a. Whether or not replies to the queries asked by him or her were given;
b. Whether or not the balance sheet, profit and loss account, cash flow statement and other
financial statements, as well, have been prepared in such format and in accordance with
such procedure as prescribed by the Rastra Bank, and whether or not they correspond to
the accounts, records, books and ledgers maintained by the institution;
c. Whether or not the accounts, records, books and ledgers have been maintained accurately
in accordance with the laws in force;
d. Whether or not any officer of the licensed institution has done any act contrary to the
laws in force or committed any irregularity or caused any loss or damage to the licensed
institution;
e. Whether or not the transactions of the licensed institution have been carried on in a
satisfactory manner;
f. Whether or not the capital fund and the risk-bearing fund have been maintained
adequately;
g. Whether or not credits have been written off as prescribed;
h. Whether or not action has been taken in accordance with the directives given by the
Rastra Bank;
i. Whether or not action has been taken to protect the interests of depositors and investors;
j. Whether or not the returns received from the offices of the licensed institution were
adequate for the purpose of audit;
k. Other matters, which, in his or her opinion, should be made known to the shareholders;
l. Such other matters prescribed by the Rastra Bank as required to be mentioned by an

auditor in his or her report, and
m. Necessary suggestions, if any
2.6 BASIC ELEMENTS OF THE AUDITOR'S REPORT
The auditor’s report shall be in writing. A written report encompasses reports issued in hard copy
and those using an electronic medium. The auditor's report includes the following basic elements,
ordinarily in the following layout:

AUDIT AND ASSURANCE
1. Title
2. Addressee
3. Auditor’s Opinion
4. Basis for Opinion
5. Going Concern (Where applicable)
6. Key Audit Matters (For listed entities)
7. Other Information (For listed entities)
8. Responsibilities for the Financial Statements
9. Auditor’s Responsibilities for the Audit of the Financial Statements
10. Other Reporting Responsibilities
11. Name of the Engagement Partner (For listed entities)
12. Signature of the Auditor
13. Auditor’s Address
14. Date of the Auditor’s Report
Brief descriptions of the above elements are as follows:
Sections Purposes
1 Title To differentiate the audit report from the rest of the financial statements
and other matters included and to focus on word independent.
2 Addressee To specify the addressee of the report, clarify its intended user. Law,
regulation or the terms of the engagement may specify to whom the
auditor’s report is to be addressed in that particular jurisdiction. The
auditor’s report is normally addressed to those for whom the report
is prepared, often either to the shareholders or to those charged with
governance of the entity whose financial statements are being audited.
3 Auditors States whether or not the financial statements show a true and fair view
opinion of the performance and position of the company. Also identify the title
of each statement comprising financial statements, specify date/period
covered of the entity
4 Basis for To provide a description of the professional standard applied during the
opinion audit to provide confidence to users that the report can be relied upon.
5 Going Concern To ensure going concern basis of accounting is appropriate or break value
required.
6 Key audit To draw attention to any other significant matters of which the users
matters should be aware to aid their understanding of the entity.
7 Other To clarify that management is responsible for the other information. The
information auditor’s opinion does not cover the other information and the auditor’s
responsibility is only to read the other information and report as per NSA
720.

Sections Purposes
8 Responsibilities To clarify that management is responsible for preparing the financial
of management statements and for the internal control. Included to help minimize the
expectation gap.
9 Auditors To clarify that auditor is responsible for expressing reasonable assurance
responsibilities only and has assessed risks, internal control, going concern and accounting
policies. Included to help minimize the expectation gap.
10 Other reporting To highlight any additional reporting responsibility, if applicable.
responsibilities
11 Name of the To identify the person responsible for the audit report in case of queries.
engagement
partner
12 Signature To show the engagement partner or firm accountable for the opinion.
13 Auditor’s To identify the specific office of the engagement partner in case of any
Address place queries.
14 Date To identify the date up to which the audit wok has been performed. Post
date information has not been considered by auditor.
Illustration of Sample Audit Report has been given below

INDEPENDENT AUDITOR’S REPORT
To the Shareholders of ABC Company [or Other Appropriate Addressee]
Report on the Audit of the Financial Statements1
Opinion
We have audited the financial statements of ABC Company (the Company), which comprise the
statement of financial position as at December 31, 20X1, and the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then ended, and
notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the accompanying financial statements present fairly, in all material respects, (or
give a true and fair view of) the financial position of the Company as at December 31, 20X1, and (of)
its financial performance and its cash flows for the year then ended in accordance with Nepal
Financial Reporting Standards (NFRSs).
Basis for Opinion

We conducted our audit in accordance with Nepal Standards on Auditing (NSAs). Our
responsibilities under those standards are further described in the Auditor’s Responsibilities for the
Audit of the Financial Statements section of our report. We are independent of the Company in
1 The sub-title “Report on the Audit of the Financial Statements” is unnecessary in circumstances when the second sub-title
“Report on Other Legal and Regulatory Requirements” is not applicable.

AUDIT AND ASSURANCE
accordance with the Institute of Chartered Accountants of Nepal’s Hand books on Code of Ethics for
Professional Accountants together with the ethical requirements that are relevant to our audit of
the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in
accordance with these requirements and the Handbooks of Code of Ethics for Professional Accountants.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our opinion.
Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most significance
in our audit of the financial statements of the current period. These matters were addressed in the
context of our audit of the financial statements as a whole, and in forming our opinion thereon,
and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with NSA 701.]
Other Information [or another title if appropriate such as “Information Other than the Financial
Statements and Auditor’s Report Thereon”]
[Reporting in accordance with the reporting requirements in NSA 720 (Revised) – see
Illustration 1 in Appendix 2 of NSA 720 (Revised).]
Responsibilities of Management and Those Charged with Governance for the

Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in
accordance with NFRSs, and for such internal control as management determines is necessary to
enable the preparation of financial statements that are free from material misstatement, whether
due to fraud or error.
In preparing the financial statements, management is responsible for assessing the Company’s
ability to continue as a going concern, disclosing, as applicable, matters related to going concern
and using the going concern basis of accounting unless management either intends to liquidate the
Company or to cease operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company’s financial reporting
process.
Auditor’s Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report
that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee
that an audit conducted in accordance with NSAs will always detect a material misstatement when

it exists. Misstatements can arise from fraud or error and are considered material if, individually
or in the aggregate, they could reasonably be expected to influence the economic decisions of users
taken on the basis of these financial statements.
Paragraph 41(b) of this NSA explains that the shaded material below can be located in
an Appendix to the auditor’s report. Paragraph 41(c) explains that when law, regulation
or national auditing standards expressly permit, reference can be made to a website of
an appropriate authority that contains the description of the auditor’s responsibilities,
rather than including this material in the auditor’s report, provided that the description
on the website addresses, and is not inconsistent with, the description of the auditor’s
responsibilities below.
As part of an audit in accordance with NSAs, we exercise professional judgment and

maintain professional skepticism throughout the audit. We also:
• Identify and assess the risks of material misstatement of the financial statements,
whether due to fraud or error, design and perform audit procedures responsive to
those risks, and obtain audit evidence that is sufficient and appropriate to provide
a basis for our opinion. The risk of not detecting a material misstatement resulting
from fraud is higher than for one resulting from error, as fraud may involve
collusion, forgery, intentional omissions, misrepresentations, or the override of
internal control.
• Obtain an understanding of internal control relevant to the audit in order to design

audit procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Company’s internal control.2
• Evaluate the appropriateness of accounting policies used and the reasonableness of

accounting estimates and related disclosures made by management.
• Conclude on the appropriateness of management’s use of the going concern basis

of accounting and, based on the audit evidence obtained, whether a material
uncertainty exists related to events or conditions that may cast significant doubt on
the Company’s ability to continue as a going concern. If we conclude that a material
uncertainty exists, we are required to draw attention in our auditor’s report to the
related disclosures in the financial statements or, if such disclosures are inadequate,
to modify our opinion. Our conclusions are based on the audit evidence obtained up
to the date of our auditor’s report. However, future events or conditions may cause
the Company to cease to continue as a going concern.
2 This sentence would be modified, as appropriate, in circumstances when the auditor also has a responsibility to issue an
opinion on the effectiveness of internal control in conjunction with the audit of the financial statements.

AUDIT AND ASSURANCE
Evaluate the overall presentation, structure and content of the financial statements,
including the disclosures, and whether the financial statements represent the underlying
transactions and events in a manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters,
the planned scope and timing of the audit and significant audit findings, including any
significant deficiencies in internal control that we identify during our audit.
We also provide those charged with governance with a statement that we have complied
with relevant ethical requirements regarding independence, and to communicate with
them all relationships and other matters that may reasonably be thought to bear on our
independence, and where applicable, related safeguards.
From the matters communicated with those charged with governance, we determine
those matters that were of most significance in the audit of the financial statements of
the current period and are therefore the key audit matters. We describe these matters
in our auditor’s report unless law or regulation precludes public disclosure about the
matter or when, in extremely rare circumstances, we determine that a matter should not
be communicated in our report because the adverse consequences of doing so would
reasonably be expected to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements

[The form and content of this section of the auditor’s report would vary depending on the nature of the
auditor’s other reporting responsibilities prescribed by local law, regulation or national auditing standards.
The matters addressed by other law, regulation or national auditing standards (referred to as “other reporting
responsibilities”) shall be addressed within this section unless the other reporting responsibilities address
the same topics as those presented under the reporting responsibilities required by the NSAs as part of the
Report on the Audit of the Financial Statements section. The reporting of other reporting responsibilities
that address the same topics as those required by the NSAs may be combined (i.e., included in the Report on
the Audit of the Financial Statements section under the appropriate subheadings) provided that the wording
in the auditor’s report clearly differentiates the other reporting responsibilities from the reporting that is
required by the NSAs where such a difference exists.
The engagement partner on the audit resulting in this independent auditor’s report is [name].
[Signature in the name of the audit firm, the personal name of the auditor, or both, as appropriate for the
particular jurisdiction]
[Auditor Address]
[Date]

TYPES OF AUDIT OPINION
Circumstances when a modification to the Auditor’s Opinion is required
As per NSA 705 Modifications To The Opinion In The Independent Auditor’s Report, the auditor shall
modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial statements
as a whole are not free from material misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement.

AUDIT AND ASSURANCE
 Unqualified Opinion /Clean Opinion
An unqualified opinion should be expressed when the auditor concludes that the financial
statements give a true and fair view.
This opinion should indicate that

- The financial statements have been prepared using the generally accepted accounting
principles, which have been consistently applied.
- The financial statements comply with the relevant statutory requirements and regulations.
- There is adequate disclosure of all material matters.
The opinion paragraph in such report is given below

‘In our opinion, the financial statements give a true and fair view of (or 'are presented fairly,
in all material respects,') the financial position of the Company as of Ashad 3X, 20XX, and
of the results of its operations and its cash flows for the year then ended in accordance with
Nepal Accounting Standards or relevant practices and comply with Companies Act, 2063’
 Modified Opinion
There are the following situations of modifying the auditor’s report
i. In respect of matters that do not affect the auditor’s opinion,

• Emphasis Of Matter:
NSA 706 Emphasis of Matter Paragraphs And Other Matter(s)Paragraphs in the

Independent Auditor’s Report deals with the auditor’s consideration of the inclusion in
the auditor’s report of:
(a) An Emphasis of Matter paragraph to draw users’ attention to a matter presented

or disclosed in the financial statements that the auditor judges important to
their understanding of the financial statements; or
(b) An Other Matter(s) paragraph to draw users’ attention to any other matter that
may be relevant to their understanding of the financial statements or the audit.
In certain circumstances, an auditor’s report may be modified by adding an emphasis

of matter paragraph to highlight a matter affecting the financial statements which
is included in a note to the financial statements that more extensively discusses the
matter. The addition of such an emphasis of matter paragraph does not affect the
auditor’s opinion. The paragraph would preferably be included after the paragraph
containing the auditor’s opinion but before the section on any other reporting
responsibilities, if any. The emphasis of matter paragraph would ordinarily refer to
the fact that the auditor’s opinion is not qualified in this respect.

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report,
the auditor shall:
(a) Include it immediately after the Opinion paragraph in the auditor’s report;
(b) Use the heading “Emphasis of Matter;”
(c) Include in the paragraph a clear reference to the matter being emphasized and
to where relevant disclosures that fully describe the matter can be found in the
(d) Indicate that the auditor’s opinion is not modified in respect of the matter
emphasized.
Illustrations of these matters are set out below.
Unqualified opinion — Emphasis of matter. Material uncertainty about the

company’s ability to continue as a going concern
“We conducted our audit in accordance with Standards on Auditing issued by the Auditing
Standard Board. An audit includes examination, on a test basis, of evidence relevant to
the amounts and disclosures in the financial statements. It also includes an assessment
of the significant estimates and judgments made by the directors in the preparation of the
financial statements, and of whether the accounting policies are appropriate to the company’s
circumstances, consistently applied and adequately disclosed. We planned and performed
our audit so as to obtain all the information and explanations which we considered necessary
in order to provide us with sufficient evidence to give reasonable assurance that the financial
statements are free from material misstatement,
whether caused by fraud or other irregularity or error. In forming our opinion we also
evaluated the overall adequacy of the presentation of information in the financial statements.
In our opinion:
• the financial statements give a true and fair view, in accordance with Nepalese
Financial Reporting Standard issued by The Institute of Chartered Accountants
of Nepal, of the state of the company’s affairs as at [Date] and of its profit [loss]
for the year then ended;
• the financial statements have been properly prepared in accordance with the
Companies Act, 2063; and
• the information given in the Directors’ Report is consistent with the financial
statements.

AUDIT AND ASSURANCE
Emphasis of matter - Going concern

In forming our opinion on the financial statements, which is not qualified, we have considered
the adequacy of the disclosure made in note x to the financial statements concerning the
company’s ability to continue as a going concern. The company incurred a net loss of
RsXXXX during the year ended [Date] and, at that date, the company’s current liabilities
exceeded its total assets by RsYYYY. These conditions, along with the other matters explained
in note x to the financial statements, indicate the existence of a material uncertainty which
may cast significant doubt about the company’s ability to continue as
a going concern. The financial statements do not include the adjustments that would result
if the company was unable to continue as a going concern.
auditors
Address
Date
• Other Matter(s) in Auditor’s Report
When the auditor considers it appropriate to communicate matters other than those
that are presented or disclosed in the financial statements, that in the auditor’s
judgment is relevant to user’s understanding of the audit, the auditor shall use an
Other Matter(s) paragraph for such matters with the heading “Other Matter(s),”
placed after the auditor’s opinion and any Emphasis of Matter paragraph provided
that it is not prohibited by law and when NSA 701 applies, the matter has not been
determined to be a key audit matter to be communicated in the auditor’s report .
ii. In respect of the matter that do affect the auditor’s opinion
• A qualified Opinion
A qualified opinion should be expressed when the auditor concludes that an

unqualified opinion cannot be expressed but that the effect of any disagreement
with management, or limitation on scope is not so material and pervasive as to
require an adverse opinion or a disclaimer of opinion. A qualified opinion should
be expressed as being ‘except for’ the effects of the matter to which the qualification
relates.
The opinion paragraph in Qualified Report due to scope limitation is given below
‘Except as discussed in the following paragraph, we conducted our audit in accordance with
Nepal Standards on Auditing or relevant practices. Those Standards or relevant practices
require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates

made by management, as well as evaluating the overall financial statement presentation. We

believe that our audit provides a reasonable basis for our opinion.
We did not observe the counting of the physical inventories as of Ashad 3X, 20XX, since
that date was prior to the time we were initially engaged as auditors for the Company.
Owing to the nature of the Company's records, we were unable to satisfy ourselves as
to inventory quantities by other audit procedures." In our opinion, except for the effects
of such adjustments, if any, as might have been determined to be necessary had we been
able to satisfy ourselves (For example: "as to physical inventory quantities"), the financial
statements give a true and fair view of (or ‘are presented fairly, in all material respects,’) the
financial position of the Company as of Ashad 3X, 20XX, and of the results of its operations
and its cash flows for the year then ended in accordance with Nepal Accounting Standards
or relevant practices and comply with Companies Act, 2063’
• A disclaimer opinion
A disclaimer of opinion should be expressed when the possible effect of a limitation

on scope is so material and pervasive that the auditor is unable to obtain sufficient
appropriate audit evidence and is thus unable to express on the financial statements.
The opinion paragraph in this report due to scope limitation is given below
‘We were not able to observe all physical inventories and confirm accounts receivable (having
material impact on the operating results and financial positions) due to limitations placed on
the scope of our work by the Company.
Because of the significance of the matters discussed in the preceding paragraph, we

do not express an opinion on the financial statements.’
• An adverse Opinion
An adverse opinion should be expressed when the disagreement with the

management is so material and pervasive to the financial statements that the auditor
concludes that a qualification of the report is inadequate to disclose the misleading
or incomplete nature of the financial statements.
The opinion paragraph in adverse report due to disagreement on accounting policies

is given below
‘As discussed in Note X to the financial statements, no depreciation has been

provided in the financial statements which practice, in our opinion, is not in
accordance with Nepal Accounting Standards or relevant practices. The provision
for the year ended Ashad 3X, 20XX, should be XXX based on the specified method
of depreciation using annual rates of X% for the building and X% for the equipment.
Accordingly, the fixed assets should be reduced by accumulated depreciation of
XXX and the loss for the year and accumulated deficit should be increased by XXX
and XXX, respectively.

AUDIT AND ASSURANCE
In our opinion, except for the effect on the financial statements of the matter referred to
in the preceding paragraph, the financial statements give a true and fair view of (or ‘are
presented fairly, in all material respects,’) the financial position of the Company as of
Ashad 3X, 20XX, and of the results of its operations and its cash flows for the year then
ended in accordance with Nepal Accounting Standards or relevant practices and comply
with Company Act, 2063’
2.7 CIRCUMSTANCES THAT MAY RESULT IN OTHER THAN AN

UNQUALIFIED OPINION
Limitation on Scope
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.
A limitation on scope may be imposed by circumstances (for example, when the timing of the
auditor's appointment is such that the auditor is unable to observe the counting of physical
inventories). It may also arise when, in the opinion of the auditor, the entity's accounting records
are inadequate or when the auditor is unable to carry out an audit procedure believed to be
desirable. In these circumstances, the auditor would attempt to carry out reasonable alternative
procedures to obtain sufficient appropriate audit evidence to support an unqualified opinion.
It may also arise when, in the opinion of the auditor, the entity's accounting records are inadequate
or when the auditor is unable to carry out an audit procedure believed to be desirable.
When there is a limitation on the scope of the auditor's work that requires expression of a qualified
opinion or a disclaimer of opinion, the auditor's report should describe the limitation and indicate
the possible adjustments to the financial statements that might have been determined to be
necessary had the limitation not existed.
Limitation on Scope—Qualified Opinion

“We have audited ... (remaining words are the same as illustrated in the introductory paragraph—paragraph
above).
Except as discussed in the following paragraph, we conducted our audit in accordance with ... (remaining
words are the same as illustrated in the scope paragraph—paragraph 28 above).

We did not observe the counting of the physical inventories as of December 31, 20X1, since that date
was prior to the time we were initially engaged as auditors for the Company. Owing to the nature of
the Company’s records, we were unable to satisfy ourselves as to inventory quantities by other audit
procedures.
In our opinion, except for the effects of such adjustments, if any, as might have been determined to be
necessary had we been able to satisfy ourselves as to physical inventory quantities, the financial statements
give a true and ... (remaining words are the same as illustrated in the opinion paragraph—paragraph
above)."
Limitation on Scope—Disclaimer of Opinion

“We were engaged to audit the accompanying balance sheet of the ABC Company as of December 31, 20X1,
and the related statements of income and cash flows for the year then ended.
These financial statements are the responsibility of the Company’s management. (Omit the sentence stating
the responsibility of the auditor).
(The paragraph discussing the scope of the audit would either be omitted or amended according to the
circumstances.) (Add a paragraph discussing the scope limitation as follows:)
We were not able to observe all physical inventories and confirm accounts receivable due to limitations
placed on the scope of our work by the Company.
Because of the significance of the matters discussed in the preceding paragraph, we do not express an opinion
on the financial statements. "
Disagreement with Management

The auditor may disagree with management about matters such as the acceptability of accounting policies
selected, the method of their application, or the adequacy of disclosures in the financial statements. If such
disagreements are material to the financial statements, the auditor should express a qualified or an adverse
opinion.
Disagreement on Accounting Policies-Inappropriate Accounting Method— Qualified Opinion
above).
We conducted our audit in accordance with ... (remaining words are the same as illustrated in the scope
paragraph—paragraph above)

AUDIT AND ASSURANCE
As discussed in Note X to the financial statements, no depreciation has been provided in the financial
statements which practice, in our opinion, is not in accordance with International Accounting Standards.
The provision for the year ended Ashad 31, 20X1, should be xxx based on the straight-line method of
depreciation using annual rates of 5% for the building and 20% for the equipment. Accordingly, the fixed
assets should be reduced by accumulated depreciation of xxx and the loss for the year and accumulated deficit
should be increased by xxx and xxx, respectively.
In our opinion, except for the effect on the financial statements of the matter referred to in the preceding
paragraph, the financial statements give a true and ... (remaining words are the same as illustrated in the
opinion paragraph—paragraph above).”
Disagreement on Accounting Policies—Inadequate Disclosure—Qualified Opinion
“We have audited ... (remaining words are the same as illustrated in the introductory paragraph—above).
paragraph—paragraph above).
On Shrawan 15, 20X2, the Company issued debentures in the amount of xxx for the purpose of financing
plant expansion. The debenture agreement restricts the payment of future cash dividends to earnings after
Ashad31, 20X1. In our opinion, disclosure of this information is required by ... .
In our opinion, except for the omission of the information included in the preceding paragraph, the financial
statements give a true and ... (remaining words are the same as illustrated in the opinion paragraph—
paragraph above).”
Disagreement on Accounting Policies—Inadequate Disclosure—Adverse Opinion
above).
paragraph—paragraph above). (Paragraph(s) discussing the disagreement).
In our opinion, because of the effects of the matters discussed in the preceding paragraph(s), the financial
statements do not give a true and fair view of (or do not ‘present fairly’) the financial position of the
Company as of Ashad 30, 20X1, and of the results of its operations and its cash flows for the year then ended
in accordance with Nepalese Financial Reporting Standards (or [title of financial reporting framework with
reference to the country of origin]) (and do not comply with ...).”

