AUDIT REVISION NOTES

1. OBJECTIVES OF AUDIT [BASED ON SA 200]

As per SA-200 “Overall Objectives of the Independent Auditor” in conducting an audit of financial statements,
the overall objectives of the auditors are:

a) To obtain reasonable assurance about whether financial statements as whole are free from material
misstatement; AND

b) To report on the financial statements, and communicate as required by SAs, in accordance with auditor’s
findings.

2. CONCEPT OF TRUE & FAIR

• True and fair is a fundamental concept of auditing. Primarily it is the responsibility of management of the
entity to prepare financial statement that provides true and fair view of the state of entity's affairs. As per
Companies Act, 2013 books of accounts of the company shall provide true and fair view.

• Primary responsibility of auditor is to express an opinion on true and fair view of the financial
statement. As per section 143 (2) of the Companies Act, 2013, it is the duty of auditor to report on true &
fair view of the financial statement.

• The term “true and fair", however, has not been defined in any legislation.
• It is a matter of an auditor's judgment in the particular circumstances of a case. An auditor has to see that

(a) The assets are neither undervalued nor overvalued.

(b) No material asset is omitted.

(c) The charge, if any on assets are disclosed.

(d) Material liabilities should not be omitted.

(e) The profit and loss account discloses all the material matters required to be disclosed by Part II of
Schedule III and the balance sheet has been prepared in accordance with Part I of Schedule III.

(f) Accounting policies have been followed consistently; and

(g) All unusual, exceptional or non-recurring items have been disclosed separately.

3. INHERENT LIMITATIONS OF AUDIT [BASED ON SA 200]

As per SA 200 “Overall Objectives of the Independent Auditor and the conduct of an Audit in Accordance with
Standards on Auditing”
“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”.

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The inherent limitations of an audit arise from:
Nature of financial • Preparation of financial statement involves judgment by management in
reporting applying the requirements of the entity’s applicable financial reporting framework
(FRF). For example: Accounting estimates.
• There may be subjective decisions. Moreover, auditor has to consider whether their
estimates appear to be reasonable. Evidence w.r.t. such items can only be persuasive.
Nature of Audit • There are practical and legal limitations on the auditor’s ability to obtain audit
procedures evidences.
• Management or others may not provide complete information intentionally or
unintentionally.
• Moreover, frauds may involve carefully designed to conceal it. Thus auditor
may not detect them.
• The audit is not an official investigation into alleged wrongdoing.
Accordingly the auditor is not given specific legal power.
Timelines of Financial • Users expect that the auditor will form an opinion on financial statements within
Reporting and Cost reasonable time and cost. Thus auditor resorts to test procedures (not 100%
Benefit Analysis checking). Moreover, he directs more efforts to risky areas.
Other Matters Fraud involving senior management or collusion.
Related party relationships and transactions

4. PROFESSIONAL SKEPTICISM
He should recognize the conditions indicating possible misstatements. It includes being alert to, for example:-
• Contradictory evidences
• Conditions indicating possible frauds
• Conditions questioning reliability
Moreover, it requires critical assessment of audit evidences gathered by maintaining professional skepticism,
overall risk can be reduced.

Crux: “Auditor should be a questioning mind not of suspicious mind”. Therefore he should always alert and
do not hesitate to ask any question/clarification from the management.

5. CONCEPT OF INDEPENDENCE OF AN AUDITOR

Meaning: The term independence means that the judgement of a person is not subordinate to wishes or
direction of other person who have engaged him i.e. the audit decisions should be taken without giving
importance to his personal wishes. It requires that he should not act under any influence. Thus, he can work
in a complete unbiased manner.
• The need for auditor’s independence is provided in the Standards on Auditing.
• The Companies Act, 2013 also contains specific provision to ensure auditor's independence [Section 141 of
the Companies Act, 2013]
• As per “The Chartered Accountants Act, 1949”, independence of auditor is required.

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OBJECTIVE
The main objective of an independent audit is to produce reliable financial statements. If auditor maintains
high degree of independence, credibility of financial statements is enhanced. Independent audit report will
be accepted & respected by all stakeholders. Independence of the auditor has not only to exist in fact, but also
appear to so exist to all reasonable persons.