A summary of conclusion has been presented below:
Unmodified Material and Not

Financial Pervasive > Qualified
Report Opinion
Auditor’s Unmodified Statement is
Report Modified Opinion Materially
Misstated Material and Pervasive >
Report Adverse Opinion
Modified
Opinion Material and Not
Auditor is Pervasive > Qualified
unable to Opinion
obtain Audit
Evidence Material and Pervasive >
Disclaimer on Opinion
Communicating Key Audit Matters in Independent Auditor’s Report

Key audit matters are those matters that, in the auditor’s professional judgment, were of most
significance in the audit of the financial statements of the current period. Key audit matters are
selected from matters communicated with those charged with governance.
NSA 701 Communicating Key Audit Matters In The Independent Auditor’s Report, applies to the audit of
general purpose financial statements of listed entities. Communicating key audit matters provides
additional information to users of the financial statements to assist them in understanding those
matters that, in the auditor’s professional judgment, were of most significance in the audit of the
financial statements of the current period.
Communicating key audit matters may also assist users of the financial statements in understanding
the entity and areas of significant management judgment in the audited financial statements, as
such matters are areas of focus in performing the audit. The communication of key audit matters
in the auditor’s report may also provide users of the financial statements a basis to further engage
with management and those charged with governance about certain matters relating to the entity
and the audited financial statements.
The auditor shall determine which of the matters communicated with those charged with
governance are the key audit matters. In making this determination, the auditor shall take into
account areas of significant auditor attention in performing the audit, including:
(a) Areas identified as significant risks in accordance with ISA 315 (Revised) or involving
significant auditor judgment.
(b) Areas in which the auditor encountered significant difficulty during the audit, including
with respect to obtaining sufficient appropriate audit evidence.

AUDIT AND ASSURANCE
(c) Circumstances that required significant modification of the auditor’s planned approach
to the audit, including as a result of the identification of a significant deficiency in internal
control.
The auditor shall communicate the key audit matters determined in a separate section of the
auditor’s report under the heading “Key Audit Matters.” The auditor’s report shall state that:
(a) Key audit matters are those matters that, in the auditor’s professional judgment, were of
most significance in the audit of the financial statements [of the current period];
(b) Key audit matters are selected from matters communicated with [those charged with
governance], but are not intended to represent all matters that were discussed with them;
(c) The auditor’s procedures relating to these matters were designed in the context of the
audit of the financial statements as a whole; and
(d) The auditor’s opinion on the financial statements is not modified with respect to any of
the key audit matters, and the auditor does not express an opinion on these individual
matters.
AUDITOR’S LIABILITY REGARDING THE UNAUDITED SUPPLEMENTARY

INFORMATION PRESENTED WITH AUDITED FINANCIAL STATEMENTS
In some circumstances, the entity may be required by law, regulation or standards, or may
voluntarily choose, to present together with the financial statements supplementary information
that is not required by the applicable financial reporting framework. The auditor’s opinion covers
supplementary information that cannot be clearly differentiated from the financial statements
because of its nature and how it is presented. Supplementary information that is covered by the
auditor’s opinion does not need to be specifically referred to in the introductory paragraph of the
auditor’s report when the reference to the notes in the description of the statements that comprise
the financial statements in the introductory paragraph is sufficient. Law or regulation may not
require that the supplementary information be audited, and management may decide not to ask
the auditor to include the supplementary information within the scope of the audit of the financial
statements.
The schedules presented for purposes of additional analysis are not a required part of the basic
financial statements. Such information is the responsibility of management and relate directly to
the underlying accounting and other records to prepare the financial statements. The information
is subjected to the audit procedures applied in the audit of the basic financial statements.
The fact that supplementary information is unaudited does not relieve the auditor of the
responsibility to read that information to identify material inconsistencies with the audited financial
statements. The auditor should read the other information to identify material inconsistencies
with the audited financial statements.

The auditor should consider the requirement of supplementary information is required in the
given circumstances. If supplementary information is required, the auditor ordinarily should
apply the following procedures to the information.
• Inquire of management about the methods of preparing the information, including
i. Whether it is measured and presented within prescribed guidelines,
ii. Whether methods of measurement or presentation have been changed from those
used in the prior period and the reasons for any such changes, and
iii. Any significant assumptions or interpretations underlying the measurement or

presentation.
• Compare the information for consistency with management's responses to the foregoing
inquiries, audited financial statements and other knowledge obtained during the
examination of the financial statements.
Consider whether representations on required supplementary information should be included in

specific written representations obtained from management.
(1) Apply additional procedures, if any, that other statements or interpretations prescribe
for specific types of required supplementary information.
(2) Make additional inquiries if application of the foregoing procedures causes the auditor
to believe that the information may not be measured or presented within applicable
guidelines.
Reporting on Required Supplementary Information

Since the supplementary information is not audited and is not a required part of the basic financial
statements, the auditor need not add an explanatory paragraph to the report on the audited
financial statements to refer to the supplementary information or to his or her limited procedures,
except in any of the following circumstances:
(a) The supplementary information that GAAP requires to be presented in the circumstances
is omitted;
(b) The auditor has concluded that the measurement or presentation of the supplementary
information departs materially from prescribed guidelines;
(c) The auditor is unable to complete the prescribed procedures;
(d) The auditor is unable to remove substantial doubts about whether the supplementary
information conforms to prescribed guidelines.
Since the required supplementary information does not change the standards of financial accounting
and reporting used for the preparation of the entity's basic financial statements, the circumstances

AUDIT AND ASSURANCE
described above do not affect the auditor's opinion on the fairness of presentation of such financial
statements in conformity with generally accepted accounting principles. Furthermore, the auditor
need not present the supplementary information if it is omitted by the entity. The following are
examples of additional explanatory paragraphs an auditor might use in these circumstances.
In conjunction with the audit of the financial statements, the auditor may subject the supplementary
information to certain auditing procedures. If the procedures are sufficient to enable the auditor to
express an opinion on whether the information is fairly stated in all material respects in relation to
the financial statements taken as a whole, the auditor may expand the audit report.
If the entity includes with the supplementary information an indication that the auditor performed
any procedures regarding the information without also indicating that the auditor does not
express an opinion on the information presented, the auditor’s report on the audited financial
statements should be expanded to include a disclaimer on the information or, if appropriate,
an opinion on whether the information is fairly stated in all material respects in relation to the
financial statements taken as a whole.
Ordinarily, the required supplementary information should be distinct from the audited financial
statements and distinguished from other information outside the financial statements that is not
required by GAAP. However, management may choose not to place the required supplementary
information outside the basic financial statements. In such circumstances, unless it is audited as
part of the basic financial statements, the information should be clearly marked as unaudited. If
the information is not clearly marked as unaudited, the auditor’s report on the audited financial
statements should be expanded to include a disclaimer on the supplementary information.
2.8 AUDIT REPORT AND AUDIT CERTIFICATE
The term 'certificate', is a written confirmation of the accuracy of the facts stated therein and does
not involve any estimate or opinion. When an auditor certifies a financial statement, it implies that
the contents of that statement can be measured and that the auditor has vouched the exactness of
the data. The' term certificate is, therefore, used where the auditor verifies certain exact facts. An
auditor May thus, certify the circulation figures of a newspaper or the value of imports or exports
of a company. An auditor's certificate represents that he has verified certain precise figures and is in
a position to vouch safe their accuracy as per the examination of documents and books of account.
An auditor's report, on the other hand, is an expression of opinion. When we say that an auditor is
reporting, we imply that he is expressing an opinion on the financial statements. The audit report
is the medium of communication of the auditor’s expert views on the financial statements and it
has a significant bearing on the credibility of such statements.
Certificate is a written confirmation of the accuracy of the fact stated therein and does not involve
any estimate of opinion. The difference between the audit report and certificate is as under:

Basis Audit Report Audit Certificate

Meaning An Audit Report is an expression Certificate is a written confirmation of
of opinion on the true and fair view the accuracy of the fact stated therein and
presented by financial statements does not involve any estimate of opinion.
Utility The term audit report is used when the The term certificate is used when the
auditor is expresses his opinion on the auditor verifies certain exact fact e.g.
financial statements Royalty payment made to foreign
collaborators, value of import/exports
of a company during a financial year.
Implication Audit report implies that the auditor An Auditors certificate implies that the
- Has examined relevant records in Auditor
accordance with generally accepted - Has verified certain precise figures;
auditing standards; and and
- Is expressing an opinion whether - Is in a position to vouch their
or not the financial statements accuracy as per the examination of
represents a true and fair view of the documents and books of account
state of affairs and of the working produced before him.
results of the enterprise.
Accuracy The Auditor is responsible for ensuring The Auditor is responsible for the factual
that the report is based on factual data accuracy of what is stated therein.
that his opinion is in due accordance
with facts, and that it is arrived at by
application of due care & Skill.
2.9 NOTES TO ACCOUNTS AND QUALIFICATION NOTES
 The notes to the financial statements of an entity shall: present information about the basis
of preparation of the financial statements and the specific accounting policies selected and
applied for significant transactions and events;
 disclose the information required by Nepal Accounting Standards that is not presented
elsewhere in the financial statements; and
 provide additional information which is not presented on the face of the financial statements
but that is necessary for a fair presentation.
Notes to the financial statements including disclosure of accounting policies shall, as far as
practicable, be presented in a systematic manner. each item on the face of the balance sheet, income
statement, statement of changes in equity and cash flow statement shall be cross – referenced to
any related information in the notes.

AUDIT AND ASSURANCE
When an auditor prepares the comprehensive report of his audit, at that time, he will write his
doubts or negative points which he found during the audit. So, collection of all his doubts or
negative points is called qualification notes.
It is pertinent here to note that the mere disclosure of the fact in the components of financial
statements cannot be substitute for the requirement of qualification in the audit report.
Example of Qualificatory notes
‘On the basis of given information and explanation, we have given our opinion that the accounts,
notes attached and financial documents are correct and proper but
(A) There is not sufficient depreciation on the capitalized assets.
(B) Valuation of Stock is on market value which is more than its cost value. ‘
2.10 MANNER OF QUALIFYING REPORTS
It is a general principle that the qualifying remarks should be placed in such a manner as to make
it very clear as to the particular item of the auditor’s report to which the qualification relates, e.g.,
if the qualification is of such a nature that it affects truth and fairness of the accounts, it should
not be placed in such a manner as to give an impression that the auditors have not obtained all
the information which has been required in the performance of their work. It enumerates the
following principles regarding manner of qualification with a view to ensuring certain degree of
uniformity and to assist the public in evaluating the contents of auditors’ reports. The principles
are follows:
(i) All qualifications should be contained in the auditor’s report. The notes to accounts
normally represent explanatory statements given by the Directors of the company and
should not contain the opinion of the auditors. The practice has also grown recently of
having a large number of notes to accounts some of which are subject matter of qualification
in the auditor’s reports and some of which are merely clarificatory. It is necessary that the
auditors should “reproduce” the notes of a qualificatory nature in their report to enable
the reader to know the importance to these qualifications. For this purpose, where a note is
already given in detail by the management, it is not necessary to reproduce verbatim such
a note in the audit report; a brief self- explanatory statement may be sufficient.
(ii) It is also necessary that the auditor should quantify, wherever possible, the effect of
individual as well as the total effect of all qualifications on profit or loss and/or state
of affairs these qualifications on the financial statements in a clear and unambiguous
manner. In circumstances where it is not possible to quantify the effect of the qualifications
accurately the auditor may do so on the estimates made by the management after carrying
out such audit tests as are possible and clearly indicate that the figures given are based
on the estimates of the management.

(iii) The use of the word “subject to” is essential to bring out the qualifications. It is customary
for qualifications to be made by the use of expressions, such as, “subject to” or “except
that”. The expressions “read with the notes thereon” or “together with the notes
thereon” are of an explanatory nature and do not constitute qualifications. It is therefore
important when seeking to qualify a report, that the auditors should use such recognized
terminology which clearly implies a qualification. It is not a correct practice to merely
make a factual statement in the auditors’ report without taking exception thereto.
2.11 CONTENTS OF REPORTS AND CERTIFICATES FOR SPECIAL

PURPOSES
In many cases, a reporting auditor can choose the form and contents of his report or certificate. In
other cases, the form and contents of the report or certificate are specified by statute or notification
and cannot be changed. Where a reporting auditor is free to draft his report or certificate, he
should consider the following:
i) Specific elements, accounts or items covered by the report or certificate should be clearly
identified and indicated.
ii) The report or certificate should indicate the manner in which the audit was conducted,
e.g., by the application of generally accepted auditing practices, or any other specific
tests.
iii) If the report or certificate is subject to any limitations in scope, such limitations should be
clearly mentioned.
iv) Assumptions on which the special purpose statement is based should be clearly indicated
if they are fundamental to the appreciation of the statement.
v) Reference to the information and explanations obtained should be included in the

report or certificate. In certain cases, apart from a general reference to information and
explanations obtained, a reporting auditor may also find it necessary to refer in his report
or certificate to specific information or explanations on which he has relied.
vi) The title of the report or certificate should clearly indicate its nature, i.e., whether it is
a report or a certificate. Similarly, the language should be unambiguous, i.e., it should
clearly bring out whether the reporting auditor is expressing an opinion (as in the case of
a report) or whether he is only confirming the accuracy of certain facts (as in the case of
a certificate). For this, the choice of appropriate words and phrases is important.
vii) If the special purposes statement is based on general purpose financial statements, the
report or certificate should contain a reference to such statements. However, the report
or certificate should not contain a reference to any other statement unless the same is
attached herewith. It should be clearly indicated whether or not the statutory audit of

AUDIT AND ASSURANCE
the general purposes financial statements has been completed and also, whether such
audit has been conducted by the reporting auditor or by another auditor. In case the
general purposes financial statements have been audited by another auditor, the
reporting auditor should specify the extent to which he has relied on them. He may
communicate with the statutory auditor for securing his co-operation and in appropriate
circumstances, discuss relevant matters with him, if possible.
viii) Where a report requires the interpretation of statute, the reporting auditor should clearly
indicate the fact that he is merely expressing his opinion in the matter. He should take
sufficient care to ensure that in respect of matters which are capable of more than one
interpretation, his report is not misconstrued as representing a settled legal position;
ix) An audit report or certificate should ordinarily be a self- contained document. It should
not confine itself to a mere reference to another report or certificate issued by the
reporting auditor but should include all relevant information contained in such report or
certificate.
x) The reporting auditor should clearly indicate in his report or certificate, the extent of
responsibility which he assumes. Where the statement on which he is required to give his
report or certificate, includes some information which has not been audited, he should
clearly indicate in his report or certificate the particulars of such information.
2.12 COMPARATIVES
The nature of the comparative information that is presented in an entity’s financial statements
depends on the requirements of the applicable financial reporting framework. There are
two different broad approaches to the auditor’s reporting responsibilities in respect of such
comparative information: corresponding figures and comparative financial statements. The
approach to be adopted is often specified by law or regulation but may also be specified in the
terms of engagement.
The essential audit reporting differences between the approaches are:
(a) For corresponding figures, the auditor’s opinion on the financial statements refers to the
current period only; whereas
(b) For comparative financial statements, the auditor’s opinion refers to each period for
which financial statements are presented.
NSA 710 Comparative Information—Corresponding Figures And Comparative Financial Statements

addresses separately the auditor’s reporting requirements for each approach.

The Auditor’s Responsibilities on Corresponding figures

Corresponding figures- where amounts and other disclosures for the preceding period are included
as part of the current period financial statements, and are intended to be read in relation to the
amounts and other disclosures relating to the current period (referred to as “current period
figures”). These corresponding figures are not presented as complete financial statements capable
of standing alone, but are an integral part of the current period financial statements intended to
be read only in relationship to the current period figures. For corresponding figures, the auditor’s
report only refers to the financial statements of the current period;
The auditor should obtain sufficient appropriate audit evidence that the corresponding figures meet
the requirements of the relevant financial reporting framework. The extent of audit procedures
performed on the corresponding figures is significantly less than for the audit of the current period
figures and is ordinarily limited to ensuring that the corresponding figures have been correctly
reported and are appropriately classified. This involves the auditor assessing whether:
 Accounting policies used for the corresponding figures are consistent with those of the
current period or whether appropriate adjustments and/or disclosures have been made;
and
 Corresponding figures agree with the amounts and other disclosures presented in the
prior period or whether appropriate adjustments and/or disclosures have been made.
When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding
figures except in the circumstances:
1. If the auditor’s report on the prior period, as previously issued, included a qualified
opinion, a disclaimer of opinion, or an adverse opinion and the matter which gave rise
to the modification is unresolved, the auditor shall modify the auditor’s opinion on the
current period’s financial statements. In the Basis for Modification paragraph in the
auditor’s report, the auditor shall either:
(a) Refer to both the current period’s figures and the corresponding figures in the
description of the matter giving rise to the modification when the effects or possible
effects of the matter on the current period’s figures are material; or
(b) In other cases, explain that the audit opinion has been modified because of the
effects or possible effects of the unresolved matter on the comparability of the
current period’s figures and the corresponding figures.
2. If the auditor obtains audit evidence that a material misstatement exists in the prior
period financial statements on which an unmodified opinion has been previously issued,
and the corresponding figures have not been properly restated or appropriate disclosures
have not been made, the auditor shall express a qualified opinion or an adverse opinion
in the auditor’s report on the current period financial statements, modified with respect

AUDIT AND ASSURANCE
to the corresponding figures included therein.3. If the prior period financial statements
were not audited, the auditor shall state in an Other Matter paragraph in the auditor’s
report that the corresponding figures are unaudited. Such a statement does not, however,
relieve the auditor of the requirement to obtain sufficient appropriate audit evidence
that the opening balances do not contain misstatements that materially affect the current
period’s financial statements.
The Auditor’s Responsibilities on Comparative financial statements

Comparative financial statements- where amounts and other disclosures for the preceding period
are included for comparison with the financial statements of the current period, but do not form
part of the current period financial statements. For comparative financial statements, the auditor’s
report refers to each period that financial statements are presented.
When reporting on prior period financial statements in connection with the current period’s audit,
if the auditor’s opinion on such prior period financial statements differs from the opinion the
auditor previously expressed, the auditor shall disclose the substantive reasons for the different
opinion in an Other Matter paragraph in accordance with NSA 706.
The auditor should obtain sufficient appropriate audit evidence that the comparative financial
statements meet the requirements of the relevant financial reporting framework. This involves the
auditor assessing whether:
 Accounting policies of the prior period are consistent with those of the current period or
whether appropriate adjustments and/or disclosures have been made; and
 Prior period figures presented agree with the amounts and other disclosures presented
in the prior period or whether appropriate adjustments and disclosures have been made.
Prior Period Financial Statements Not Audited

When the prior period financial statements are not audited, the incoming auditor should state in
the auditor’s report that the comparative financial statements are unaudited. Such a statement
does not, however, relieve the auditor of the requirement to carry out appropriate procedures
regarding opening balances of the current period. Clear disclosure in the financial statements
that the comparative financial statements are unaudited is encouraged. In situations where the
incoming auditor identifies that the prior year unaudited figures are materially misstated, the
auditor should request management to revise the prior year’s figures or if management refuses to
do so, appropriately modify the report.
Other Information in Documents Containing Audited Financial Statements

An entity ordinarily issues on annual basis a document which includes its audited financial
statements together with the auditor’s reports thereon. Such document is called “annual report”.
In issuing such document entity may also include, either by law or by custom, other financial and
non-financial information.

Auditor responsibility
An audit conducted in accordance with NSAs or relevant practices is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement,
whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent so the
auditor is not and cannot be held responsible for the prevention of fraud and error. Thus auditor
has no specific responsibility to determine that other information is properly stated.
Material inconsistencies
On reading the other information, the auditor identifies a material inconsistencies, the auditor
should determine whether the audited financial statement or other information needs to be
amended.
If an amendment is necessary in the audited financial statement and the entity refuses to make the
amendment, the auditor should express a qualified or adverse opinion.
If an amendment is necessary in the other information and the entity refuses to make the
amendment, the auditor should consider including in the auditor’s report an emphasis of mater
paragraph describing the material inconsistency or taking other actions.
Material misstatement of the fact

If the auditor becomes aware that the information appears to include a material misstatement of
fact, auditor should discuss the matter with entity’s management. When the auditor still considers
that there is an apparent misstatement of fact, the auditor should request management to consult
with a qualified third party, such as the entity legal counsel and should consider the advice
received.
If the auditor concludes that there is a material misstatement of the fact in other information which
management refuses to correct, the auditor should consider taking further appropriate actions
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.
Types of assurance engagement

There are two types of assurance engagement a practitioner is permitted to perform:
 Reasonable assurance engagement &
 Limited assurance engagement

AUDIT AND ASSURANCE
The objective of a reasonable assurance engagement is a reduction in assurance engagement risk

to an acceptably low level in the circumstances of the engagement, but where that risk is greater
than for a reasonable assurance engagement, as the basis for a positive form of expression of the
practitioner’s conclusion.
The objective of a limited assurance engagement is a reduction in assurance engagement risk to

a level that is acceptable in the circumstances of the engagement, but where that risk is greater
than for a reasonable assurance engagement, as the basis for a negative form of expression of the
practitioner’s conclusion.
Elements of an Assurance Engagement

The following elements of an assurance engagement are discussed in this section:
 A three party relationship involving a practitioner, a responsible party, and intended

users;
 An appropriate subject matter;
 Suitable criteria;
 Sufficient appropriate evidence; and
 A written assurance report in the form appropriate to a reasonable assurance engagement

or a limited assurance engagement.
i. Three Party Relationships

intended users.
ii. Subject Matter

The subject matter, and subject matter information, of an assurance engagement can take
many forms, such as:
• Financial performance or conditions (for example, historical or prospective financial

• Non-financial performance or conditions (for example, performance of an entity) for

• Physical characteristics (for example, capacity of a facility) for which the subject matter
• Systems and processes (for example, an entity’s internal control or IT system) for which

• Behavior (for example, corporate governance, compliance with regulation, human

iii. Suitable Criteria

the preparation of financial statements, the criteria may be Nepal Accounting Standards; when
reporting on internal control, the criteria may be an established internal control framework or
individual control objectives specifically designed for the engagement; and when reporting
on compliance, the criteria may be the applicable law, regulation or contract.
iv. Evidence
skepticism to obtain sufficient appropriate evidence about whether the subject matter
information is free of material misstatement. The practitioner considers materiality, assurance
engagement risk, and the quantity and quality of available evidence when planning and
performing the engagement, in particular when determining the nature, timing and extent of
evidence-gathering procedures.
v. Assurance Report
obtained about the subject matter information.
2.13 ENGAGEMENTS TO PERFORM AGREED-UPON PROCEDURES
The objective of an agreed-upon procedures engagement is for the auditor to carry out procedures
of an audit nature to which the auditor and the entity and any appropriate third parties have
agreed and to report on factual findings.
As the auditor simply provides a report of the factual findings of agreed-upon procedures, no
assurance is expressed. Instead, users of the report assess for themselves the procedures and
findings reported by the auditor and draw their own conclusions from the auditor’s work.
General Principles of an Agreed-upon Procedures Engagement

The auditor should comply with the Code of Ethics for Professional Accountants issued by the
Institute of Chartered Accountants of Nepal (ICAN). Ethical principles governing the auditor’s
professional responsibilities for this type of engagement are:

AUDIT AND ASSURANCE
a) Integrity
b) Objectivity;
c) professional competence and due care;
d) confidentiality;
e) professional behavior; and
f) Technical standards.
The auditor should conduct an agreed-upon procedures engagement in accordance with this NSA
4400 and the terms of the engagement.
Defining the Terms of the Engagement

The auditor should ensure with representatives of the entity and, ordinarily, other specified
parties who will receive copies of the report of factual findings, that there is a clear understanding
regarding the agreed procedures and the conditions of the engagement. Matters to be agreed
• Nature of the engagement including the fact that the procedures performed will not
constitute an audit or a review and that accordingly no assurance will be expressed,
• Stated purpose for the engagement,
• Identification of the financial information to which the agreed-upon procedures will be

applied,
• Nature, timing and extent of the specific procedures to be applied,
• Anticipated form of the report of factual findings, and
• Limitations on distribution of the report of factual findings. When such limitation would
be in conflict with the legal requirements, if any, the auditor would not accept the
engagement.
Planning
The auditor should plan the work so that an effective engagement will be performed.
Documentation
The auditor should document matters which are important in providing evidence to support the
report of factual findings, and evidence that the engagement was carried out in accordance with
this NSA and the terms of the engagement.