THREATS TO INDEPENDENCE

1. Self-interest Threats: It occurs when an auditing firm, its partner or associate could benefit from a financial
interest in an audit client. It includes (i) direct financial interest or materially significant indirect financial
interest in a client, (ii) loan or guarantee to or from the concerned client, (iii) undue independence on a
client's fees and, hence concerns about losing the engagement, (iv) close business relationship with an audit
client, (v) potential employment with the client, and (vi) contingent fees for the audit engagement etc.

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

3. Advocacy Threats: It occurs when the auditor promotes, or is perceived to promote, a client's opinion to a
point where people may believe that objectivity is getting compromised, e.g. when an auditor deals with
shares or securities of the audited company or becomes the client's advocate in litigation and third-party
disputes.

4. Familiarity threats: It occurs when, because of relationships, a professional accountant becomes too
sympathetic to the client's interests. This can occur in many ways: (i) close relative of the audit team
working in a senior position in the client company. (ii) Former partner of the audit firm being a director
or senior employee of the client. (iii) Long association between specific auditors and their specific client
counterparts, and (iv) acceptance of significant gifts or hospitality from the client company, its directors
or employees.

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

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6. PRECONDITIONS FOR AN AUDIT [SA 210]
As per SA, before accepting any audit engagement, the auditor shall confirm existence of preconditions for
an audit of financial statements. As per the standard in order to establish whether the preconditions for an audit
are present the auditor shall:
(1) Determine that the financial reporting framework [FRF] to be applied in the preparation of financial statement
is acceptable.
(2) Obtain the agreement of management that it acknowledges and understands its responsibility w.r.t.
(a) Preparation of financial statement as per financial reporting framework.
(b) Internal control exists so that financial statement should be free from fraud and error.
(c) To provide the auditor with access to all information and additional information that the auditor may
request from management for audit.
(d) Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain
audit evidence.
If the preconditions for an audit are not present, the auditor shall discuss the matter with management. The auditor
shall not accept the audit engagement:
(i) If the auditor has determined that the financial reporting framework [FRF] to be applied in preparation of
the financial statement is unacceptable, or
(ii) If the management does not agree with its responsibilities as mentioned above.

7. ENGAGEMENT LETTER IN CASE OF RECURRING AUDIT [SA 210]

As per SA, it is not mandatory to send a new engagement letter in recurring audit, but sometimes it becomes
mandatory to send new engagement letter in recurring audit engagement.
Following factors may make it appropriate to send a new letter in recurring audit engagement:

(a) Any change in the senior management of the entity

(b) Any significant change in the nature of business of the entity

(c) Any significant change in ownership

(d) Any change in legal requirement

(e) Any indication that client misunderstands the objectives and scope of the audit

(f) Any change in the financial reporting framework adopted in the preparation of the financial statements.

(g) Any change in the term of engagement.

(h) Any change in reporting requirement.

8. AUDIT PLANNING – A CONTINUOUS PROCESS

Planning is not a discrete phase of an audit but rather a continuous process. It normally begins shortly after
the completion of the previous audit and continues till the completion of current audit engagement.
Planning however, includes, consideration of the timing of certain activities and audit procedures that need to
completed prior to the performance of further audit procedures.