Procedures and Evidence

The auditor should carry out the procedures agreed upon and use the evidence obtained as the
basis for the report of factual findings.
The procedures applied in an engagement to perform agreed-upon procedures may include the
following:
• inquiry and analysis,
• Re-computation,
• comparison and other clerical accuracy checks,
• observation,
• inspection,
• Obtaining confirmations.
Reporting
The report of factual findings should contain:
a) Title;
b) Addressee (ordinarily the client who engaged the auditor to perform the agreed-upon
procedures);
c) Identification of specific financial or non-financial information to which the agreed-upon

procedures have been applied;
d) A statement that the procedures performed were those agreed upon with the recipient;
e) A statement that the engagement was performed in accordance with this NSA applicable
to agreed-upon procedures engagements, or with relevant national standards or
practices;
f) When relevant a statement that the auditor is not independent of the entity;
g) Identification of the purpose for which the agreed-upon procedures were performed;
h) A listing of the specific procedures performed;
i) A description of the auditor’s factual findings including sufficient details of errors and
exceptions found; statement that the procedures performed do not constitute either an
audit or a review and, as such, no assurance is expressed;
j) A statement that had the auditor performed additional procedures, an audit or a review,
other matters might have come to light that would have been reported;

AUDIT AND ASSURANCE
k) A statement that the report is restricted to those parties that have agreed to the procedures
to be performed;
l) A statement (when applicable) that the report relates only to the elements, accounts,
items or financial and non-financial information specified and that it does not extend to
the entity’s financial statements taken as a whole;
m) Date of the report;
n) Auditor’s address;
o) Auditor’s signature.
2.14 ENGAGEMENTS TO COMPILE FINANCIAL STATEMENTS
The objective of a compilation engagement is for the accountant to use accounting expertise,
as opposed to auditing expertise, to collect, classify and summarise financial information. This
ordinarily entails reducing detailed data to a manageable and understandable form without a
requirement to test the assertions underlying that information. The procedures employed are not
designed and do not enable the accountant to express any assurance on the financial information.
However, users of the compiled financial information derive some benefit as a result of the
accountant’s involvement because the service has been performed with professional competence
and due care.
General Principles of a Compilation Engagement

The auditor should comply with the Code of Ethics for Professional Accountants issued by the
Institute of Chartered Accountants of Nepal (ICAN). Ethical principles governing the auditor’s
professional responsibilities for this type of engagement are:
a) Integrity
b) Objectivity;
c) professional competence and due care;
d) confidentiality; and
e) professional behavior.
Defining the Terms of the Engagement

The accountant should ensure that there is a clear understanding between the client and the
accountant regarding the terms of the engagement. Matters to be considered include the following:
• Nature of the engagement including the fact that neither an audit nor a review will be
carried out and that accordingly no assurance will be expressed.

• Fact that the engagement cannot be relied upon to disclose errors, illegal acts or other
irregularities, for example, fraud or defalcations that may exist.
• Nature of the information to be supplied by the client.
• Fact that management is responsible for the accuracy and completeness of the information
supplied to the accountant for the completeness and accuracy of the compiled financial
information.
• Basis of accounting on which the financial information is to be compiled and the fact that
it, and any known departures there from, will be disclosed.
• Intended use and distribution of the information, once compiled.
• Form of report to be rendered regarding the financial information compiled, when the
accountant’s name is to be associated therewith.
Planning
The accountant should plan the work so that an effective engagement will be performed.
Documentation
The accountant should document matters which are important in providing evidence that the
engagement was carried out in accordance with this NSA and the terms of the engagement.
Procedures
The accountant should obtain a general knowledge of the business and operations of the entity
and should be familiar with the accounting principles and practices of the industry in which the
entity operates and with the form and content of the financial information that is appropriate in
the circumstances.
If the accountant becomes aware that information supplied by management is incorrect,

incomplete, or otherwise unsatisfactory, the accountant should consider performing the above
procedures and request management to provide additional information. If management refuses to
provide additional information, the accountant should withdraw from the engagement, informing
the entity of the reasons for the withdrawal.
The accountant should read the compiled information and consider whether it appears to be
appropriate in form and free from obvious material misstatements. In this sense, misstatements
• Mistakes in the application of the identified financial reporting framework.
• Non-disclosure of the financial reporting framework and any known departures there
from.

AUDIT AND ASSURANCE
• Non-disclosure of any other significant matters of which the accountant has become
aware.
Responsibility of Management
The accountant should obtain an acknowledgement from management of its responsibility for
the appropriate presentation of the financial information and of its approval of the financial
information. Such acknowledgement may be provided by representations from management
which cover the accuracy and completeness of the underlying accounting data and the complete
disclosure of all material and relevant information to the accountant.
Reporting on a Compilation Engagement

• Reports on compilation engagements should contain the following:
• Title
• Addressee
• A statement that the engagement was performed in accordance with the Nepal Standard
on Auditing or relevant practices applicable to compilation engagements
• When relevant, a statement that the accountant is not independent of the entity
• Identification of the financial information noting that it is based on information provided

by management
• A statement that management is responsible for the financial information compiled by

the accountant
• A statement that neither an audit nor a review has been carried out and that accordingly
no assurance is expressed on the financial information;
• A paragraph, when considered necessary, drawing attention to the disclosure of material

departures from the identified financial reporting framework
• Date of the report;
• Accountant’s address;
• Accountant’s signature.
The financial information compiled by the accountant should contain a reference such as
“Unaudited,” “Compiled without Audit or Review” or “Refer to Compilation Report” on each
page of the financial information or on the front of the complete set of financial statements.

Self-Evaluation Questions:
Question 1 Explain the types of opinion.
Question 2 Distinguish between audit report and certificate
Question 3 Explain the relationship between management representation letters and audit
evidences
Question 4 Write short note on Audit report to be issued in case of bank audits.

AUDIT AND ASSURANCE

CHAPER 11 : NEPAL STANDARDS ON AUDITING (NSA)
CHAPTER 11
NEPAL STANDARDS ON
AUDITING (NSA)

AUDIT AND ASSURANCE
A. BACKGROUND
Professional accountant should to adhere to standards and procedures laid down by the
professional accountancy bodies of which he/she is a member while discharging auditor’s
duties in a responsible manner. In this direction, the role of a professional accounting body is
to lay down such standards and procedures with the aim of providing guidance to members.
The Accounting Standards Board (ASB) and The Auditing Standards Board (AuSB) develop,
amend standards and submit to the Institute of Chartered Accountants of Nepal (ICAN) to make
standards effective. In this chapter, we provide an overview of auditing standards and guidance
notes issued by the Institute from time to time. Though these standards and guidance notes have
been dealt at appropriate places, the main purpose is to acquaint and inculcate appreciation on the
part of students in a focused manner as to significance of the standards in their day to day auditing
activities.
B. INTERNATIONAL STANDARDS ON AUDITING
International Standards on Auditing (ISA) are professional standards for the performance of
financial audit of financial information. These standards are issued by International Federation of
Accountants (IFAC) through the International Auditing and Assurance Standards Board (IAASB).
The International Auditing and Assurance Standards Board (IAASB) is an independent standard-
setting body that serves the public interest by setting high-quality international standards
for auditing, assurance, and other related standards, and by facilitating the convergence of
international and national auditing and assurance standards. In doing so, the IAASB enhances the
quality and consistency of practice throughout the world and strengthens public confidence in the
global auditing and assurance profession.
IFAC is the global organization for the accountancy profession dedicated to serving the public
interest by strengthening the profession and contributing to the development of strong international
economies. IFAC is comprised of over 175 members and associates in more than 130 countries and
jurisdictions, representing almost 3 million accountants in public practice, education, government
service, industry, and commerce.
IFAC provides the structures and processes that support the development, adoption, and
implementation of high quality international standards. The standards IFAC supports —in the
areas of auditing, assurance, and quality control; public sector accounting; accounting education;
and ethics — are an important part of the global financial infrastructure and contribute to economic
stability around the world. In addition, working closely with its member bodies, IFAC provides
tools and guidance to support professional accountants in business and small and medium
practices (SMP). IFAC supports the development of the accountancy profession in emerging
economies, and speaks out on public interest issues where the profession’s voice is most relevant.
Through all of these activities, IFAC promotes its values of integrity, transparency, and expertise.

ISA and NSA

In 2006 the Auditing Standards Board (AuSB) adopted an official position of convergence to ISAs
- aligning its agenda with that of the IAASB and using the ISAs as a base. AuSB started redrafting
Nepal Auditing Standards in line with relevant ISAs, including the Preface and Framework. 36 out
of 36 issued NSAs are already updated and revised and one new standard, NSA 701, is introduced
from year 2076-77 voluntarily and mandatory from year the date of notice to be issued by the
Institute of Chartered Accountants of Nepal.
C. AUDITING STANDARDS BOARD
The International Federation of Accountants (IFAC) came into existence in 1977 and constituted
International Auditing Practices Committee (IAPC) to formulate International Auditing
Guidelines. These guidelines were later on converted into International Standards on Auditing
(ISA). Considering the developments in the field of auditing at international level, the need for
issuing Standards and Guidance Notes in tandem with international standards but conforming to
national laws, customs, usages and business environments was felt.
With this objective, Government of Nepal constituted the Auditing Standards Board (AuSB) on
March 10, 2003 under Nepal Chartered Accountants Act, 1997 (first amendment 2002) to spearhead
the new framework of Nepal Standard on Auditing (NSA) and Guidance Notes (GNs) inter alia
to replace various chapters of the old omnibus Auditing Standard. AuSB believes that the issue
of such standards will improve the degree of uniformity of auditing practices in Nepal. The main
function of AuSB is to review existing practices in Nepal and to develop Nepal Standards on
Auditing (NSAs) so that these may be issued and regulated by the Council of the ICAN. While
formulating NSA(s), the AuSB considers the applicable laws, customs, usages and business
environments in Nepal. The NSAs are issued under the authority of the Chartered Accountants
Act, 1997 (first amendment 2002). The AuSB issues Guidance notes on the issues arising from the
NSAs wherever necessary. AuSB reviews and revises the NSAs at periodical intervals or as per
the need of the respective standards. The AuSB determines the broad areas in which the NSAs
need to be formulated and the priority in regard to the selection thereof. The AuSB, till date, has
formulated 37 Nepal Standards on Auditing.
Scope and Functions of AuSB

• The main function of AuSB is to review existing practices in Nepal and to develop Nepal
Standards on Auditing (NSAs) so that these may be issued and regulated by the Council
of the ICAN.
• While formulating NSA(s), the AuSB will take into consideration the applicable laws,
customs, usage and business environments in Nepal.
• The NSA(s) will be issued under the authority of the Council of the ICAN.

AUDIT AND ASSURANCE
• The AuSB will issue Guidance Notes on the issues arising from the NSA(s) wherever
necessary.
• AuSB will review the NSA(s) at periodical intervals.
Working Procedures of AuSB

• The AuSB will determine the broad areas in which the NSA(s) need to be formulated and
the priority in regard to the selection thereof.
• The quorum for a meeting is 51% of the total members. Standards and Statements require
approval of three quarter of members present at the meeting.
• The preparation of NSA(s) shall be in accordance with the working procedure formulated
by the AuSB.
• The NSA(s) will be submitted by the AuSB to the Council to issue and regulate under the
authority of the ICAN.
Scope of the NSA

The NSAs apply whenever an independent audit is carried out; that is, in the independent
examination of financial information of any entity, whether profit oriented or not, and irrespective
of its size, or legal form (unless specified otherwise) when such an examination is conducted with
a view to expressing an opinion. The NSAs may also have application, as appropriate, to other
related functions of auditors. Any limitation on the applicability of a specific NSA is made clear in
the introductory paragraph of the NSA. In short, the scope can be listed as under:
• The NSA is to be applied in the audit of Financial Statements carried out with a view to
expressing an opinion.
• The NSA may also have application as, appropriate, to other related functions of the
auditors.
• Any limitation of the applicability of a specific NSA will be made clear in the introductory
paragraph of the relevant NSA.
Procedure for issuing NSAs

Broadly, the following procedure is adopted for the formulation of NSAs:
• The AuSB determines the broad areas in which the NSAs need to be formulated and the
priority in regard to the selection thereof.
• In the preparation of NSAs, the AuSB is assisted by Study Groups constituted to consider
specific subjects. In the formation of Study Groups, provision is made for participation of
a cross-section of members of the Institute.

• On the basis of the work of the Study Groups, an exposure draft of the proposed NSA is
prepared by the Committee and issued for comments by members of the Institute.
• After taking into consideration the comments received, the draft of the proposed NSA is
finalised by the AuSB and submitted to the Council of the Institute.
• The Council of the Institute considers the final draft of the proposed NSA, and, if
necessary, modifies the same in consultation with the AuSB. The NSA is then issued
under the authority of the Council.
Compliance with the NSA
• While discharging their attest function, the members of the ICAN are under obligation to
ensure that the NSA(s) are followed in the audit of FS covered by their audit reports.
• If a member is not able to perform an audit in accordance with the NSA, auditor’s report
should draw attention to the material departures therefrom.
• Members are expected to follow NSAs in the audits commencing on or after the date
specified in the relevant NSA.
• The NSAs (as well as other statements on auditing) represent the generally accepted
procedure(s) of audit.
• A member, who does not perform audit in accordance with these statements and
fails to disclose the material departures therefrom, becomes liable to the disciplinary
proceedings of the Nepal Chartered Accountants Act, 1997.
So far, AuSB has issued the following Nepal Standards on Auditing (NSAs) for implementations:
Compliance Status
S. No. NSA No. Titles of the Standards
as on 01.04.2076
1. NSA 200 Overall Objectives of the Independent Auditor and Mandatory
the conduct of an Audit in Accordance with Nepal
Standards on Auditing
2. NSA 210 Agreeing the Terms of Audit Engagements Mandatory
3. NSA 220 Quality Control for an Audit of Financial Statements Mandatory
4. NSA 230 Audit Documentation Mandatory
5. NSA 240 The Auditor’s Responsibilities Relating to Fraud in an Mandatory
Audit of Financial Statements
6. NSA 250 Consideration of Laws and Regulations in an Audit of Mandatory
Financial Statements
7. NSA 260 Communication with Those Charged with Governance Mandatory
(Revised)

AUDIT AND ASSURANCE
Compliance Status
as on 01.04.2076
8. NSA 265 Communicating Deficiencies in Internal Control to Mandatory
Those Charged with Governance and Management
9. NSA 300 Planning an Audit of Financial Statements Mandatory
10. NSA 315 Identifying and Assessing the Risks of Material Mandatory
(Revised) Misstatement through Understanding the Entity and
Its Environment
11. NSA 320 Materiality in Planning and Performing an Audit Mandatory
12. NSA 330 The Auditor’s Responses to Assessed Risks Mandatory
13. NSA 402 Audit Considerations Relating to an Entity Using a Mandatory
Service Organization
14. NSA 450 Evaluation of Misstatements Identified during the Mandatory
Audit
15. NSA 500 Audit Evidence Mandatory
16. NSA 501 Audit Evidence-Specific Considerations for Selected Mandatory
Items
17. NSA 505 External Confirmations Mandatory
18. NSA 510 Initial Audit Engagements—Opening Balances Mandatory
19. NSA 520 Analytical Procedures Mandatory
20. NSA 530 Audit Sampling Mandatory
21. NSA 540 Auditing Accounting Estimates, Including Fair Value Mandatory
Accounting Estimates, and Related Disclosures
22. NSA 550 Related Parties Mandatory
23. NSA 560 Subsequent Events Mandatory
24. NSA 570 Going Concern Mandatory
(Revised)
25. NSA 580 Written Representations Mandatory
26. NSA 600 Special considerations- Audits of Group Financial Mandatory
statements (including the work of component
Auditors)
27. NSA 610 Using the work of Internal Auditors Mandatory
(Revised)
2013
28. NSA 620 Using the work of an Auditors Expert Mandatory
29. NSA 700 Forming an opinion and Reporting on Financial Mandatory
(Revised) Statements

Compliance Status
as on 01.04.2076
30. NSA 701 Communicating Key Audit Matters in the Independent Voluntary1
Auditor’s Report
31. NSA 705 Modifications to the opinion in the Independent Mandatory
(Revised) Auditors report
32. NSA 706 Emphasis of Matter Paragraphs and other Matter Mandatory
(Revised) Paragraphs in the Independent Auditors Report
33. NSA 710 Comparative information-corresponding Figures and Mandatory
comparative Financial Statements
34. NSA 720 The auditor’s responsibilities relating to Other Mandatory
(Revised) information
35. NSA 800 Special Considerations-Audit of financial statements Mandatory
(Revised) Prepared in Accordance with special Purpose
Frameworks
36. NSA 805 Special Considerations-Audits of Single Financial Mandatory
(Revised) statements and Specific Elements, Accounts or Items
of a Financial statements
37. NSA 810 Engagements to Report on Summary of Financial Mandatory
(Revised) Statements
In addition to above, AuSB has formulated Nepal Standards on Assurance Engagements (NSAE),
Nepal Standards on Review Engagements (NSRE), Nepal Standards on Related Services (NSRS), Nepal
Standards on Quality Control (NSQC), Nepal Auditing Practice Notes (NAPN) and quality frameworks.
A brief summary of NSAs covered in syllabus of CAP II level is given next section.
1. NSA 200: OVERALL OBJECTIVES OF THE INDEPENDENT AUDITOR

AND THE CONDUCT OF AN AUDIT IN ACCORDANCE WITH NEPAL
STANDARDS ON AUDITING
Purpose of this standard

Purpose of this NSA is to establish standards and provide guidance on the objective and general
principles governing an audit of financial statements.
Overall Objectives of an Audit
 To obtain reasonable assurance about whether the financial statements as a whole are
1 Mandatory compliance after the announcement of ICAN

AUDIT AND ASSURANCE
 To report on the financial statements, and communicate as required by the NSAs, in

accordance with the auditor’s findings
General Principles of an Audit

Auditor should comply with ethical principles governing professional responsibilities.
Ethical Principles Governing Professional

Responsibilities
Professional
Professional
Integrity Objectivity Competence and Confidentiality
Behaviour
due care
Professional Skepticism
 Professional skepticism means an attitude of the auditor which makes a critical
assessment, with a questioning mind, of the validity of audit evidence obtained and is
alert to audit evidence that contradicts or brings into question the reliability of documents
or management representation.
 The auditor should plan and perform the audit with professional skepticism recognizing
that circumstances may exist which cause the financial statements to be materially
misstated.
 Professional skepticism includes being alert to, for example:

• Audit evidence that contradicts another 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 NSAs.
 Maintaining professional skepticism throughout the audit is necessary if the auditor is,
for example, to reduce the risks of:
• Overlooking unusual circumstances.
• Over generalizing 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. .

 Professional skepticism is necessary to the critical assessment of audit evidence. This

includes questioning contradictory audit evidence and the reliability of documents and
responses to inquiries and other information obtained from management and those charged
with governance. It also includes consideration of the sufficiency and appropriateness of
audit evidence obtained in the light of the circumstances, for example, in the case where
fraud risk factors exist and a single document, of a nature that is susceptible to fraud, is the
sole supporting evidence for a material financial statement amount.
Reasonable Assurance
Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for
the auditor to conclude that there are no material misstatements in the financial statements taken
as a whole. An audit in accordance with NSA is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement.
Inherent limitations of audit

The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain
absolute assurance that the financial statements are free from material misstatement due to fraud
or error. This is because there are inherent limitations of an audit, which result in most of the
audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being
persuasive rather than conclusive. The inherent limitations of an audit arise from:
• The nature of financial reporting;
• The nature of audit procedures; and
• The need for the audit to be conducted within a reasonable period of time and at a
reasonable cost.
Other Matters that Affect the Inherent Limitations of an Audit

In the case of certain assertions or subject matters, the potential effects of the inherent limitations on
the auditor’s ability to detect material misstatements are particularly significant. Such assertions
or subject matters include:
• Fraud, particularly fraud involving senior management or collusion.
• The existence and completeness of related party relationships and transactions.
• The occurrence of non-compliance with laws and regulations.
• Future events or conditions that may cause an entity to cease to continue as a going
concern.
Because of the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements may not be detected, even though the audit is properly
planned and performed in accordance with NSAs. Accordingly, the subsequent discovery of a

AUDIT AND ASSURANCE
material misstatement of the financial statements resulting from fraud or error does not by itself
indicate a failure to conduct an audit in accordance with NSAs. However, the inherent limitations
of an audit are not a justification for the auditor to be satisfied with less than persuasive audit
evidence. Whether the auditor has performed an audit in accordance with NSAs is determined by
the audit procedures performed in the circumstances, the sufficiency and appropriateness of the
audit evidence obtained as a result thereof and the suitability of the auditor’s report based on an
evaluation of that evidence in light of the overall objectives of the audit.
Financial Statement Responsibilities
Responsibilities for the Financial Statements
Management Auditor
Preparing and Presenting Forming and Expressing an opinion
2. NSA 210: TERMS OF AUDIT ENGAGEMENT
Purpose
To assist the auditor in the preparation of engagement letters relating to audits of financial
statements.
Audit Engagement Letters

 The auditor and the client should agree on the terms of the engagement.
 The agreed terms would need to be recorded in an audit engagement letter/contract.
 It is to be signed preferably before the commencement of the engagement, to help in

avoiding misunderstandings with respect to the engagement.
Contents of engagement letter

Engagement letter generally include reference to:
 The objective and scope of the audit of the financial statements;

 The responsibilities of the auditor;
 The responsibilities of management;
 Identification of the applicable financial reporting framework for the preparation of the
 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.
In addition to including the above matters, an audit engagement letter may make reference to, for
example:
 Elaboration of the scope of the audit, including reference to applicable legislation,

regulations, NSAs, and ethical and other pronouncements of professional bodies to
which the auditor adheres.
 The form of any other communication of results of the audit engagement.
 The fact that because of the inherent limitations of an audit, together with the inherent
limitations of internal control, there is an unavoidable risk that some material
misstatements may not be detected, even though the audit is properly planned and
performed in accordance with NSAs.
 Arrangements regarding the planning and performance of the audit, including the
composition of the audit team.
 The expectation that management will provide written representations.
 The agreement of management to make available to the auditor draft financial statements
and any accompanying other information in time to allow the auditor to complete the
audit in accordance with the proposed timetable.
 The agreement of management to inform the auditor of facts that may affect the financial
statements, of which management may become aware during the period from the date
of the auditor’s report to the date the financial statements are issued.
 The basis on which fees are computed and any billing arrangements.
 A request for management to acknowledge receipt of the audit engagement letter and to
agree to the terms of the engagement outlined therein.
Wherever relevant, the following points could also be incorporated:
 Arrangements concerning the involvement of other auditors and experts in some aspects
of the audit.
 Arrangements concerning the involvement of internal auditors and other client staff.

AUDIT AND ASSURANCE
 Arrangements to be made with the predecessor auditor, if any, in the case of an initial
audit.
 Any restriction of the auditor's liability when such possibility exists.
 A reference to any further agreements between the auditor and the client.
 Any obligations to provide audit working papers to other parties.
Audits of Components
When the auditor of a parent entity is also the auditor of its subsidiary, branch or division
(component), the factors that influence the decision whether to send a separate engagement letter
to the component include:
 Who appoints the auditor of the components;
 Whether a separate audit report is to be issued on the component;
 Legal requirements in relation to audit appointments;
 Degree of ownership by parent; and Degree of independence of the component's

management from the parent company.
Recurring Audits/Ongoing Audits

The auditor may decide not to send a new engagement letter each period. Auditor should access
the need whether circumstances require the terms of the engagement to be revised and whether
there is a need to remind the client of the existing terms of the engagement.
However, in case of the following it is appropriate to send a new letter:
a. Any indication that the client misunderstands the objective and scope of the audit;
b. Any revised or special terms of the engagement;
c. A recent change of senior management, ;
d. A significant change in ownership;
e. A significant change in nature or size of the client's business;
f. A change in legal or regulatory requirements.
g. A change in the financial reporting framework adopted in the preparation of the financial
statements; and
h. A change in other reporting requirements.

Acceptance of a Change in the Terms of the Audit Engagement

 If an auditor is requested to change terms of the engagement to one which provides a
lower level of assurance, should consider the appropriateness of doing so.
 Where it is changed the auditor and the client should agree on the new terms.
 The auditor should not agree to a change of engagement where there is no reasonable
justification for doing so.
When auditor is unable to change and unable to continue with original terms of
engagement
If the auditor is unable to agree to a change of the engagement and is not permitted to continue the
original engagement, the auditor should withdraw and consider whether there is any obligation,
either contractual or otherwise, to report to board of directors or shareholders, the circumstances
necessitating such withdrawal.
3. NSA 230: AUDIT DOCUMENTATION
Purpose
To establish standards and provide guidance regarding documentation in the context of the audit
of financial statements. The specific documentation requirements of other NSAs do not limit the
application of this NSA. Law or regulation may establish additional documentation requirements.
Nature and Purposes of Audit Documentation

Audit documentation that meets the requirements of this NSA and the specific documentation
requirements of other relevant NSAs provides:
(a) Evidence of the auditor’s basis for a conclusion about the achievement of the overall
objectives of the auditor; and
(b) Evidence that the audit was planned and performed in accordance with NSAs and
applicable legal and regulatory requirements.
Audit documentation serves a number of additional purposes, including the following:
• Assisting the engagement team to plan and perform the audit.
• Assisting members of the engagement team responsible for supervision to direct and
supervise the audit work, and to discharge their review responsibilities in accordance
with NSA 220.
• Enabling the engagement team to be accountable for its work.
• Retaining a record of matters of continuing significance to future audits.

AUDIT AND ASSURANCE
• Enabling the conduct of quality control reviews and inspections in accordance with
NSQC 1 or national requirements that are at least as demanding.
• Enabling the conduct of external inspections in accordance with applicable legal,

regulatory or other requirements.
Objective
The objective of the auditor is to prepare documentation that provides:
(a) A sufficient and appropriate record of the basis for the auditor’s report; and
(b) Evidence that the audit was planned and performed in accordance with NSAs and
applicable legal and regulatory requirements.
Form, Content and Extent of Audit Documentation

The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor,
having no previous connection with the audit, to understand-
(a) The nature, timing and extent of the audit procedures performed to comply with the
NSAs and applicable legal and regulatory requirements;
(b) The results of the audit procedures performed, and the audit evidence obtained; and
(c) Significant matters arising during the audit, the conclusions reached thereon, and
significant professional judgments made in reaching those conclusions.
In documenting the nature, timing and extent of audit procedures performed, the auditor shall
record:
(a) The identifying characteristics of the specific items or matters tested;
(b) Who performed the audit work and the date such work was completed; and
(c) Who reviewed the audit work performed and the date and extent of such review.
The auditor shall document discussions of significant matters with management, those charged
with governance, and others, including the nature of the significant matters discussed and when
and with whom the discussions took place.
If the auditor identified information that is inconsistent with the auditor’s final conclusion regarding
a significant matter, the auditor shall document how the auditor addressed the inconsistency.
Permanent Working File and Current /Temporary Working File

The above documents can be segregated into permanent and working file on the basis of usage of
evidences, validity and repetitiveness in case of recurring audits as under:

Working Papers File
PERMANENT CURRENT
x legal and organisational structure, x Reappointment correspondence,
x Minutes of board and general meetings,
x legal documents, agreements and minutes,
x Audit planning and audit programme,
x Evaluation controls system, x Analysis of transactions and balances,
x Financial statements of previous years, x Nature, extent and timing of auditing procedures,
x Analysis of significant ratios and trends, x Supervision and review of assistants,
x management letters issued, x Communications with third parties,
x communication with the retiring auditor, x Correspondance with client,
x Significant accounting policies and x Letters of representation or confirmation from client,
x Conclusions reached and resolved by the auditor and
x Major audit observations of earlier years
x Financial information being reported on and the
related audit reports.
Working papers are the property of the auditor. Although portions of or extracts from the working
papers may be made available to the client at the discretion of the auditor.
The auditor should adopt appropriate procedures for maintaining the confidentiality and safe
custody of the working papers and for retaining them for a period sufficient to meet the needs of
the practice and in accordance with legal and professional requirements of record retention.
Departure from a Relevant Requirement

If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement
in an NSA, the auditor shall document how the alternative audit procedures performed achieve
the aim of that requirement, and the reasons for the departure.
Matters Arising after the Date of the Auditor’s Report

If, in exceptional circumstances, the auditor performs new or additional audit procedures or draws
new conclusions after the date of the auditor’s report, the auditor shall document:
(a) The circumstances encountered;
(b) The new or additional audit procedures performed, audit evidence obtained, and
conclusions reached, and their effect on the auditor’s report; and
(c) When and by whom the resulting changes to audit documentation were made and
reviewed.

AUDIT AND ASSURANCE
Assembly of the Final Audit File

The auditor shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor’s report
ordinarily not more than 60 days after the date of the auditor’s report. After the assembly of the
final audit file has been completed, the auditor shall not delete or discard audit documentation of
any nature before the end of its retention period ordinarily is no shorter than five years from the
date of the auditor’s report, or, if later, the date of the group auditor’s report.
4. NSA 250: CONSIDERATION OF LAWS AND REGULATIONS IN

AN AUDIT OF FINANCIAL STATEMENTS
When planning and performing audit procedures and in evaluating and reporting the results
thereof, the auditor should recognise that noncompliance by the entity with laws and regulations
may materially affect the financial statements.
However, an audit cannot be expected to detect noncompliance with all laws and regulations.
Detection of non-compliance, regardless of materiality, requires consideration of the implications
for the integrity of management or employees and the possible effect on other aspects of the audit.
It is the responsibility of management, with the oversight of those charged with governance, to
ensure that the entity’s operations are conducted in accordance with the provisions of laws and
regulations, including compliance with the provisions of laws and regulations that determine the
reported amounts and disclosures in an entity’s financial statements.
The following policies and procedures, among others, may assist management in discharging its
responsibilities for the prevention and detection of noncompliance:
 monitoring legal requirements and ensuring that operating procedures are designed to
meet these requirements,
 instituting and operating appropriate systems of internal control,
 developing, publicizing and following a Code of Conduct,
 ensuring employees are properly trained and understand the Code of Conduct,
 monitoring compliance with the Code of Conduct and acting appropriately to discipline
employees who fail to comply with it,
 engaging legal advisors to assist in monitoring legal requirements, and
 Maintaining a register of significant laws with which the entity has to comply within its
particular industry and a record of complaints.

In case of larger entities, these policies and procedures may be supplemented by assigning
appropriate responsibilities to:
• An internal audit function, and
• An audit committee.
The Auditor’s Consideration of Compliance with Laws and Regulations

The auditor is not, and cannot be held responsible for preventing noncompliance. The fact that an
annual audit is carried out may, however, act as a deterrent.
An audit is subject to the unavoidable risk that some material misstatements of the financial
statements will not be detected, even though the audit is properly planned and performed in
accordance with NSAs. This risk is higher with regard to material misstatements resulting from
noncompliance with laws and regulations due to factors such as:
 there are many laws and regulations, relating principally to the operating aspects of the
entity, that typically do not have a material effect on the financial statements and are not
captured by the accounting and internal control systems,
 the effectiveness of audit procedures is affected by the inherent limitations of the

accounting and internal control systems and by the use of testing,
 much of the evidence obtained by the auditor is persuasive rather than conclusive in
nature, and
 Noncompliance may involve conduct designed to conceal it, such as collusion, deliberate
failure to record transactions, senior management override of controls or intentional
misrepresentations being made to the auditor.
In accordance with NSA 200 - Overall Objectives of the Independent Auditor and the conduct of an
Audit in Accordance with Nepal Standards on Auditing, the auditor should plan and perform the
audit with an attitude of professional skepticism recognizing that the audit may reveal conditions
or events that would lead to questioning whether an entity is complying with laws and regulations.
In accordance with specific statutory requirements, the auditor may be specifically required to
report as part of the audit of the financial statements whether the entity complies with certain
provisions of laws or regulations. In these circumstances, the auditor would plan to test for
compliance with these provisions of the laws and regulations.
In order to plan the audit, the auditor should obtain a general understanding of the legal and
regulatory framework applicable to the entity and the industry and how the entity is complying
with that framework.
Noncompliance with certain laws and regulations may cause the entity to cease operations, or
call into question the entity’s continuance as a going concern. For example, noncompliance with

AUDIT AND ASSURANCE
the requirements of the entity’s license or other title to perform its operations could have such an
impact.
To obtain the general understanding of laws and regulations, the auditor would ordinarily:
 use the existing knowledge of the entity’s industry and business,
 update the understanding of those laws and regulations that directly determine the
reported amounts and disclosures in the financial statements;
 inquire of management concerning the entity’s policies and procedures regarding

compliance with laws and regulations,
 inquire of management as to the laws or regulations that may be expected to have a

fundamental effect on the operations of the entity,
 discuss with management the policies or procedures adopted for identifying, evaluating
and accounting for litigation claims and assessments, and
 discuss the legal and regulatory framework with auditors of subsidiaries in other
countries.
After obtaining the general understanding, the auditor should perform procedures to help identify
instances of noncompliance with those laws and regulations where noncompliance should be
considered when preparing financial statements, specifically:
a) Inquiring of management as to whether the entity is in compliance with such laws and
regulations,
b) Inspecting correspondence with the relevant licensing or regulatory authorities.
Further, the auditor should obtain sufficient appropriate audit evidence about compliance
with those laws and regulations generally recognised by the auditor to have an effect on the
determination of material amounts and disclosures in financial statements. The auditor should
have a sufficient understanding of these laws and regulations in order to consider them when
auditing the assertions related to the determination of the amounts to be recorded and the
disclosures to be made.
The auditor should be alert to the fact that procedures applied for the purpose of forming an
opinion on the financial statements may bring instances of possible noncompliance with laws and
regulations to the auditor’s attention.
The auditor should obtain written representations that management has disclosed to the auditor
all known actual or possible noncompliance with laws and regulations whose effects should be
considered when preparing financial statements.

Procedures When Noncompliance is discovered

When the auditor becomes aware of information concerning a possible instance of noncompliance,
the auditor should obtain an understanding of the nature of the act and the circumstances in which
it has occurred, and sufficient other information to evaluate the possible effect on the financial
statements.
When evaluating the possible effect on the financial statements, the auditor considers:
 the potential financial consequences, such as fines, penalties, damages, threat of

expropriation (confiscation) of assets, enforced discontinuation of operations and
litigation,
 whether the potential financial consequences require disclosure, and
 whether the potential financial consequences are so serious as to call into question the
true and fair view (fair presentation) given by the financial statements.
When the auditor believes there may be noncompliance, the auditor should document the findings
and discuss them with management.
When adequate information about the suspected noncompliance cannot be obtained, the auditor
should consider the effect of the lack of audit evidence on the auditor’s report. The auditor should
consider the implications of noncompliance in relation to other aspects of the audit, particularly
the reliability of management representations.
Reporting of Non-compliance
The auditor should, as soon as practicable, either communicate with the audit committee, the board
of directors and senior management, or obtain evidence that they are appropriately informed,
regarding noncompliance that comes to the auditor’s attention.
If in the auditor’s judgment the noncompliance is believed to be intentional and material, the
auditor should communicate the finding without delay.
If the auditor suspects that members of senior management, including members of the board of
directors, are involved in noncompliance, the auditor should report the matter to the next higher
level of authority at the entity, if it exists, such as an audit committee or a supervisory board.
Where no higher authority exists, or if the auditor believes that the report may not be acted upon
or is unsure as to the person to whom to report, the auditor would consider seeking legal advice.
If the auditor concludes that the non-compliance has a material effect on the financial statements,
and has not been properly reflected in the financial statements, the auditor should express a
qualified or an adverse opinion.

AUDIT AND ASSURANCE
If the auditor is precluded by the entity from obtaining sufficient appropriate audit evidence to
evaluate whether noncompliance that may be material to the financial statements, has, or is likely
to have, occurred, the auditor should express a qualified opinion or a disclaimer of opinion on the
financial statements on the basis of a limitation on the scope of the audit.
Reporting of non compliance to Regulatory and Enforcement Authorities

The auditor’s duty of confidentiality would ordinarily preclude reporting noncompliance to
a third party. However, in certain circumstances, that duty of confidentiality is overridden by
statute, law or by courts of law (for example, in some countries the auditor is required to report
noncompliance by financial institutions to the supervisory authorities). The auditor may need to
seek legal advice in such circumstances, giving due consideration to the auditor’s responsibility
to the public interest.
Withdrawal from the Engagement

The auditor may conclude that withdrawal from the engagement is necessary when the entity
does not take the remedial action that the auditor considers necessary in the circumstances, even
when the noncompliance is not material to the financial statements.
As stated in the Code of Ethics for Professional Accountants issued by The Institute of Chartered
Accountants of Nepal, on receipt of an inquiry from the proposed auditor, the existing auditor
should advise whether there are any professional reasons why the proposed auditor should not
accept the appointment. If permission from the client to discuss its affairs with the proposed
auditor is denied by the client, that fact should be disclosed to the proposed auditor.
5. NSA 300: PLANNING AN AUDIT OF FINANCIAL STATEMENTS
Purpose
To establish standards and provide guidance on planning an audit of financial statements in the
context of recurring audits.
As per the standard, planning an audit involves establishing the overall audit strategy for the
engagement and developing an audit plan.
Planning the Work

Adequate planning benefits the audit of financial statements in several ways, including the
following:
• Helping the auditor to devote appropriate attention to important areas of the audit.
• Helping the auditor identify and resolve potential problems on a timely basis.

• Helping the auditor properly organize and manage the audit engagement so that it is
performed in an effective and efficient manner.
• Assisting in the selection of engagement team members with appropriate levels of

capabilities and competence to respond to anticipated risks, and the proper assignment
of work to them.
• Facilitating the direction and supervision of engagement team members and the review
of their work.
• Assisting, where applicable, in coordination of work done by auditors of components

and experts.
The extent of planning depends upon-
 The size of the entity,
 The complexity of the audit
 The auditor’s experience with the entity and knowledge of the business and
 Changes in circumstances that occur during the audit engagement.
The overall audit plan and the audit program is the auditor’s responsibility. However, the auditor
may wish to discuss elements of the overall audit plan and certain audit procedures with the
entity’s audit committee, management and staff.
The Overall Audit Plan

The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the
audit, and that guides the development of the audit plan. In establishing the overall audit strategy,
the auditor shall:
(a) Identify the characteristics of the engagement that define its scope;
(b) Ascertain the reporting objectives of the engagement to plan the timing
(c) of the audit and the nature of the communications required;
(d) Consider the factors that, in the auditor’s professional judgment, are significant in
directing the engagement team’s efforts;
(e) Consider the results of preliminary engagement activities and, where applicable, whether
knowledge gained on other engagements performed by the engagement partner for the
entity is relevant; and
(f) Ascertain the nature, timing and extent of resources necessary to perform the engagement.

AUDIT AND ASSURANCE
The auditor shall develop an audit plan that shall include a description of:
(a) The nature, timing and extent of planned risk assessment procedures, as determined
under NSA 315.
(b) The nature, timing and extent of planned further audit procedures at the assertion level,
as determined under NSA 330
(c) Other planned audit procedures that are required to be carried out so that the engagement
complies with NSAs.
The record of the overall audit plan will need to be sufficiently detailed to guide the development
of the audit program; its precise form and content will vary depending on the size of the entity, the
complexity of the audit and the specific methodology and technology used by the auditor. Matters
to be considered by the auditor in developing the overall audit plan include:
A. Knowledge of the Business

 General economic factors and industry conditions affecting the entity’s business.
 Important characteristics of the entity, its business, its financial performance and its
reporting requirements including changes since the date of the prior audit.
 The general level of competence of management.
B. Understanding the Accounting and Internal Control Systems

 The accounting policies adopted by the entity and changes in those policies.
 The effect of new accounting or auditing pronouncements.
 The auditor’s cumulative knowledge of the accounting and internal control systems and
reliance expected to be placed on tests of control and substantive procedures.
C. Risk and Materiality

 The expected assessments of audit risks and the identification of significant audit areas.
 The setting of materiality levels for audit purposes.
 The possibility of material misstatement, including the experience of past or fraud.
 The identification of complex accounting areas.
 Nature, Extent and Timing (NET) of Procedures.
 Possible change of emphasis on specific audit areas.
 The effect of information technology on the audit.
 The work of internal auditing and its expected effect on external audit procedures.

D. Coordination, Direction, Supervision and Review

 The involvement of other auditors in the audit of components.
 The involvement of experts.
 The number of locations.
 Staffing requirements.
E. Other Matters
 The going concern assumption related questions.
 Conditions requiring special attention, such as the existence of related parties.
 The terms of the engagement and any statutory responsibilities.
 The nature and timing of reports or other communication with the entity.
The Audit Program

The audit program serves as a-
 Set of instructions to assistants involved in the audit.
 Means to control and record the proper execution of the work.
 Measure of audit objectives for each area and
 A time budget in which hours are budgeted for the various audit areas or procedures.
In Preparing The Audit Program, The Auditor Would Consider
The specific assessments of inherent The availability of assistants and the

and control risks. involvement of other auditors or experts.
The required level of assurance to be Coordination of any assistance expected

provided by substantive procedures. from the entity.
The timing of tests of controls and

substantive procedures.
Changes to the Overall Audit Strategy and Audit Plan

The overall audit strategy and the audit plan should be revised as necessary during the course
of the audit as the planning is continuous throughout the engagement because of changes in
conditions or unexpected results of audit procedures. The reasons for significant changes would
be recorded along with the overall audit strategy and audit plan.

AUDIT AND ASSURANCE
6. NSA 315: IDENTIFYING AND ASSESSING THE RISKS OF

MATERIAL MISSTATEMENT THROUGH UNDERSTANDING
THE ENTITY AND ITS ENVIRONMENT (REVISED)
Purpose
To identify and assess the risks of material misstatement in the financial statements, through
understanding the entity and its environment, including the entity’s internal control.
Risk Assessment Procedures and Related Activities
The auditor shall perform risk assessment procedures to provide a basis for the identification
and assessment of risks of material misstatement at the financial statement and assertion levels.
Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit
evidence on which to base the audit opinion.
The risk assessment procedures shall include the following:
(a) Inquiries of management, of appropriate individuals within the internal audit function
(if the function exists), and of others within the entity who in the auditor’s judgment may
have information that is likely to assist in identifying risks of material misstatement due
to fraud or error.
(b) Analytical procedures.
(c) Observation and inspection.
The auditor shall consider whether information obtained from the auditor’s client acceptance or
continuance process is relevant to identifying risks of material misstatement.
If the engagement partner has performed other engagements for the entity, the engagement
partner shall consider whether information obtained is relevant to identifying risks of material
misstatement.
Where the auditor intends to use information obtained from the auditor’s previous experience with the
entity and from audit procedures performed in previous audits, the auditor shall determine whether
changes have occurred since the previous audit that may affect its relevance to the current audit.
The Required Understanding of the Entity and Its Environment, Including the Entity’s
Internal Control
The Entity and Its Environment
The auditor shall obtain an understanding of the following:
(a) Relevant industry, regulatory, and other external factors including the applicable
financial reporting framework.

(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make, including
investments in special-purpose entities; and
(iv) the way that the entity is structured and how it is financed,
to enable the auditor to understand the classes of transactions, account balances, and
disclosures to be expected in the financial statements.
(c) The entity’s selection and application of accounting policies, including the reasons for
changes thereto. The auditor shall evaluate whether the entity’s accounting policies
are appropriate for its business and consistent with the applicable financial reporting
framework and accounting policies used in the relevant industry.
(d) The entity’s objectives and strategies, and those related business risks that may result in
risks of material misstatement.
(e) The measurement and review of the entity’s financial performance.
The Entity’s Internal Control

The auditor shall obtain an understanding of internal control relevant to the audit. Although most
controls relevant to the audit are likely to relate to financial reporting, not all controls that relate
to financial reporting are relevant to the audit. It is a matter of the auditor’s professional judgment
whether a control, individually or in combination with others, is relevant to the audit.
Components of Internal Control

Control environment
The auditor shall obtain an understanding of the control environment. As part of obtaining this
understanding, the auditor shall evaluate whether:
(a) Management, with the oversight of those charged with governance, has created and
maintained a culture of honesty and ethical behavior; and
(b) The strengths in the control environment elements collectively provide an appropriate
foundation for the other components of internal control, and whether those other
components are not undermined by deficiencies in the control environment.
The entity’s risk assessment process
The auditor shall obtain an understanding of whether the entity has a process for:
(a) Identifying business risks relevant to financial reporting objectives;

AUDIT AND ASSURANCE
(b) Estimating the significance of the risks;
(c) Assessing the likelihood of their occurrence; and
(d) Deciding about actions to address those risks.
If the entity has established such a process (referred to hereafter as the “entity’s risk assessment
process”), the auditor shall obtain an understanding of it, and the results thereof. If the auditor
identifies risks of material misstatement that management failed to identify, the auditor shall
evaluate whether there was an underlying risk of a kind that the auditor expects would have been
identified by the entity’s risk assessment process. If there is such a risk, the auditor shall obtain
an understanding of why that process failed to identify it, and evaluate whether the process is
appropriate to its circumstances or determine if there is a significant deficiency in internal control
with regard to the entity’s risk assessment process.
The information system, including the related business processes, relevant to financial reporting,
and communication
The auditor shall obtain an understanding of the information system, including the related
business processes, relevant to financial reporting, including the following areas:
(a) The classes of transactions in the entity’s operations that are significant to the financial
statements;
(b) The procedures, within both information technology (IT) and manual systems, by which
those transactions are initiated, recorded, processed, corrected as necessary, transferred
to the general ledger and reported in the financial statements;
(c) The related accounting records, supporting information and specific accounts in the
financial statements that are used to initiate, record, process and report transactions; this
includes the correction of incorrect information and how information is transferred to
the general ledger. The records may be in either manual or electronic form;
(d) How the information system captures events and conditions, other than transactions,
that are significant to the financial statements;
(e) The financial reporting process used to prepare the entity’s financial statements,
including significant accounting estimates and disclosures; and
(f) Controls surrounding journal entries, including non-standard journal entries used to
record non-recurring, unusual transactions or adjustments.
This understanding of the information system relevant to financial reporting shall include relevant
aspects of that system relating to information disclosed in the financial statements that is obtained
from within or outside of the general and subsidiary ledgers.
The auditor shall obtain an understanding of how the entity communicates financial reporting
roles and responsibilities and significant matters relating to financial reporting, including:

(a) Communications between management and those charged with governance; and
(b) External communications, such as those with regulatory authorities.
Control activities relevant to the audit
The auditor shall obtain an understanding of control activities relevant to the audit, being those
the auditor judges it necessary to understand in order to assess the risks of material misstatement
at the assertion level and design further audit procedures responsive to assessed risks. An audit
does not require an understanding of all the control activities related to each significant class
of transactions, account balance, and disclosure in the financial statements or to every assertion
relevant to them.
Monitoring of controls
The auditor shall obtain an understanding of the major activities that the entity uses to monitor
internal control relevant to financial reporting, including those related to those control activities
relevant to the audit, and how the entity initiates remedial actions to deficiencies in its controls.
If the entity has an internal audit function, the auditor shall obtain an understanding of the
nature of the internal audit function’s responsibilities, its organizational status, and the activities
performed, or to be performed.
The auditor shall obtain an understanding of the sources of the information used in the entity’s
monitoring activities, and the basis upon which management considers the information to be
sufficiently reliable for the purpose.
Identifying and Assessing the Risks of Material Misstatement

The auditor shall identify and assess the risks of material misstatement at:
(a) the financial statement level; and
(b) the assertion level for classes of transactions, account balances, and disclosures, to
provide a basis for designing and performing further audit procedures.
For this purpose, the auditor shall:
(a) Identify risks throughout the process of obtaining an understanding of the entity and its
environment, including relevant controls that relate to the risks, and by considering the
classes of transactions, account balances, and disclosures (including the quantitative or
qualitative aspects of such disclosures) in the financial statements;
(b) Assess the identified risks, and evaluate whether they relate more pervasively to the
financial statements as a whole and potentially affect many assertions;

AUDIT AND ASSURANCE
(c) Relate the identified risks to what can go wrong at the assertion level, taking account of
relevant controls that the auditor intends to test; and
(d) Consider the likelihood of misstatement, including the possibility of multiple

misstatements, and whether the potential misstatement could result in a material
misstatement.
Risks that Require Special Audit Consideration

As part of the risk assessment, the auditor shall determine whether any of the risks identified are,
in the auditor’s judgment, a significant risk. In exercising this judgment, the auditor shall exclude
the effects of identified controls related to the risk.
In exercising judgment as to which risks are significant risks, the auditor shall consider at least the
following:
(a) Whether the risk is a risk of fraud;
(b) Whether the risk is related to recent significant economic, accounting or other
developments and, therefore, requires specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;
(e) The degree of subjectivity in the measurement of financial information related to the risk,
especially those measurements involving a wide range of measurement uncertainty; and
(f) Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual.
If the auditor has determined that a significant risk exists, the auditor shall obtain an understanding
of the entity’s controls, including control activities, relevant to that risk.
Risks for Which Substantive Procedures Alone Do Not Provide Sufficient Appropriate Audit
Evidence
In respect of some risks, the auditor may judge that it is not possible or practicable to obtain
sufficient appropriate audit evidence only from substantive procedures. Such risks may relate to
the inaccurate or incomplete recording of routine and significant classes of transactions or account
balances, the characteristics of which often permit highly automated processing with little or no
manual intervention. In such cases, the entity’s controls over such risks are relevant to the audit
and the auditor shall obtain an understanding of them.
Revision of Risk Assessment

The auditor’s assessment of the risks of material misstatement at the assertion level may change
during the course of the audit as additional audit evidence is obtained. In circumstances where the

auditor obtains audit evidence from performing further audit procedures, or if new information
is obtained, either of which is inconsistent with the audit evidence on which the auditor originally
based the assessment, the auditor shall revise the assessment and modify the further planned
audit procedures accordingly.
Documentation
The auditor shall include in the audit documentation:
(a) The discussion among the engagement team, and the significant decisions reached;
(b) Key elements of the understanding obtained regarding each of the aspects of the
entity and its environment and of each of the internal control components; the sources
of information from which the understanding was obtained; and the risk assessment
procedures performed;
(c) The identified and assessed risks of material misstatement at the financial statement
level and at the assertion level; and
(d) The risks identified, and related controls about which the auditor has obtained an
understanding.
7. NSA 320: MATERIALITY IN PLANNING AND PERFORMING AN

AUDIT
Purpose
To establish standards and provide guidance on the concept of materiality and its relationship
with audit risk.
Materiality
a) Misstatements, including omissions, are considered to be material if they, individually
or in the aggregate, could reasonably be expected to influence the economic decisions of
users taken on the basis of the financial statements;
b) Judgments about materiality are made in light of surrounding circumstances, and are
affected by the size or nature of a misstatement, or a combination of both; and
c) Judgments about matters that are material to users of the financial statements are based
on a consideration of the common financial information needs of users as a group. The
possible effect of misstatements on specific individual users, whose needs may vary
widely, is not considered.
d) The auditor should consider materiality and its relationship with audit risk when
conducting an audit.

AUDIT AND ASSURANCE
e) The objective of an audit of financial statements is to enable the auditor to express an

opinion whether the financial statements are prepared, in all material respects.
f) The auditor’s determination of materiality is a matter of professional judgment and is

affected by the auditor’s perception of the financial information needs of users of the
The concept of materiality is applied by the auditor both in planning and performing the audit, and
in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements,
if any, on the financial statements and in forming the opinion in the auditor’s report.
In planning the audit, the auditor makes judgments about the size of misstatements that will be
considered material. These judgments provide a basis for:
(a) Determining the nature, timing and extent of risk assessment procedures;
(b) Identifying and assessing the risks of material misstatement; and
(c) Determining the nature, timing and extent of further audit procedures.
When establishing the overall audit strategy, the auditor shall determine materiality for the financial
statements as a whole. If, in the specific circumstances of the entity, there is one or more particular
classes of transactions, account balances or disclosures for which misstatements of lesser amounts
than materiality for the financial statements as a whole could reasonably be expected to influence
the economic decisions of users taken on the basis of the financial statements, the auditor shall also
determine the materiality level or levels to be applied to those particular classes of transactions,
account balances or disclosures. The auditor shall determine performance materiality for purposes
of assessing the risks of material misstatement and determining the nature, timing and extent of
further audit procedures. The materiality determined when planning the audit does not necessarily
establish an amount below which uncorrected misstatements, individually or in the aggregate,
will always be evaluated as immaterial. The circumstances related to some misstatements may
cause the auditor to evaluate them as material even if they are below materiality. Although it is
not practicable to design audit procedures to detect misstatements that could be material solely
because of their nature, the auditor considers not only the size but also the nature of uncorrected
misstatements, and the particular circumstances of their occurrence, when evaluating their effect
on the financial statements.
The auditor shall revise materiality for the financial statements as a whole (and, if applicable, the
materiality level or levels for particular classes of transactions, account balances or disclosures) in
the event of becoming aware of information during the audit that would have caused the auditor to
have determined a different amount (or amounts) initially as a result of a change in circumstances
that occurred during the audit (for example, a decision to dispose of a major part of the entity’s
business), new information, or a change in the auditor’s understanding of the entity and its
operations as a result of performing further audit procedures. If the auditor concludes that a lower

materiality for the financial statements as a whole (and, if applicable, materiality level or levels for
particular classes of transactions, account balances or disclosures) than that initially determined is
appropriate, the auditor shall determine whether it is necessary to revise performance materiality,
and whether the nature, timing and extent of the further audit procedures remain appropriate.
The auditor shall include in the audit documentation the following amounts and the factors
considered in their determination:
(a) Materiality for the financial statements as a whole;
(b) If applicable, the materiality level or levels for particular classes of transactions, account
balances or disclosures
(c) Performance materiality; and
(d) Any revision of (a)–(c) as the audit progressed.
Determining materiality involves the exercise of professional judgment. A percentage is often

applied to a chosen benchmark as a starting point in determining materiality for the financial
statements as a whole. Factors that may affect the identification of an appropriate benchmark
• The elements of the financial statements (for example, assets, liabilities, equity, revenue,
expenses);
• Whether there are items on which the attention of the users of the particular entity’s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
• The nature of the entity, where the entity is in its life cycle, and the industry and economic
environment in which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is
financed solely by debt rather than equity, users may put more emphasis on assets, and
claims on them, than on the entity’s earnings); and
• The relative volatility of the benchmark.
The Relationship between Materiality and Audit Risk

In conducting an audit of financial statements, the overall objectives of the auditor are 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 to report on the financial statements, and
communicate as required by the NSAs, in accordance with the auditor’s findings. The auditor
obtains reasonable assurance by obtaining sufficient appropriate audit evidence to reduce audit

AUDIT AND ASSURANCE
risk to an acceptably low level. Audit risk is the risk that the auditor expresses an inappropriate
audit opinion when the financial statements are materially misstated. Audit risk is a function of
the risks of material misstatement and detection risk. Materiality and audit risk are considered
throughout the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures; and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial statements
and in forming the opinion in the auditor’s report.
Performance Materiality
Planning the audit solely to detect individually material misstatements overlooks the fact that
the aggregate of individually immaterial misstatements may cause the financial statements to be
materially misstated, and leaves no margin for possible undetected misstatements. Performance
materiality (which, as defined, is one or more amounts) is set to reduce to an appropriately low level
the probability that the aggregate of uncorrected and undetected misstatements in the financial
statements exceeds materiality for the financial statements as a whole. Similarly, performance
materiality relating to a materiality level determined for a particular class of transactions, account
balance or disclosure is set to reduce to an appropriately low level the probability that the
aggregate of uncorrected and undetected misstatements in that particular class of transactions,
account balance or disclosure exceeds the materiality level for that particular class of transactions,
account balance or disclosure. The determination of performance materiality is not a simple
mechanical calculation and involves the exercise of professional judgment. It is affected by the
auditor’s understanding of the entity, updated during the performance of the risk assessment
procedures; and the nature and extent of misstatements identified in previous audits and thereby
the auditor’s expectations in relation to misstatements in the current period.
8. NSA 500: AUDIT EVIDENCE
Purpose
To establish standards and provide guidance on the quality and quantity of audit evidence to be
obtained when auditing financial statements and the procedures for obtaining that audit evidence.
Audit evidence
a. Audit evidence means the information used by the auditor in arriving at the conclusions on
which the auditor’s opinion is based. Audit evidence includes both information contained in
the accounting records underlying the financial statements and information obtained from
other sources.

The auditor shall design and perform audit procedures that are appropriate in the
circumstances for the purpose of obtaining sufficient appropriate audit evidence. The
auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion. Sufficiency is the measure of the quantity of
audit evidence; appropriateness is the measure of the quality of audit evidence. If the auditor
is unable to obtain sufficient appropriate audit evidence, he/she should express a qualified
opinion or a disclaimer of opinion.
Sufficiency of appropriate audit evidence is influenced by following factors:
 Nature and level of inherent risk at both the financial statement and the account balances
level,
 Nature of the accounting and internal control systems and the assessment of control risks,
 Materiality of the item being examined,
 Experience gained during previous audits,
 Results of audit procedures, including fraud or error and Source and reliability of
information available.
b. Management’s expert – An individual or organization possessing expertise in a field other

than accounting or auditing, whose work in that field is used by the entity to assist the entity
in preparing the financial statements.
c. Sufficiency (of audit evidence) – The measure of the quantity of audit evidence. The quantity
of the audit evidence needed is affected by the auditor’s assessment of the risks of material
misstatement and also by the quality of such audit evidence.
Financial Statement Assertions

The auditor should consider the sufficiency and appropriateness of audit evidence to support
financial statement assertions. Financial statement assertions are assertions by management; they
can be categorized as follows:
a) Measurement: A transaction or event is recorded at the proper amount and for proper
period;
b) Completeness: There are no unrecorded/undisclosed assets, liabilities, transactions or

events;
c) Occurrence: A transaction or event took place which pertains to the entity during the
period;
d) Valuation: An asset or liability is recorded at an appropriate carrying value;
e) Existence: An asset or a liability exists at a given date;

AUDIT AND ASSURANCE
f) Rights and Obligations: An asset or a liability pertains to the entity at a given date;
g) Presentation and Disclosure: An item is disclosed, classified, and described as per

requirement.
Further, the aspects of the accounting and internal control systems about which the auditor would
obtain audit evidence are:
a. Design: The systems are suitably designed to prevent/ detect/ correct material
misstatements; and
b. Operation: The systems exist and have operated effectively throughout the relevant
period.
Information to Be Used as Audit Evidence (Relevance and Reliability)

When designing and performing audit procedures, the auditor shall consider the relevance and
reliability of the information to be used as audit evidence.
If information to be used as audit evidence has been prepared using the work of a management’s
expert, the auditor shall, to the extent necessary, having regard to the significance of that expert’s
work for the auditor’s purposes:
(a) Evaluate the competence, capabilities and objectivity of that expert;
(b) Obtain an understanding of the work of that expert; and
(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevant
assertion.
When using information produced by the entity, the auditor shall evaluate whether the
information is sufficiently reliable for the auditor’s purposes, including, as necessary in
the circumstances:
(a) Obtaining audit evidence about the accuracy and completeness of the information; and
(b) Evaluating whether the information is sufficiently precise and detailed for the auditor’s
purposes.
The reliability of audit evidence is influenced by: -
 Its source-internal or external, and
 Its nature: visual, documentary or oral and
 The circumstances under which it is obtained, including the controls over its preparation
and maintenance where relevant.

Following generalizations will help in assessing the reliability of audit evidence:
 Audit Evidence from external sources is more reliable than that generated internally,
 Audit Evidence generated internally is more reliable when the related control systems
including those over its preparation and maintenance, imposed by the entity are effective,
 Audit Evidence obtained directly by the auditor is more reliable than obtained indirectly
or by inference and
 Audit evidence in documentary form, whether paper, electronic, or other medium, is

more reliable than evidence obtained orally (for example, a contemporaneously written
record of a meeting is more reliable than a subsequent oral representation of the matters
discussed).
 Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles, or documents that have been filmed, digitized or
otherwise transformed into electronic form, the reliability of which may depend on the
controls over their preparation and maintenance.
Relevance deals with the logical connection with, or bearing upon, the purpose of the audit
procedure and, where appropriate, the assertion under consideration. The relevance of information
to be used as audit evidence may be affected by the direction of testing. For example, if the purpose
of an audit procedure is to test for overstatement in the existence or valuation of accounts payable,
testing the recorded accounts payable may be a relevant audit procedure. On the other hand,
when testing for understatement in the existence or valuation of accounts payable, testing the
recorded accounts payable would not be relevant, but testing such information as subsequent
disbursements, unpaid invoices, suppliers’ statements, and unmatched receiving reports may be
relevant.
The auditor needs to consider the relationship between the cost of obtaining audit evidence and
the usefulness of the information (Audit Evidence) obtained. However, the matter of difficulty and
expense involved is not in itself a valid basis for omitting a necessary procedure.
Procedures for Obtaining Audit Evidence

Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is obtained
by performing:
(a) Risk assessment procedures; and
(b) Further audit procedures, which comprise:
(i) Tests of controls, when required by the NSAs or when the auditor has chosen to do
so; and

AUDIT AND ASSURANCE
(ii) Substantive procedures, including tests of details and substantive analytical

procedures.
The audit procedures as below may be used as risk assessment procedures, tests of controls or
substantive procedures, depending on the context in which they are applied by the auditor:-
Inspection
Inspection consists of examining records, documents, or tangible assets. Three major categories of
evidence, which provide different degrees of reliability to the auditor, are documentary audit evidence:
(a) Created and held by third parties;
(b) Created by third parties and held by the entity; and
(c) Created and held by the entity.
Inspection of tangible assets provides reliable audit evidence with respect to their existence but
not necessarily as to their ownership or value.
Observation
Observation consists of looking at a process or procedure being performed by others e.g. counting
of inventories.
Inquiry and Confirmation

Inquiry consists of seeking information of knowledgeable persons inside or outside the entity and
formal-outside or informal like oral-inside for example, seeking direct confirmation of receivables.
Computation
Computation consists of checking the arithmetical accuracy of source documents and accounting
records.
Analytical Procedures
Analytical procedures consist of the analysis of significant ratios and trends.
9. NSA 505: EXTERNAL CONFIRMATIONS
Purpose
To establish standards and provide guidance on the auditor’s use of external confirmations as a
means of obtaining audit evidence.
External confirmation
It is the process of obtaining and evaluating audit evidence through a direct communication from
a third party in response to a request for information about a particular item affecting assertions
made by management in the financial statements. In deciding to what extent to use external

confirmations the auditor considers the characteristics of the environment in which the entity
being audited operates and the practice of potential respondents in dealing with requests for
direct confirmation.
External confirmations are frequently used in relation to account balances and their components,
but need not be restricted to these items. For example, the auditor may request external confirmation
of the terms of agreements or transactions an entity has with third parties. The confirmation
request is designed to ask if any modifications have been made to the agreement, and if so, what
the relevant details are. Other examples of situations where external confirmations may be used
include the followings:
 bank balances and other information from bankers,
 accounts receivable balances,
 stocks held by third parties at bonded warehouses for processing or on consignment,
 property title deeds held by lawyers or financiers for safe custody or as security,
 investments purchased from stockbrokers but not delivered at the balance sheet date,
 loans from lenders, and
 Accounts payable balances.
Relationship of External Confirmation Procedures to the Auditor’s Assessments of Inherent

Risk and Control Risk
The lower the assessed level of inherent and control risk, the less assurance the auditor needs from
substantive procedures to form a conclusion about a financial statement assertion.
Unusual or complex transactions may be associated with higher levels of inherent or control risk
than simple transactions. If the entity has entered into an unusual or complex transaction and the
level of inherent and control risk is assessed as high, the auditor considers confirming the terms of
the transaction with the other parties in addition to examining documentation held by the entity.
Assertions Addressed by External Confirmations

Assertions embodied in financial statements as existence, rights and obligations, occurrence,
completeness, valuation, measurement, and presentation and disclosure. While external
confirmations may provide audit evidence regarding these assertions, the ability of an external
confirmation to provide evidence relevant to a particular financial statement assertion varies.
External confirmation of an account receivable provides strong evidence regarding the existence
of the account as at a certain date. Confirmation also provides evidence regarding the operation
of cut-off procedures. However, such confirmation does not ordinarily provide all the necessary
audit evidence relating to the valuation assertion, since it is not practicable to ask the debtor to
confirm detailed information relating to its ability to pay the account.

AUDIT AND ASSURANCE
Design of the External Confirmation Request

The auditor should tailor external confirmation requests to the specific audit objective. When
designing the request, the auditor considers the assertions being addressed and the factors that
are likely to affect the reliability of the confirmations. Factors such as the form of the external
confirmation request, prior experience on the audit or similar engagements, the nature of the
information being confirmed, and the intended respondent, affect the design of the requests
because these factors have a direct effect on the reliability of the evidence obtained through
external confirmation procedures.
Use of Positive and Negative Confirmations

The auditor may use positive or negative external confirmation requests or a combination of both.
A positive external confirmation request asks the respondent to reply to the auditor in all cases
either by indicating the respondent’s agreement with the given information, or by asking the
respondent to fill in information. A response to a positive confirmation request is ordinarily
expected to provide reliable audit evidence. There is a risk; however, that a respondent may reply
to the confirmation request without verifying that the information is correct. The auditor is not
ordinarily able to detect whether this has occurred. The auditor may reduce this risk, however,
by using positive confirmation requests that do not state the amount (or other information) on the
confirmation request, but ask the respondent to fill in the amount or furnish other information. On
the other hand, use of this type of “blank” confirmation request may result in lower response rates
because additional effort is required of the respondents.
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response has been
received to a negative confirmation request, the auditor remains aware that there will be no explicit
evidence that intended third parties have received the confirmation requests and verified that the
information contained therein is correct. Accordingly, the use of negative confirmation requests
ordinarily provides less reliable evidence than the use of positive confirmation requests, and the
auditor considers performing other substantive procedures to supplement the use of negative
confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level when:
a) The assessed level of inherent and control risk is low;
b) A large number of small balances are involved;
c) A substantial number of errors is not expected; and
d) The auditor has no reason to believe that respondents will disregard these requests.

Management Requests
When the auditor seeks to confirm certain balances or other information, and management
requests the auditor not to do so, the auditor should consider whether there are valid grounds
for such a request and obtain evidence to support the validity of management’s requests. If the
auditor agrees to management’s request not to seek external confirmation regarding a particular
matter, the auditor should apply alternative procedures to obtain sufficient appropriate evidence
regarding that matter.
If the auditor does not accept the validity of management’s request and is prevented from carrying
out the confirmations, there has been a limitation on the scope of the auditor’s work and the
auditor should consider the possible impact on the auditor’s report.
Characteristics of Respondents
The reliability of evidence provided by a confirmation is affected by the respondent’s competence,
independence, authority to respond, knowledge of the matter being confirmed, and objectivity.
For this reason, the auditor attempts to ensure, where practicable, that the confirmation request is
directed to an appropriate individual.
The External Confirmation Process

When performing confirmation procedures, the auditor should maintain control over the process
of selecting those to whom a request will be sent, the preparation and sending of confirmation
requests, and the responses to those requests.
No Response to a Positive Confirmation Request

The auditor should perform alternative procedures where no response is received to a positive
external confirmation request. The alternative audit procedures should be such as to provide the
evidence about the financial statement assertions that the confirmation request was intended to
provide.
Reliability of Responses Received

The auditor considers whether there is any indication that external confirmations received may
not be reliable. The auditor considers the response’s authenticity and performs procedures to
dispel any concern. The auditor may choose to verify the source and contents of a response in a
telephone call to the purported sender.
Causes and Frequency of Exceptions

When the auditor forms a conclusion that the confirmation process and alternative procedures
have not provided sufficient appropriate audit evidence regarding an assertion, the auditor should
undertake additional procedures to obtain sufficient appropriate audit evidence.

AUDIT AND ASSURANCE
Evaluating the Results of the Confirmation Process

The auditor should evaluate whether the results of the external confirmation process together with
the results from any other procedures performed, provide sufficient appropriate audit evidence
regarding the financial statement assertion being audited.
External Confirmations Prior to the Year-End

When the auditor uses confirmation as at a date prior to the balance sheet to obtain evidence to
support a financial statement assertion, the auditor obtains sufficient appropriate audit evidence
that transactions relevant to the assertion in the intervening period have not been materially
misstated.
10. NSA 510: INITIAL ENGAGEMENTS - OPENING BALANCES
Objective
To establish standards and provide guidance regarding opening balances when the financial
statements are audited for the first time or when the financial statements for the prior period were
audited by another auditor.
This NSA would also be considered so the auditor may become aware of contingencies and
commitments existing at the beginning of the period.
Sufficient appropriate audit evidence

For initial audit engagements, the auditor should obtain sufficient appropriate audit evidence that:
(a) The opening balances do not contain misstatements that materially affect the current
period’s financial statements;
(b) The prior period’s closing balances have been correctly brought forward to the current
period or, when appropriate, have been restated; and
(c) Appropriate accounting policies reflected in the opening balances are consistently applied
or changes in accounting policies have been properly accounted for and adequately
disclosed in accordance with applicable reporting framework.
Opening balances
It means those account balances which exist at the beginning of the period. Opening balances are
based upon the closing balances of the prior period and reflect the effects of:
a. Transactions of prior periods and reflect the effects of transactions and events of prior
periods; and
b. Accounting policies applied in the prior period.

In an initial audit engagement, the auditor will not have previously obtained audit evidence
supporting such opening balances.
Audit Procedures
The auditor shall read the most recent financial statements, if any, and the predecessor auditor’s
report thereon, if any, for information relevant to opening balances, including disclosures.
The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances
contain misstatements that materially affect the current period’s financial statements by:
(a) Determining whether the prior period’s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated;
(b) Determining whether the opening balances reflect the application of appropriate
accounting policies; and
(c) Performing one or more of the following:
(i) Where the prior year financial statements were audited, reviewing the predecessor
auditor’s working papers to obtain evidence regarding the opening balances;
(ii) Evaluating whether audit procedures performed in the current period provide
evidence relevant to the opening balances; or
(iii) Performing specific audit procedures to obtain evidence regarding the opening
balances.
The sufficiency and appropriateness of the audit evidence the auditor will need to obtain regarding
opening balances depends on such matters as:
 the accounting policies followed by the entity,
 whether the prior period’s financial statements were audited, and if so whether the
auditor’s report was modified,
 the nature of the accounts balances, classes of transactions and disclosures and the risk
of misstatement in the current periods financial statements, and
 The significance of the opening balances relative to the current period’s financial
statements.
When the prior period’s financial statements were audited by another auditor, the current auditor
may be able to obtain sufficient appropriate audit evidence regarding opening balances by
reviewing the predecessor auditor’s working papers. In these circumstances, the current auditor
would also consider the professional competence and independence of the predecessor auditor. If
the prior period’s auditor’s report was modified, the auditor would pay particular attention in the
current period to the matter which resulted in the modification

AUDIT AND ASSURANCE
Prior to communicating with the predecessor auditor, the current auditor will need to consider
the Code of Ethics for Professional Accountants issued by The Institute of Chartered Accountants
of Nepal.
For current assets and liabilities some audit evidence can ordinarily be obtained as part of the
current period’s audit procedures. For non-current assets and liabilities, such as property, plant
and equipment, investments and long-term debt, some audit evidence may be obtained by
examining the accounting records and other information underlying the opening balances.
If the auditor obtains audit evidence that the opening balances contain misstatements that
could materially affect the current period’s financial statements, the auditor shall perform such
additional audit procedures as are appropriate in the circumstances to determine the effect on the
current period’s financial statements. If the auditor concludes that such misstatements exist in the
current period’s financial statements, the auditor shall communicate the misstatements with the
appropriate level of management and those charged with governance.
The auditor shall obtain sufficient appropriate audit evidence about whether the accounting
policies reflected in the opening balances have been consistently applied in the current period’s
financial statements, and whether changes in the accounting policies have been appropriately
accounted for and adequately presented and disclosed in accordance with the applicable financial
reporting framework.
If the prior period’s financial statements were audited by a predecessor auditor and there was
a modification to the opinion, the auditor shall evaluate the effect of the matter giving rise to
the modification in assessing the risks of material misstatement in the current period’s financial
statements in accordance with NSA 315.
Audit Conclusions and Reporting

If, after performing procedures including those set out above, the auditor is unable to obtain
sufficient appropriate audit evidence concerning opening balances, the auditor’s report should
include:
(a) a qualified opinion,

“We did not observe the counting of the physical inventory stated at Rs... as at Ashad 3X,
20XX, since that date was prior to our appointment as auditors. We were unable to satisfy
ourselves as to the inventory quantities at that date by other audit procedures.
In our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had we been able to observe the counting of physical inventory
and satisfy ourselves as to the opening balance of inventory, the financial statements give a
true and fair view of (are presented fairly, in all material respects,) the financial position of
ABC Company as at Ashad 3X, 20XX and the results of its operations and its cash flows for the

year then ended in accordance with Nepal Accounting Standards or relevant practices and
comply with (Quote the relevant statute or law)
(b) a disclaimer of opinion; or
(c) in those jurisdictions where it is permitted, an opinion which is qualified or disclaimed

regarding the results of operations and unqualified regarding financial position,
However, if a modification regarding the prior period’s financial statements remains relevant
and material to the current period’s financial statements, the auditor should modify the
current auditor’s report accordingly.
If the current period’s accounting policies have not been consistently applied in relation to
opening balances and if the change has not been properly accounted for and adequately
disclosed, the auditor should express a qualified opinion or an adverse opinion as appropriate
11. NSA 530: AUDIT SAMPLING
Objective
To establish standards and provide guidance on the use of audit sampling procedures and other
means of selecting items for testing to gather audit evidence.
Audit Evidence
Audit evidence is obtained from an appropriate mix of tests of control and substantive
procedures.
a) Tests of Control
 Risk Assessments and Internal Control tests are performed if the auditor plans to assess
control risk less than high for a particular assertion.
 Audit sampling for tests of control is generally appropriate when application of the
control leaves evidence of performance.
b) Substantive Procedures
 Substantive procedures are concerned with amounts and are of two types: analytical
procedures and tests of details of transactions and balances.
 The purpose of substantive procedures is to obtain audit evidence to detect material

misstatements in the financial statements.
 When performing substantive tests of details, audit sampling and other means of
selecting items for testing and gathering audit evidence may be used to verify one or
more assertions about a financial statement amount.

AUDIT AND ASSURANCE
In obtaining evidence, the auditor should use professional judgment to assess audit risk and
design audit procedures to ensure this risk is reduced to an acceptably low level.
Audit risk
It is the risk that the auditor gives an inappropriate audit opinion when the financial statements
are materially misstated. Audit risk consists of:
a. Inherent risk - the susceptibility of an account balance to material misstatement, assuming

there are no related internal controls;
b. Control risk - the risk that a material misstatement will not be prevented or detected and
corrected on a timely basis by the accounting and internal control systems; and,
c. Detection risk - the risk that the material misstatements will not be detected by the
auditor's substantive procedures.
These three components of audit risk are considered during the planning process in the design of
audit procedures in order to reduce audit risk to an acceptably low level.
Procedures for Obtaining Evidence

Procedures for obtaining audit evidence include inspection, observation, inquiry and confirmation,
computation and analytical procedures. The choice of appropriate procedures is a matter of
professional judgment in the circumstances.
Application of these procedures will often involve the selection of items for testing from a
population.
Selecting Items for Testing to Gather Audit Evidence

When designing audit procedures, the auditor should determine appropriate means of selecting
items for testing. The means available to the auditor are:
a. Selecting all items (100% examination);

100% examination is unlikely in the case of tests of control; however, it is more common
for substantive procedures. 100% examination may be appropriate when the population
constitutes a small number of large value items, when both inherent and control risks are high
and other means do not provide sufficient appropriate audit evidence, or when the repetitive
nature of a calculation or other process performed by a computer information system makes
a 100% examination cost effective.
b. Selecting specific items;

It will be based on such factors as knowledge of the client's business, preliminary assessments
of inherent and control risks, and the characteristics of the population being tested.

• High value or key items.
• All items over a certain amount.
• Items to obtain information (to know about knowledge of business, nature of transaction).
• Items to test procedures.
c. Audit sampling
The auditor may decide to apply audit sampling to an account balance or class of transactions.
Statistical versus Non-Statistical Sampling Approaches

The decision whether to use a statistical or non-statistical sampling approach is a matter for the
auditor's judgment regarding the most efficient manner to obtain sufficient appropriate audit
evidence in the particular circumstances.
When applying statistical sampling, the sample size can be determined using either probability
theory or professional judgment.
Design of the Sample

When designing an audit sample, the auditor should consider the objectives of the test and the
attributes of the population from which the sample will be drawn.
Population
It is important for the auditor to ensure that the population is:
a. Appropriate to the objective of the sampling procedure, which will include consideration
of the direction of testing.
b. Complete. For example, if the auditor intends to select payment vouchers from a file,
conclusions cannot be drawn about all vouchers for the period unless the auditor is
satisfied that all vouchers have in fact been filed.
Stratification
Audit efficiency may be improved if the auditor stratifies a population by dividing it into discrete
sub-populations which have an identifying characteristic. The objective of stratification is to
reduce the variability of items within each stratum and therefore allow sample size to be reduced
without a proportional increase in sampling risk.
Sub-populations need to be carefully defined such that any sampling unit can only belong to one
stratum.

AUDIT AND ASSURANCE
Value weighted selection

This approach to defining the sampling unit ensures that audit effort is directed to the larger value
items because they have a greater chance of selection, and can result in smaller sample sizes.
This approach is ordinarily used in conjunction with the systematic method of sample selection
and is most efficient when selecting from a computerized database.
Sample Size
In determining the sample size, the auditor should consider whether sampling risk is reduced to
an acceptably low level.
Sample size is affected by the level of sampling risk that the auditor is willing to accept. The lower
the risk the auditor is willing to accept, the greater the sample size will need to be.
The sample size can be determined by the application of a statistically-based formula or through
the exercise of professional judgment objectively applied to the circumstances.
Selecting the Sample

The auditor should select items for the sample with the expectation that all sampling units in the
population have a chance of selection.
Performing the Audit Procedure

The auditor should perform audit procedures appropriate to the particular test objective on each
item selected.
Nature and Cause of Errors

The auditor should consider the sample results, the nature and cause of any errors identified, and
their possible effect on the particular test objective and on other areas of the audit.
When conducting tests of control, the auditor is primarily concerned with the design and operation
of the controls themselves and the assessment of control risk. However, when errors are identified,
the auditor also needs to consider matters such as:
a. The direct effect of identified errors on the financial statements; and
b. The effectiveness of the accounting and internal control systems and their effect on the
audit approach when, for example, the errors result from management override of an
internal control.
Projecting Errors
For substantive procedures, the auditor should project monetary errors found in the sample to the
population, and should consider the effect of the projected error on the particular test objective
and on other areas of the audit.

Evaluating the Sample Results

The auditor should evaluate the sample results to determine whether the preliminary assessment
of the relevant characteristic of the population is confirmed or needs to be revised.
If the evaluation of sample results indicates that the preliminary assessment of the relevant
characteristic of the population needs to be revised, the auditor may:
(a) Request management to investigate identified errors and the potential for further errors,
and to make any necessary adjustments; and/or
(b) Modify planned audit procedures. For example, in the case of a test of control, the auditor
might extend the sample size, test an alternative control or modify related substantive
procedures; and/or
(c) Consider the effect on the audit report.
12. NSA 610: USING THE WORK OF INTERNAL AUDITORS (REVISED)
Objective
The purpose of this NSA is to establish standards and provide guidance to external auditors
in considering using the work of internal audit function in obtaining audit evidence and using
internal auditors to provide direct assistance under the direction, supervision and review of the
external auditor.
Internal audit function

Internal audit function is a function of an entity that performs assurance and consulting activities
designed to evaluate and improve the effectiveness of the entity’s governance, risk management
and internal control processes.
Scope and Objectives of Internal Audit function

The scope and objectives of internal audit function vary widely and depend on the size and
structure of the entity and the requirements of its management. Ordinarily, internal auditing
activities include one or more of the following:
i. Activities Relating to Governance

 The internal audit function may assess the governance process in its accomplishment
of objectives on ethics and values, performance management and accountability,
communicating risk and control information to appropriate areas of the organization
and effectiveness of communication among those charged with governance, external
and internal auditors, and management.

AUDIT AND ASSURANCE
ii. Activities Relating to Risk Management

 The internal audit function may assist the entity by identifying and evaluating significant
exposures to risk and contributing to the improvement of risk management and internal
control (including effectiveness of the financial reporting process).
 The internal audit function may perform procedures to assist the entity in the detection
of fraud.
iii. Activities Relating to Internal Control

 Evaluation of internal control. The internal audit function may be assigned specific
responsibility for reviewing controls, evaluating their operation and recommending
improvements thereto. In doing so, the internal audit function provides assurance on the
control. For example, the internal audit function might plan and perform tests or other
procedures to provide assurance to management and those charged with governance
regarding the design, implementation and operating effectiveness of internal control,
including those controls that are relevant to the audit.
 Examination of financial and operating information. The internal audit function may be
assigned to review the means used to identify, recognize, measure, classify and report
financial and operating information, and to make specific inquiry into individual items,
including detailed testing of transactions, balances and procedures.
 Review of operating activities. The internal audit function may be assigned to review
the economy, efficiency and effectiveness of operating activities, including non-financial
activities of an entity.
 Review of compliance with laws and regulations. The internal audit function may be
assigned to review compliance with laws, regulations and other external requirements,
and with management policies and directives and other internal requirements.
The External Auditor’s Responsibility for the Audit

The external auditor has sole responsibility for the audit opinion expressed, and that responsibility
is not reduced by the external auditor’s use of the work of the internal audit function or internal
auditors to provide direct assistance on the engagement. Although they may perform audit
procedures similar to those performed by the external auditor, neither the internal audit function
nor the internal auditors are independent of the entity as is required of the external auditor in an
audit of financial statements in accordance with NSA 200.
The objectives of the external auditor, where the entity has an internal audit function and the
external auditor expects to use the work of the function to modify the nature or timing, or reduce
the extent, of audit procedures to be performed directly by the external auditor, or to use internal
auditors to provide direct assistance, are:

(a) To determine whether the work of the internal audit function or direct assistance from
internal auditors can be used, and if so, in which areas and to what extent; and having
made that determination:
(b) If using the work of the internal audit function, to determine whether that work is
adequate for purposes of the audit; and
(c) If using internal auditors to provide direct assistance, to appropriately direct, supervise
and review their work.
Determining Whether, in Which Areas, and to What Extent the Work of the Internal Audit
Function Can Be Used
The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:
a. The extent to which the internal audit function’s organizational status and relevant
policies and procedures support the objectivity of the internal auditors;
b. The level of competence of the internal audit function; and
c. Whether the internal audit function applies a systematic and disciplined approach,
including quality control.
Objectivity and competence

Factors that may affect the external auditor’s evaluation of objectivity include the following:
• Whether the organizational status of the internal audit function, including the function’s
authority and accountability, supports the ability of the function to be free from bias,
conflict of interest or undue influence of others to override professional judgments. For
example, whether the internal audit function reports to those charged with governance
or an officer with appropriate authority, or if the function reports to management,
whether it has direct access to those charged with governance.
• Whether the internal audit function is free of any conflicting responsibilities, for example,
having managerial or operational duties or responsibilities that are outside of the internal
audit function.
• Whether those charged with governance oversee employment decisions related to the
internal audit function, for example, determining the appropriate remuneration policy.
• Whether there are any constraints or restrictions placed on the internal audit function
by management or those charged with governance, for example, in communicating the
internal audit function’s findings to the external auditor.
• Whether the internal auditors are members of relevant professional bodies and their
memberships obligate their compliance with relevant professional standards relating to
objectivity, or whether their internal policies achieve the same objectives.

AUDIT AND ASSURANCE
Factors that may affect the external auditor’s determination of competence include the following:
• Whether the internal audit function is adequately and appropriately resourced relative
to the size of the entity and the nature of its operations.
• Whether there are established policies for hiring, training and assigning internal auditors
to internal audit engagements.
• Whether the internal auditors have adequate technical training and proficiency in
auditing. Relevant criteria that may be considered by the external auditor in making
the assessment may include, for example, the internal auditors’ possession of a relevant
professional designation and experience.
• Whether the internal auditors possess the required knowledge relating to the entity’s
financial reporting and the applicable financial reporting framework and whether the
internal audit function possesses the necessary skills (for example, industry-specific
knowledge) to perform work related to the entity’s financial statements.
• Whether the internal auditors are members of relevant professional bodies that
oblige them to comply with the relevant professional standards including continuing
professional development requirements.
Application of a Systematic and Disciplined Approach

The application of a systematic and disciplined approach to planning, performing, supervising,
reviewing and documenting its activities distinguishes the activities of the internal audit function
from other monitoring control activities that may be performed within the entity. Factors that
may affect the external auditor’s determination of whether the internal audit function applies a
systematic and disciplined approach include the following:
• The existence, adequacy and use of documented internal audit procedures or guidance
covering such areas as risk assessments, work programs, documentation and reporting,
the nature and extent of which is commensurate with the size and circumstances of an
entity.
• Whether the internal audit function has appropriate quality control policies and
procedures, for example, such as those policies and procedures in NSQC 1 that would
be applicable to an internal audit function (such as those relating to leadership, human
resources and engagement performance) or quality control requirements in standards
set by the relevant professional bodies for internal auditors. Such bodies may also
establish other appropriate requirements such as conducting periodic external quality
assessments.
The external auditor shall not use the work of the internal audit function if the external auditor
determines that:

a. The function’s organizational status and relevant policies and procedures do not
adequately support the objectivity of internal auditors;
b. The function lacks sufficient competence; or
c. The function does not apply a systematic and disciplined approach, including quality
control.
Determining the Nature and Extent of Work of the Internal Audit Function that
Can Be Used
As a basis for determining the areas and the extent to which the work of the internal audit function
can be used, the external auditor shall consider the nature and scope of the work that has been
performed, or is planned to be performed, by the internal audit function and its relevance to the
external auditor’s overall audit strategy and audit plan.
The external auditor shall make all significant judgments in the audit engagement and, to prevent
undue use of the work of the internal audit function, shall plan to use less of the work of the
function and perform more of the work directly:
(a) The more judgment is involved in:
(i) Planning and performing relevant audit procedures; and
(ii) Evaluating the audit evidence gathered;
(b) The higher the assessed risk of material misstatement at the assertion level, with special
consideration given to risks identified as significant;
(c) The less the internal audit function’s organizational status and relevant policies and
procedures adequately support the objectivity of the internal auditors; and
(d) The lower the level of competence of the internal audit function. The external auditor
shall, in communicating with those charged with governance an overview of the
planned scope and timing of the audit in accordance with NSA 260, communicate how
the external auditor has planned to use the work of the internal audit function.
Examples of work of the internal audit function that can be used by the external auditor include
the following:
 Testing of the operating effectiveness of controls.
 Substantive procedures involving limited judgment.
 Observations of inventory counts.
 Tracing transactions through the information system relevant to financial reporting.
 Testing of compliance with regulatory requirements.

AUDIT AND ASSURANCE
 In some circumstances, audits or reviews of the financial information of subsidiaries

that are not significant components to the group (where this does not conflict with the
requirements of NSA 600).
Using the Work of the Internal Audit Function

If the external auditor plans to use the work of the internal audit function, the external auditor shall
discuss the planned use of its work with the function as a basis for coordinating their respective
activities.
The external auditor shall read the reports of the internal audit function relating to the work of the
function that the external auditor plans to use to obtain an understanding of the nature and extent
of audit procedures it performed and the related findings.
The external auditor shall perform sufficient audit procedures on the body of work of the internal
audit function as a whole that the external auditor plans to use to determine its adequacy for
purposes of the audit, including evaluating whether:
(a) The work of the function had been properly planned, performed, supervised, reviewed
and documented;
(b) Sufficient appropriate evidence had been obtained to enable the function to draw
reasonable conclusions; and
(c) Conclusions reached are appropriate in the circumstances and the reports prepared by
the function are consistent with the results of the work performed.
The nature and extent of the external auditor’s audit procedures shall be responsive to the external
auditor’s evaluation of:
(a) The amount of judgment involved;
(b) The assessed risk of material misstatement;
(c) The extent to which the internal audit function’s organizational status and relevant
policies and procedures support the objectivity of the internal auditors; and
(d) The level of competence of the function; and shall include reperformance of some of the
work.
Determining Whether, in Which Areas, and to What Extent Internal Auditors Can Be Used to
Provide Direct Assistance
If using internal auditors to provide direct assistance is not prohibited by law or regulation, and
the external auditor plans to use internal auditors to provide direct assistance on the audit, the
external auditor shall evaluate the existence and significance of threats to objectivity and the
level of competence of the internal auditors who will be providing such assistance. The external

auditor’s evaluation of the existence and significance of threats to the internal auditors’ objectivity
shall include inquiry of the internal auditors regarding interests and relationships that may create
a threat to their objectivity. The external auditor shall not use an internal auditor to provide direct
assistance if:
(a) There are significant threats to the objectivity of the internal auditor; or
(b) The internal auditor lacks sufficient competence to perform the proposed work.
In determining the nature and extent of work that may be assigned to internal auditors and
the nature, timing and extent of direction, supervision and review that is appropriate in the
circumstances, the external auditor shall consider:
(a) The amount of judgment involved in:

(b) The assessed risk of material misstatement; and
(c) The external auditor’s evaluation of the existence and significance of threats to the
objectivity and level of competence of the internal auditors who will be providing such
assistance.
The external auditor shall not use internal auditors to provide direct assistance to perform
procedures that:
(a) Involve making significant judgments in the audit;
(b) Relate to higher assessed risks of material misstatement where the judgment required in
performing the relevant audit procedures or evaluating the audit evidence gathered is
more than limited;
(c) Relate to work with which the internal auditors have been involved and which has
already been, or will be, reported to management or those charged with governance by
the internal audit function; or
(d) Relate to decisions the external auditor makes in accordance with this NSA regarding the
internal audit function and the use of its work or direct assistance.
Using Internal Auditors to Provide Direct Assistance

Prior to using internal auditors to provide direct assistance for purposes of the audit, the external
auditor shall:
(a) Obtain written agreement from an authorized representative of the entity that the
internal auditors will be allowed to follow the external auditor’s instructions, and that
the entity will not intervene in the work the internal auditor performs for the external
auditor; and

AUDIT AND ASSURANCE
(b) Obtain written agreement from the internal auditors that they will keep confidential
specific matters as instructed by the external auditor and inform the external auditor of
any threat to their objectivity.
The external auditor shall direct, supervise and review the work performed by internal auditors
on the engagement in accordance with NSA 220. In so doing:
(a) The nature, timing and extent of direction, supervision, and review shall recognize that
the internal auditors are not independent of the entity and be responsive to the outcome
of the evaluation of the factors; and
(b) The review procedures shall include the external auditor checking back to the underlying
audit evidence for some of the work performed by the internal auditors. The direction,
supervision and review by the external auditor of the work performed by the internal
auditors shall be sufficient in order for the external auditor to be satisfied that the internal
auditors have obtained sufficient appropriate audit evidence to support the conclusions
based on that work.
13. NSA 620: USING THE WORK OF AN AUDITORS EXPERT
Objective
The purpose of this Nepal Standard on Auditing (NSA) is to establish standards and provide
guidance on using the work of an auditor’s expert as audit evidence.
Determining the Need for an Auditor’s Expert

An auditor’s expert may be needed to assist the auditor in one or more of the following:
• Obtaining an understanding of the entity and its environment, including its internal
control.
• Identifying and assessing the risks of material misstatement.
• Determining and implementing overall responses to assessed risks at the financial

statement level.
• Designing and performing further audit procedures to respond to assessed risks at the
assertion level, comprising tests of controls or substantive procedures.
• Evaluating the sufficiency and appropriateness of audit evidence obtained in forming an

opinion on the financial statements.
Considerations when deciding whether to use an auditor’s expert may include:

• Whether management has used a management’s expert in preparing the financial
statements.

• The nature and significance of the matter, including its complexity.
• The risks of material misstatement in the matter.
• The expected nature of procedures to respond to identified risks, including: the auditor’s
knowledge of and experience with the work of experts in relation to such matters; and
the availability of alternative sources of audit evidence.
Nature, Timing and Extent of Audit Procedures

The nature, timing and extent of audit procedures with respect to the requirements of this NSA
will vary depending on the circumstances. For example, the following factors may suggest the
need for different or more extensive procedures than would otherwise be the case:
• The work of the auditor’s expert relates to a significant matter that involves subjective
and complex judgments.
• The auditor has not previously used the work of the auditor’s expert, and has no prior
knowledge of that expert’s competence, capabilities and objectivity.
• The auditor’s expert is performing procedures that are integral to the audit, rather than
being consulted to provide advice on an individual matter.
• The expert is an auditor’s external expert and is not, therefore, subject to the firm’s
quality control policies and procedures
The Competence, Capabilities and Objectivity of the Auditor’s Expert

The auditor shall evaluate whether the auditor’s expert has the necessary competence, capabilities
and objectivity for the auditor’s purposes. In the case of an auditor’s external expert, the evaluation
of objectivity shall include inquiry regarding interests and relationships that may create a threat
to that expert’s objectivity.
Information regarding the competence, capabilities and objectivity of an auditor’s expert may
come from a variety of sources, such as:
• Personal experience with previous work of that expert.
• Discussions with that expert.
• Discussions with other auditors or others who are familiar with that expert’s work.
• Knowledge of that expert’s qualifications, membership of a professional body or industry

association, license to practice, or other forms of external recognition.
• Published papers or books written by that expert.
• The auditor’s firm’s quality control policies and procedures

AUDIT AND ASSURANCE
Matters relevant to evaluating the competence, capabilities and objectivity of the auditor’s
expert include whether that expert’s work is subject to technical performance standards or other
professional or industry requirements, for example, ethical standards and other membership
requirements of a professional body or industry association, accreditation standards of a licensing
body, or requirements imposed by law or regulation.
Other matters that may be relevant include:
• The relevance of the auditor’s expert’s competence to the matter for which that expert’s
work will be used, including any areas of specialty within that expert’s field. For example,
a particular actuary may specialize in property and casualty insurance, but have limited
expertise regarding pension calculations.
• The auditor’s expert’s competence with respect to relevant accounting and auditing
requirements, for example, knowledge of assumptions and methods, including models
where applicable, that are consistent with the applicable financial reporting framework.
• Whether unexpected events, changes in conditions, or the audit evidence obtained from
the results of audit procedures indicate that it may be necessary to reconsider the initial
evaluation of the competence, capabilities and objectivity of the auditor’s expert as the
audit progresses.
When evaluating the objectivity of an auditor’s external expert, it may be relevant to:
a) Inquire of the entity about any known interests or relationships that the entity has with
the auditor’s external expert that may affect that expert’s objectivity.
b) Discuss with that expert any applicable safeguards, including any professional
requirements that apply to that expert; and evaluate whether the safeguards are adequate
to reduce threats to an acceptable level. Interests and relationships that it may be relevant
to discuss with the auditor’s expert include:
• Financial interests.
• Business and personal relationships.
• Provision of other services by the expert, including by the organization in the case
of an external expert that is an organization.
In some cases, it may also be appropriate for the auditor to obtain a written representation from
the auditor’s external expert about any interests or relationships with the entity of which that
expert is aware.
Obtaining an Understanding of the Field of Expertise of the Auditor’s Expert

The auditor shall obtain a sufficient understanding of the field of expertise of the auditor’s expert
to enable the auditor to:

a. Determine the nature, scope and objectives of that expert’s work for the auditor’s
purposes; and
b. Evaluate the adequacy of that work for the auditor’s purposes.
Agreement with the Auditor’s Expert

The auditor shall agree, in writing when appropriate, on the following matters with the auditor’s
expert:
a. The nature, scope and objectives of that expert’s work;
b. The respective roles and responsibilities of the auditor and that expert;
c. The nature, timing and extent of communication between the auditor and that expert,
including the form of any report to be provided by that expert; and
d. The need for the auditor’s expert to observe confidentiality requirements.
Evaluating the Adequacy of the Auditor’s Expert’s Work

The auditor’s evaluation of the auditor’s expert’s competence, capabilities and objectivity, the
auditor’s familiarity with the auditor’s expert’s field of expertise, and the nature of the work
performed by the auditor’s expert affect the nature, timing and extent of audit procedures to
evaluate the adequacy of that expert’s work for the auditor’s purposes.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes,
including:
a. The relevance and reasonableness of that expert’s findings or conclusions, and their
consistency with other audit evidence;
b. If that expert’s work involves use of significant assumptions and methods, the relevance
and reasonableness of those assumptions and methods in the circumstances; and
c. If that expert’s work involves the use of source data that is significant to that expert’s
work, the relevance, completeness, and accuracy of that source data.
Specific procedures to evaluate the adequacy of the auditor’s expert’s work for the auditor’s
purposes may include:
• Inquiries of the auditor’s expert.

• Reviewing the auditor’s expert’s working papers and reports.
• Corroborative procedures, such as:
o Observing the auditor’s expert’s work;
o Examining published data, such as statistical reports from reputable, authoritative
sources;

AUDIT AND ASSURANCE
o Confirming relevant matters with third parties;
o Performing detailed analytical procedures; and
o Reperforming calculations.
• Discussion with another expert with relevant expertise when, for example, the findings
or conclusions of the auditor’s expert are not consistent with other audit evidence.
• Discussing the auditor’s expert’s report with management.
If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s
purposes, the auditor shall:
a. Agree with that expert on the nature and extent of further work to be performed by that
expert; or
b. Perform additional audit procedures appropriate to the circumstances.
Reference to the Auditor’s Expert in the Auditor’s Report

The auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an
unmodified opinion unless required by law or regulation to do so.
If such reference is required by law or regulation, the auditor shall indicate in the auditor’s report
that the reference does not reduce the auditor’s responsibility for the auditor’s opinion. If the
auditor makes reference to the work of an auditor’s expert in the auditor’s report because such
reference is relevant to an understanding of a modification to the auditor’s opinion, the auditor
shall indicate in the auditor’s report that such reference does not reduce the auditor’s responsibility
for that opinion.

THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
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.
Types of assurance engagement

 Reasonable assurance engagement
 Limited assurance engagement
There are two types of assurance engagement a practitioner is permitted to perform: a reasonable
assurance engagement and a limited assurance engagement. The objective of a reasonable
assurance engagement is a reduction in assurance engagement risk to an acceptably low level
in the circumstances of the engagement as the basis for a positive form of expression of the
practitioner’s conclusion. The objective of a limited assurance engagement is a reduction in
assurance engagement risk to a level that is acceptable in the circumstances of the engagement, but
where that risk is greater than for a reasonable assurance engagement, as the basis for a negative
form of expression of the practitioner’s conclusion.
Elements of an Assurance Engagement

The following elements of an assurance engagement are discussed in this section:
 A three-party relationship involving a practitioner, a responsible party, and intended

users;
 An appropriate subject matter;
 Suitable criteria;
 Sufficient appropriate evidence; and
 A written assurance report in the form appropriate to a reasonable assurance engagement

or a limited assurance engagement.
Three Party Relationships

intended users.

AUDIT AND ASSURANCE
Subject Matter
The subject matter, and subject matter information, of an assurance engagement can take many
forms, such as:
• Financial performance or conditions (for example, historical or prospective financial

• Non-financial performance or conditions (for example, performance of an entity) for

• Physical characteristics (for example, capacity of a facility) for which the subject matter
• Systems and processes (for example, an entity’s internal control or IT system) for which
• Behavior (for example, corporate governance, compliance with regulation, human

Criteria
the preparation of financial statements, the criteria may be Nepal Accounting Standards; when
reporting on internal control, the criteria may be an established internal control framework or
individual control objectives specifically designed for the engagement; and when reporting on
compliance, the criteria may be the applicable law, regulation or contract.
Evidence
skepticism to obtain sufficient appropriate evidence about whether the subject matter information
is free of material misstatement. The practitioner considers materiality, assurance engagement
risk, and the quantity and quality of available evidence when planning and performing the
engagement, in particular when determining the nature, timing and extent of evidence-gathering
procedures.
Assurance Report
obtained about the subject matter information.

GLOSSARY OF TERMS
GLOSSARY OF TERMS

AUDIT AND ASSURANCE
Accounting estimate—An approximation of a monetary amount in the absence of a precise means

of measurement. This term is used for an amount measured at fair value where there is estimation
uncertainty, as well as for other amounts that require estimation. Where NSA 5401 addresses
only accounting estimates involving measurement at fair value, the term “fair value accounting
estimates” is used.
Accounting records—The records of initial accounting entries and supporting records, such as
checks and records of electronic fund transfers; invoices; contracts; the general and subsidiary
ledgers, journal entries and other adjustments to the financial statements that are not reflected
in formal journal entries; and records such as work sheets and spreadsheets supporting cost
allocations, computations, reconciliations and disclosures.
Analytical procedures—Evaluations of financial information through analysis of plausible

relationships among both financial and non-financial data. Analytical procedures also encompass
such investigation as is necessary of identified fluctuations or relationships that are inconsistent
with other relevant information or that differ from expected values by a significant amount.
Anomaly—A misstatement or deviation that is demonstrably not representative of misstatements

or deviations in a population.
Applicable financial reporting framework—The financial reporting framework adopted by

management and, where appropriate, those charged with governance in the preparation of the
financial statements that is acceptable in view of the nature of the entity and the objective of
the financial statements, or that is required by law or regulation. In the context of NSRS 4410
(Revised),2 reference is to the financial information, rather than to the financial statements.
Applied criteria (in the context of NSA 810 (Revised)3)—The criteria applied by management in the
preparation of the summary financial statements.
Appropriateness (of audit evidence)—The measure of the quality of audit evidence; that is, its relevance
and its reliability in providing support for the conclusions on which the auditor’s opinion is based.
Arm’s length transaction—A transaction conducted on such terms and conditions as between a
willing buyer and a willing seller who are unrelated and are acting independently of each other
and pursuing their own best interests.
Assertions—Representations by management, explicit or otherwise, that are embodied in the

financial statements, as used by the auditor to consider the different types of potential misstatements
that may occur. In the context of NSAE 3410, assertions are defined as representations by the
1 NSA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures
*
Denotes a term defined in the NSAs
Denotes a term defined in NSQC 1
2 NSRS 4410 (Revised), Compilation Engagements
3 NSA 810 (Revised), Engagements to Report on Summary Financial Statements

GLOSSARY OF TERMS
entity, explicit or otherwise, that are embodied in the GHG statement, as used by the practitioner
to consider the different types of potential misstatements that may occur.
Audit documentation—The record of audit procedures performed, relevant audit evidence obtained,
and conclusions the auditor reached (terms such as “working papers” or “workpapers” are also
sometimes used).
Audit evidence—Information used by the auditor in arriving at the conclusions on which the
auditor’s opinion is based. Audit evidence includes both information contained in the accounting
records underlying the financial statements and other information.
Audit file— One or more folders or other storage media, in physical or electronic form, containing
the records that comprise the audit documentation for a specific engagement.
Audit risk—The risk that the auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated. Audit risk is a function of the risks of material misstatement
and detection risk.
Audit sampling (sampling)—The application of audit procedures to less than 100% of items within
a population of audit relevance such that all sampling units have a chance of selection in order
to provide the auditor with a reasonable basis on which to draw conclusions about the entire
population.
Audited financial statements (in the context of NSA 810 (Revised))—Financial statements4 audited
by the auditor in accordance with NSAs, and from which the summary financial statements are
derived.
Auditor—“Auditor” is used to refer to the person or persons conducting the audit, usually the
engagement partner or other members of the engagement team, or, as applicable, the firm. Where
an NSA expressly intends that a requirement or responsibility be fulfilled by the engagement
partner, the term “engagement partner” rather than “auditor” is used. “Engagement partner” and
“firm” are to be read as referring to their public sector equivalents where relevant.
Auditor’s expert—An individual or organization possessing expertise in a field other than

accounting or auditing, whose work in that field is used by the auditor to assist the auditor in
obtaining sufficient appropriate audit evidence. An auditor’s expert may be either an auditor’s
internal expert (who is a partner5 or staff, including temporary staff, of the auditor’s firm or a
network firm), or an auditor’s external expert.
Auditor’s point estimate or auditor’s range—The amount, or range of amounts, respectively, derived
from audit evidence for use in evaluating management’s point estimate.
4 NSA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Nepal
Standards on Auditing, paragraph 13(f), defines the term “financial statements.”
5 “Partner” and “firm” should be read as referring to their public sector equivalents where relevant.

AUDIT AND ASSURANCE
Business risk—A risk resulting from significant conditions, events, circumstances, actions or
inactions that could adversely affect an entity’s ability to achieve its objectives and execute its
strategies, or from the setting of inappropriate objectives and strategies.
Comparative financial statements—Comparative information where amounts and other disclosures for
the prior period are included for comparison with the financial statements of the current period but, if
audited, are referred to in the auditor’s opinion. The level of information included in those comparative
financial statements is comparable with that of the financial statements of the current period.
Comparative information—The amounts and disclosures included in the financial statements

in respect of one or more prior periods in accordance with the applicable financial reporting
framework. In the context of NSAE 3410, comparative information is defined as the amounts and
disclosures included in the GHG statement in respect of one or more prior periods.
Complementary user entity controls—Controls that the service organization assumes, in the design
of its service, will be implemented by user entities, and which, if necessary to achieve control
objectives, are identified in the description of its system.
Component—An entity or business activity for which group or component management prepares
financial information that should be included in the group financial statements.
Component auditor—An auditor who, at the request of the group engagement team, performs work
on financial information related to a component for the group audit.
Component management—Management responsible for the preparation of the financial information

of a component.
Component materiality—The materiality for a component determined by the group engagement

team.
Corresponding figures—Comparative information where amounts and other disclosures for the
prior period are included as an integral part of the current period financial statements, and are
intended to be read only in relation to the amounts and other disclosures relating to the current
period (referred to as “current period figures”).
Date of approval of the financial statements—The date on which all the statements that comprise the
financial statements, including the related notes, have been prepared and those with the recognized
authority have asserted that they have taken responsibility for those financial statements.
Date of report (in relation to quality control)—The date selected by the practitioner to date the report.
Date of the auditor’s report—The date the auditor dates the report on the financial statements in
accordance with NSA 700 (Revised).6
6 NSA 700 (Revised), Forming an Opinion and Reporting on Financial Statements

GLOSSARY OF TERMS
Date of the financial statements—The date of the end of the latest period covered by the financial
statements.
Date the financial statements are issued—The date that the auditor’s report and audited financial
statements are made available to third parties.
Deficiency in internal control—This exists when:
(a) A control is designed, implemented or operated in such a way that it is unable to prevent,
or detect and correct, misstatements in the financial statements on a timely basis; or
(b) A control necessary to prevent, or detect and correct, misstatements in the financial
statements on a timely basis is missing.
Detection risk—The risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that exists and that could be material, either
individually or when aggregated with other misstatements.
Direct assistance—The use of internal auditors to perform audit procedures under the direction,
supervision and review of the external auditor.
Element of a financial statement (in the context of NSA 805 (Revised)7)—An element, account or item
of a financial statement.
Emphasis of Matter paragraph—A paragraph included in the auditor’s report that refers to a matter
appropriately presented or disclosed in the financial statements that, in the auditor’s judgment,
is of such importance that it is fundamental to users’ understanding of the financial statements.
Engagement partner8—The partner or other person in the firm who is responsible for the engagement
and its performance, and for the report that is issued on behalf of the firm, and who, where required,
has the appropriate authority from a professional, legal or regulatory body. “Engagement partner”
should be read as referring to its public sector equivalents where relevant.
Engagement quality control review—A process designed to provide an objective evaluation, on or

before the date of the report, of the significant judgments the engagement team made and the
conclusions it reached in formulating the report. The engagement quality control review process
is for audits of financial statements of listed entities and those other engagements, if any, for which
the firm has determined an engagement quality control review is required.
Engagement quality control reviewer—A partner, other person in the firm, suitably qualified
external person, or a team made up of such individuals, none of whom is part of the
engagement team, with sufficient and appropriate experience and authority to objectively
7 NSA 805 (Revised), Special Considerations—Audits of Single Financial Statements and Specific Elements, Accounts
or Items of a Financial Statement
8 “Engagement partner,” “partner,” and “firm” should be read as referring to their public sector equivalents where
relevant.

AUDIT AND ASSURANCE
evaluate the significant judgments the engagement team made and the conclusions it reached
in formulating the report.
Engagement team—All partners and staff performing the engagement, and any individuals engaged
by the firm or a network firm who perform procedures on the engagement. This excludes an
auditor’s external expert engaged by the firm or by a network firm. The term “engagement team”
also excludes individuals within the client’s internal audit function who provide direct assistance
on an audit engagement when the external auditor complies with the requirements of NSA 610
(Revised).9
Engagement team (in the context of NSAE 3000 (Revised)10— All partners and staff performing the
engagement, and any individuals engaged by the firm or a network firm who perform procedures
on the engagement. This excludes a practitioner’s external expert engaged by the firm or a network
firm.
Estimation uncertainty—The susceptibility of an accounting estimate and related disclosures to an

inherent lack of precision in its measurement.
to be confirmed, or contained in the entity’s records, and information provided by the confirming
party.
Experienced auditor—An individual (whether internal or external to the firm) who has practical
audit experience, and a reasonable understanding of:
(a) Audit processes;
(b) NSAs and applicable legal and regulatory requirements;
(c) The business environment in which the entity operates; and
(d) Auditing and financial reporting issues relevant to the entity’s industry.
Expertise—Skills, knowledge and experience in a particular field.
External confirmation—Audit evidence obtained as a direct written response to the auditor from a
third party (the confirming party), in paper form, or by electronic or other medium.
Financial statements—A structured representation of historical financial information, including

disclosures, intended to communicate an entity’s economic resources or obligations at a point
in time, or the changes therein for a period of time, in accordance with a financial reporting
framework. The term “financial statements” ordinarily refers to a complete set of financial
statements as determined by the requirements of the applicable financial reporting framework,
9 NSA 610 (Revised), Using the Work of Internal Auditors, establishes limits on the use of direct assistance. It also
acknowledges that the external auditor may be prohibited by law or regulation from obtaining direct assistance from
internal auditors. Therefore, the use of direct assistances is restricted to situations where it is permitted.
10 NSAE 3000 (Revised), Assurance Engagements Other Than Audits or Reviews of Historical Financial Information

GLOSSARY OF TERMS
but can also refer to a single financial statement. Disclosures comprise explanatory or descriptive
information, set out as required, expressly permitted or otherwise allowed by the applicable
financial reporting framework, on the face of a financial statement, or in the notes, or incorporated
therein by cross-reference.
Firm—A sole practitioner, partnership or corporation or other entity of professional accountants.

“Firm” should be read as referring to its public sector equivalents where relevant.
Forecast—Prospective financial information prepared on the basis of assumptions as to future

events which management expects to take place and the actions management expects to take as of
the date the information is prepared (best-estimate assumptions).
Fraud—An intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or
illegal advantage.
Fraud risk factors—Events or conditions that indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
General purpose financial statements—Financial statements prepared in accordance with a general

purpose framework.
General purpose framework – A financial reporting framework designed to meet the common
financial information needs of a wide range of users. The financial reporting framework may be a
fair presentation framework or a compliance framework.
Group—All the components whose financial information is included in the group financial
statements. A group always has more than one component.
Group audit—The audit of group financial statements.
Group audit opinion—The audit opinion on the group financial statements.
Group engagement partner—The partner or other person in the firm who is responsible for the
group audit engagement and its performance, and for the auditor’s report on the group financial
statements that is issued on behalf of the firm. Where joint auditors conduct the group audit,
the joint engagement partners and their engagement teams collectively constitute the group
engagement partner and the group engagement team.
Group engagement team—Partners, including the group engagement partner, and staff who
establish the overall group audit strategy, communicate with component auditors, perform work
on the consolidation process, and evaluate the conclusions drawn from the audit evidence as the
basis for forming an opinion on the group financial statements.

AUDIT AND ASSURANCE
Group financial statements—Financial statements that include the financial information of more
than one component. The term “group financial statements” also refers to combined financial
statements aggregating the financial information prepared by components that have no parent
but are under common control.
Group management—Management responsible for the preparation of the group financial statements.
Group-wide controls—Controls designed, implemented and maintained by group management

over group financial reporting.
Historical financial information—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.
Initial audit engagement—An engagement in which either:
(a) The financial statements for the prior period were not audited; or
(b) The financial statements for the prior period were audited by a predecessor auditor.
Inspection (in relation to quality control)—In relation to completed engagements, procedures

designed to provide evidence of compliance by engagement teams with the firm’s quality control
policies and procedures.
Internal audit function—A function of an entity that performs assurance and consulting activities
designed to evaluate and improve the effectiveness of the entity’s governance, risk management
and internal control processes.
Internal control—The process designed, implemented and maintained by those charged with
governance, management and other personnel to provide reasonable assurance about the
achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness
and efficiency of operations, and compliance with applicable laws and regulations. The term
“controls” refers to any aspects of one or more of the components of internal control.
Nepal Financial Reporting Standards—The Nepal Financial Reporting Standards issued by the
Accounting Standards Board.
Key audit matters—Those matters that, in the auditor’s professional judgment, were of most
significance in the audit of the financial statements of the current period. Key audit matters are
selected from matters communicated with those charged with governance.
Listed entity—An entity whose shares, stock or debt are quoted or listed on a recognized stock
exchange, or are marketed under the regulations of a recognized stock exchange or other equivalent
body.

GLOSSARY OF TERMS
Management—The person(s) with executive responsibility for the conduct of the entity’s operations.
For some entities in some jurisdictions, management includes some or all of those charged with
governance, for example, executive members of a governance board, or an owner-manager.
Management bias—A lack of neutrality by management in the preparation of information.
Management’s expert—An individual or organization possessing expertise in a field other than

accounting or auditing, whose work in that field is used by the entity to assist the entity in
preparing the financial statements.
Management’s point estimate—The amount selected by management for recognition or disclosure in

the financial statements as an accounting estimate.
Misstatement—A difference between the reported amount, classification, presentation, or

disclosure of a financial statement item and the amount, classification, presentation, or disclosure
that is required for the item to be in accordance with the applicable financial reporting framework.
Misstatements can arise from error or fraud.
Modified opinion—A qualified opinion, an adverse opinion or a disclaimer of opinion on the

Monitoring (in relation to quality control)—A process comprising an ongoing consideration and
evaluation of the firm’s system of quality control, including a periodic inspection of a selection of
completed engagements, designed to provide the firm with reasonable assurance that its system
of quality control is operating effectively.
Negative confirmation request—A request that the confirming party respond directly to the auditor
only if the confirming party disagrees with the information provided in the request.
Network—A larger structure:
(a) That is aimed at cooperation, and
(b) That is clearly aimed at profit or cost-sharing or shares common ownership, control
or management, common quality control policies and procedures, common business
strategy, the use of a common brand name, or a significant part of professional resources.
Network firm—A firm or entity that belongs to a network.
Non-compliance (in the context of NSA 25011)—Acts of omission or commission by the entity, either
intentional or unintentional, which are contrary to the prevailing laws or regulations. Such
acts include transactions entered into by, or in the name of, the entity, or on its behalf, by those
charged with governance, management or employees. Noncompliance does not include personal
11 NSA 250, Consideration of Laws and Regulations in an Audit of Financial Statements

AUDIT AND ASSURANCE
misconduct (unrelated to the business activities of the entity) by those charged with governance,
management or employees of the entity.
Non-response—A failure of the confirming party to respond, or fully respond, to a positive

confirmation request, or a confirmation request returned undelivered.
Non-sampling risk—The risk that the auditor reaches an erroneous conclusion for any reason not
related to sampling risk.
Opening balances—Those account balances that exist at the beginning of the period. Opening
balances are based upon the closing balances of the prior period and reflect the effects of
transactions and events of prior periods and accounting policies applied in the prior period.
Opening balances also include matters requiring disclosure that existed at the beginning of the
period, such as contingencies and commitments.
Other information— Financial or non-financial information (other than financial statements and the
auditor’s report thereon) included in an entity’s annual report.
Other Matter paragraph—A paragraph included in the auditor’s report that refers to a matter other
than those presented or disclosed in the financial statements that, in the auditor’s judgment, is
relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.
Outcome of an accounting estimate—The actual monetary amount which results from the resolution
of the underlying transaction(s), event(s) or condition(s) addressed by the accounting estimate.
Partner—Any individual with authority to bind the firm with respect to the performance of a
professional services engagement.
Performance materiality—The amount or amounts set by the auditor at less than materiality for
the financial statements as a whole to reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial
statements as a whole. If applicable, performance materiality also refers to the amount or amounts
set by the auditor at less than the materiality level or levels for particular classes of transactions,
account balances or disclosures. In the context of NSAE 3410, performance materiality is defined
as the amount or amounts set by the practitioner at less than materiality for the GHG statement
to reduce to an appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the GHG statement. If applicable, performance
materiality also refers to the amount or amounts set by the practitioner at less than the materiality
level or levels for particular types of emissions or disclosures.
Pervasive—A term used, in the context of misstatements, to describe the effects on the financial
statements of misstatements or the possible effects on the financial statements of misstatements,
if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence.
Pervasive effects on the financial statements are those that, in the auditor’s judgment:

GLOSSARY OF TERMS
(a) Are not confined to specific elements, accounts or items of the financial statements;
(b) If so confined, represent or could represent a substantial proportion of the financial

statements; or
(c) In relation to disclosures, are fundamental to users’ understanding of the financial

statements.
Population—The entire set of data from which a sample is selected and about which the auditor
wishes to draw conclusions.
Positive confirmation request—A request that the confirming party respond directly to the auditor
indicating whether the confirming party agrees or disagrees with the information in the request,
or providing the requested information.
Preconditions for an audit—The use by management of an acceptable financial reporting framework

in the preparation of the financial statements and the agreement of management and, where
appropriate, those charged with governance to the premise12 on which an audit is conducted.
Predecessor auditor—The auditor from a different audit firm, who audited the financial statements
of an entity in the prior period and who has been replaced by the current auditor.
Premise, relating to the responsibilities of management and, where appropriate, those charged with
governance, on which an audit is conducted—That management and, where appropriate, those charged
with governance have acknowledged and understand that they have the following responsibilities
that are fundamental to the conduct of an audit in accordance with NSAs. That is, responsibility:
(a) For the preparation of the financial statements in accordance with the applicable financial
reporting framework, including where relevant their fair presentation;
(b) For such internal control as management and, where appropriate, those charged with
governance determine is necessary to enable the preparation of financial statements that
are free from material misstatement, whether due to fraud or error; and
(c) To provide the auditor with:
(i) Access to all information of which management and, where appropriate, those
charged with governance are aware that is relevant to the preparation of the financial
statements such as records, documentation and other matters;
(ii) Additional information that the auditor may request from management and, where
appropriate, those charged with governance for the purpose of the audit; and
(iii) Unrestricted access to persons within the entity from whom the auditor determines
it necessary to obtain audit evidence.
12 NSA 200, paragraph 13

AUDIT AND ASSURANCE
In the case of a fair presentation framework, (a) above may be restated as “for the preparation and
fair presentation of the financial statements in accordance with the financial reporting framework,”
or “for the preparation of financial statements that give a true and fair view in accordance with the
financial reporting framework.”
The “premise, relating to the responsibilities of management and, where appropriate, those charged
with governance, on which an audit is conducted” may also be referred to as the “premise.”
Professional judgment—The application of relevant training, knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in making informed decisions
about the courses of action that are appropriate in the circumstances of the audit engagement.
Professional skepticism—An attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical assessment of
evidence.
Professional standards—Nepal Standards on Auditing (NSAs) and relevant ethical requirements
Professional standards (in the context of NSQC 113)—AuSB Engagement Standards, as defined in the
AuSB’s Preface to the Nepal Quality Control, Auditing, Review, Other Assurance, and Related Services
Pronouncements, and relevant ethical requirements.
Reasonable assurance (in the context of audit engagements, and in quality control)— A high, but not
absolute, level of assurance.
Related party—A party that is either:

(a) A related party as defined in the applicable financial reporting framework; or
(b) Where the applicable financial reporting framework establishes minimal or no related
party requirements:
(i) A person or other entity that has control or significant influence, directly or indirectly
through one or more intermediaries, over the reporting entity;
(ii) Another entity over which the reporting entity has control or significant influence,
directly or indirectly through one or more intermediaries; or
(iii) Another entity that is under common control with the reporting entity through
having:
a. Common controlling ownership;
b. Owners who are close family members; or
c. Common key management.
13 NSQC 1, Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance
and Related Services Engagements

GLOSSARY OF TERMS
However, entities that are under common control by a state (that is, a national, regional or local
government) are not considered related unless they engage in significant transactions or share
resources to a significant extent with one another.
Relevant ethical requirements—Ethical requirements to which the engagement team and engagement
quality control reviewer are subject, which ordinarily comprise Parts A and B of the Institute
of Chartered Accountants of Nepal’s Handbook of Code of Ethics for Professional Accountants
together with national requirements that are more restrictive. In the context of NSRE 2400
(Revised), relevant ethical requirements are defined as the ethical requirements the engagement
team is subject to when undertaking review engagements. These requirements ordinarily
comprise Parts A and B of the Institute of Chartered Accountants of Nepal’s Handbook of Code of
Ethics for Professional Accountants, together with national requirements that are more restrictive.
In the context of NSRS 4410 (Revised), relevant ethical requirements are defined as the ethical
requirements the engagement team is subject to when undertaking compilation engagements.
These requirements ordinarily comprise Parts A and B of the Institute of Chartered Accountants
of Nepal’s Handbook of Code of Ethics for Professional Accountants (excluding Section 290,
Independence—Audit and Review Engagements, and Section 291, Independence—Other Assurance
Engagements in Part B), together with national requirements that are more restrictive.
Risk assessment procedures—The audit procedures performed to obtain an understanding of the

entity and its environment, including the entity’s internal control, to identify and assess the risks
of material misstatement, whether due to fraud or error, at the financial statement and assertion
levels.
Risk of material misstatement—The risk that the financial statements are materially misstated prior
to audit. This consists of two components, described as follows at the assertion level:
(a) Inherent risk—The susceptibility of an assertion about a class of transaction, account

balance or disclosure to a misstatement that could be material, either individually or
when aggregated with other misstatements, before consideration of any related controls.
(b) Control risk—The risk that a misstatement that could occur in an assertion about a class of
transaction, account balance or disclosure and that could be material, either individually
or when aggregated with other misstatements, will not be prevented, or detected and
corrected, on a timely basis by the entity’s internal control. Risk of material misstatement
(in the context of NSAE 3000 (Revised))―The risk that the subject matter information is
materially misstated prior to the engagement.
Sampling risk—The risk that the auditor’s conclusion based on a sample may be different from the
conclusion if the entire population were subjected to the same audit procedure. Sampling risk can
lead to two types of erroneous conclusions:

AUDIT AND ASSURANCE
(a) In the case of a test of controls, that controls are more effective than they actually are, or
in the case of a test of details, that a material misstatement does not exist when in fact it
does. The auditor is primarily concerned with this type of erroneous conclusion because
it affects audit effectiveness and is more likely to lead to an inappropriate audit opinion.
(b) In the case of a test of controls, that controls are less effective than they actually are, or
in the case of a test of details, that a material misstatement exists when in fact it does
not. This type of erroneous conclusion affects audit efficiency as it would usually lead to
additional work to establish that initial conclusions were incorrect.
Sampling unit—The individual items constituting a population.
Service auditor—An auditor who, at the request of the service organization, provides an assurance
report on the controls of a service organization.
Service organization—A third-party organization (or segment of a third-party organization) that

provides services to user entities that are part of those entities’ information systems relevant to
financial reporting.
Service organization’s system—The policies and procedures designed, implemented and maintained
by the service organization to provide user entities with the services covered by the service
auditor’s report.
Significant component—A component identified by the group engagement team (i) that is of
individual financial significance to the group, or (ii) that, due to its specific nature or circumstances,
is likely to include significant risks of material misstatement of the group financial statements.
Significant deficiency in internal control—A deficiency or combination of deficiencies in internal

control that, in the auditor’s professional judgment, is of sufficient importance to merit the
attention of those charged with governance.
Significant risk—An identified and assessed risk of material misstatement that, in the auditor’s
judgment, requires special audit consideration.
Special purpose financial statements—Financial statements prepared in accordance with a special

purpose framework.
Special purpose framework—A financial reporting framework designed to meet the financial
information needs of specific users. The financial reporting framework may be a fair presentation
framework or a compliance framework.14
Staff—Professionals, other than partners, including any experts the firm employs.
14 NSA 200, paragraph 13(a)

GLOSSARY OF TERMS
Statistical sampling—An approach to sampling that has the following characteristics:
(a) Random selection of the sample items; and
(b) The use of probability theory to evaluate sample results, including measurement of
sampling risk.
Stratification—The process of dividing a population into sub-populations, each of which is a group

of sampling units which have similar characteristics (often monetary value).
Subsequent events—Events occurring between the date of the financial statements and the date of
the auditor’s report, and facts that become known to the auditor after the date of the auditor’s
report.
Subservice organization—A service organization used by another service organization to perform

some of the services provided to user entities that are part of those user entities’ information
systems relevant to financial reporting.
Substantive procedure—An audit procedure designed to detect material misstatements at the

assertion level. Substantive procedures comprise:
(a) Tests of details (of classes of transactions, account balances, and disclosures); and
(b) Substantive analytical procedures.
Sufficiency (of audit evidence)—The measure of the quantity of audit evidence. The quantity of the
audit evidence needed is affected by the auditor’s assessment of the risks of material misstatement
and also by the quality of such audit evidence.
Suitably qualified external person—An individual outside the firm with the competence and
capabilities to act as an engagement partner, for example a partner of another firm, or an employee
(with appropriate experience) of either a professional accountancy body whose members may
perform audits and reviews of historical financial information, or other assurance or related
services engagements, or of an organization that provides relevant quality control services.
Summary financial statements (in the context of NSA 810 (Revised))—Historical financial information
that is derived from financial statements but that contains less detail than the financial statements,
while still providing a structured representation consistent with that provided by the financial
statements of the entity’s economic resources or obligations at a point in time or the changes
therein for a period of time.15 Different jurisdictions may use different terminology to describe
such historical financial information.
Tests of controls—An audit procedure designed to evaluate the operating effectiveness of controls
in preventing, or detecting and correcting, material misstatements at the assertion level.
15 NSA 200, paragraph 13(f)

AUDIT AND ASSURANCE
Those charged with governance—The person(s) or organization(s) (for example, a corporate trustee)
with responsibility for overseeing the strategic direction of the entity and obligations related to
the accountability of the entity. This includes overseeing the financial reporting process. For some
entities in some jurisdictions, those charged with governance may include management personnel,
for example, executive members of a governance board of a private or public sector entity, or an
owner-manager.16
Tolerable misstatement—A monetary amount set by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is
not exceeded by the actual misstatement in the population.
Tolerable rate of deviation—A rate of deviation from prescribed internal control procedures set by the
auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the
rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the population.
Uncorrected misstatements—Misstatements that the auditor has accumulated during the audit and
that have not been corrected.
Unmodified opinion—The opinion expressed by the auditor when the auditor concludes that the
financial statements are prepared, in all material respects, in accordance with the applicable
financial reporting framework.17
User auditor—An auditor who audits and reports on the financial statements of a user entity.
User entity—An entity that uses a service organization and whose financial statements are being
audited.
Written representation—A written statement by management provided to the auditor to confirm

certain matters or to support other audit evidence. Written representations in this context do not
include financial statements, the assertions therein, or supporting books and records.
16 For discussion of the diversity of governance structures, see paragraphs A1–A8 of NSA 260 (Revised), Communica-
tion with Those Charged with Governance.
17 Paragraphs 25–26 deal with the phrases used to express this opinion in the case of a fair presentation framework and
a compliance framework respectively.

ACRONYMS
Acronyms Full Form
ASB Accounting Standards Board Nepal
AT Accounting Technician
AuSb Auditing Standards Board Nepal
CA Chartered Accountants
CAPA Confederation of Asian and Pacific Accountants
COP Certificate of Practice
CPE Continuous Professional Education
FATF Financial Action Task Force
FCA Fellow Chartered Accountants
IAASB International Auditing and Assurance Standards Board
IAS International Accounting Standards
IASB International Accounting Standards Board
ICAN Institute of Chartered Accountants of Nepal
IFAC International Federation of Accountants
IFRS International Financial Reporting Standards
KYM Know Your Member
NAPN Nepal Auditing Practice Notes
NAS Nepal Accounting Standards
NFRS Nepal Financial Reporting Standards
NSA Nepal Standards on Auditing

AUDIT AND ASSURANCE
NSAE Nepal Standards on Assurance Engagements
NSQC Nepal Standards on Quality Control
NSRE Nepal Standards on Review Engagement
NSRS Nepal Standards on Related Services
OAG Office of Auditor General
RA Registered Auditor
SAFA South Asian Federation of Accountants
SOX Sarbanes-Oxley
UDIN Unique Documents Identification Number

IMPORTANT LINKS
S. N. Websites Organisation Names Jurisdictions

Institute of Chartered Accountants of
1. www.ican.org.np
Nepal
2. www.bsib.org.np Beema Samiti
3. www.nrb.org.np Nepal Rastra Bank
4. www.lawcommission.gov.np Nepal Law Commission
5. www.ird.gov.np Inland Revenue Department
6. www.sebon.gov.np Securities Exchange Board of Nepal
National
7. www.ocr.gov.np Company Registrar Office Nepal
8. www.mof.gov.np Ministry of Finance Nepal
Department of Labor and Occupational

9. www.dol.gov.np
Safety
10. www.moi.gov.np Ministry of Industries
11. www.standards.org.np Accounting Standards Board Nepal
12. www.ausb.org.np Auditing Standards Board Nepal
13. www.oagnep.gov.np Office of Auditor General Nepal
14. www.coso.org Committee of Sponsoring organizations
15. www.fatf-gafi.org Financial Action Task Force
International Federation of
16. www.ifac.org
International
Accountants
International Financial Reporting

17. www.ifrs.org
Standards
18. www.journalofaccountancy.com Journal OF Accountancy
International Auditing and Assurance

19. www.iaasb.org
Standards Board

AUDIT AND ASSURANCE

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Study Material

Audit and Assurance

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL

© The Institute of Chartered Accountants of Nepal

This study material has been prepared by the Institute

All rights reserved. No part of this publication may be

Price : Rs. 300/-

First : March, 2011

Second Edition : December, 2015

Third Edition : September, 2019

Designed & Printed at:

PRINCIPLES AND CONCEPT

Objectives of this Chapter:

 Definition and objective of assurance and audit

 The statutory requirement for audit

 Various types of audit in practice

 Principles governing an audit &

 What an audit is not .

 Concept of error and fraud

 Analyse the responsibility of auditor relating to fraud

 Difference between audit and investigation

 Different types of audit and relationship of auditing with other

The Institute of Chartered Accountants of Nepal 1

1.1 AUDITING AND ASSURANCE

As per Para 7 of Nepal Accounting Standard (NAS) - 01 on Presentation of Financial Statements, a

2 The Institute of Chartered Accountants of Nepal

iv. the information conveyed by the statements is clear and unambiguous;

The Institute of Chartered Accountants of Nepal 3

a. Reasonable Assurance Engagement: - The objective of a reasonable assurance engagement is

b. Limited Assurance Engagement:- The objective of a limited assurance engagement is a

The following are the elements of an assurance engagement:

A practitioner may be requested to perform assurance engagements on a wide range of

The responsible party is the person (or persons) who:

(a) In a direct reporting engagement, is responsible for the subject matter; or

1 A professional accountant in public practice

4 The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal 5

b. An appropriate subject matter;

 Financial performance or conditions (for example, historical or prospective financial

 Non-financial performance or conditions (for example, performance of an entity) for

 Behavior (for example, corporate governance, compliance with regulation, human

(b) The persuasiveness of available evidence.

An appropriate subject matter is:

6 The Institute of Chartered Accountants of Nepal

(c) Reliability: reliable criteria allow reasonably consistent evaluation or measurement of

(e) Understandability: understandable criteria contribute to conclusions that are clear,

The Institute of Chartered Accountants of Nepal 7

(c) Through inclusion in a clear manner in the assurance report.

d. Sufficient appropriate evidence; and

In a direct reporting engagement, the practitioner’s conclusion is worded directly in terms of

8 The Institute of Chartered Accountants of Nepal

In a reasonable assurance engagement, the practitioner expresses the conclusion in the

The Institute of Chartered Accountants of Nepal 9

1.2 BENEFITS OF AUDIT AND ASSURANCE

2. It acts as a moral check on the employees from committing defalcation or embezzlement.

1.3 SCOPE OF AUDIT

NSA - 200 provides the scope of audit as:

10 The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal 11

1.4 OBJECTIVES OF AUDIT AND ASSURANCE

As per NSA 200, the overall objectives of the auditor are:

12 The Institute of Chartered Accountants of Nepal

 The financial Statements do not contain any material misstatements,