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Such matter as:
1. The analytical procedures to be applied as risk assessment procedures.
2. Obtaining a general understanding of the legal and regulatory framework applicable to entity and how the
entity is complying with that framework.
3. The determination of materiality.
4. The involvement of experts.
5. The performance of other risk assessment procedures.
Changes to Planning decisions: The auditor shall update and change the overall audit strategy and the audit plan
as necessary during the course of the audit. The auditor may need to modify the overall audit strategy and audit
plan as a result of:
(a) unexpected events;
(b) changes in conditions;
(c) the audit evidence obtained from the result of audit procedures
Based on the revised consideration of assessed risk, auditor need to modify the nature, timing and extent of further
audit procedures. This may be the case when information comes to the auditor’s attention that differs significantly
from the information available when the auditor planned the audit procedures.
9. AUDIT PLANNING AND MATERIALITY
When planning the audit, the auditor considers what would make the financial information materially misstated.
The auditor's preliminary assessment of materiality related to specific account balances and classes of transactions
helps the auditor decide such question as what items to be examine and whether to use sampling and analytical
procedures.
Materiality:
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 amount than the materiality for the financial
statements as a whole could reasonably be expected to influence the economic decision 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.
Performance materiality:
It means the amount or amounts set by the auditor at less than the 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
material level or levels for particular classes of transactions, account balances or disclosures.
Following factors are considered by auditor for determining materiality
(a) Item of materiality may be determined individually or in aggregate.
(b) The materiality depends on the regulatory or legal consideration.
(c) Materiality is not in respect to quantitative detail only. It has qualitative dimension as well.
(d) Even insignificant item in term quality may be material in special circumstances.
(e) An item whose impact is insignificant at present, but in future it may be significant may be material item.

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 Audit Procedure

Risk Assessment Procedure Further Audit Procedure

Substantive Procedure Compliance Procedure

Test of Control

Test of Details Analytical Procedures Design

Vouching & Verification Operation

Continuity

Account Balance Transaction Presentation and Disclosure

Existence Occurrence Occurrence

Completeness Completeness Completeness

Valuation Accuracy Accuracy and Valuation

Rights & Obligation Classification Classification &

Understandability

Cut-off

10. INTERNAL CONTROL

The Process designed, implemented and maintained by
• Those charged with governance
• Management
• Other personnel
To provide Reasonable Assurance with regard to
• Reliability of financial reporting
• Effectiveness & Efficiency of operations
• Safeguarding of assets
• Compliance with applicable law & regulations

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11. RISK ASSESSMENT PROCEDURES
• Risk Assessment Procedures are used to obtain an understanding of the entity and its environment, including
its internal control in order to assess the risk of material misstatement and determine the nature extent and
timing of further audit procedures.
• Risk Assessment procedures alone do not provide audit evidence sufficient to support audit opinion.
• They are required to all financial statement audit.
SA 315 defines “Significant Risk” as an identified and assessed risk of material misstatement that in the auditor’s
judgment requires special consideration.
In exercising this 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 accounting or other development like changes in
regulatory requirement etc. and therefore requires specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;
(e) Whether the risk involves significant transactions that are outside the normal course of the entity or that
otherwise appear to be unusual.
When the auditor has determined that a significant risk exists, the auditor shall obtain an understanding of the
entity’s internal control relevant to that risk.
Audit Procedures to obtain audit evidence:
(a) Observation (b) Inspection
(c) Inquiries of management and of others within the entity (d) Analytical procedures
12. USE OF ASSERTIONS [REPRESENTATION BY MANAGEMENT]
Assertions refer to representations by management, explicit or otherwise, that are embodied in the financial
statements, as used by auditor to consider the different types of potential misstatements that may occur.
In obtaining audit evidence from substantive procedures, the auditor is concerned with the following assertions:
(a) Assertion about CLASS OF TRANSACTIONS for the period under audit:
1. Occurrence: Transactions and events that have been recorded have occurred and pertain to the entity.
2. Completeness: All the transactions and events that should have been recorded.
3. Cut Off: Whether transaction of different financial years are properly segregated.
4. Accuracy: Amounts and other data relating to recorded transactions and events have been recorded
appropriately.
5. Classification: Transaction and events have been recorded in the proper accounts.
(b) Assertions about ACCOUNT BALANCES at the period end:
1. Existence: Assets, liabilities and equity interest exist.
2. Rights and obligations: The entity holds or controls the rights to assets, and liabilities are the obligations
of the entity.
3. Completeness: All assets, liabilities and equity interest that should have been recorded.
4. Valuation: Assets, liabilities and equity interest are included in the financial statement at appropriate
amounts.

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(c) Assertions about PRESENTATION AND DISCLOURE
1. Occurrence and rights and obligations: Disclosed events, transactions and other matters have occurred
and pertain to the entity.

2. Completeness: All disclosures that should have been included in the financial statements have been
included.

3. Classification and understandability: Financial information is appropriately presented and described,

and disclosures are clearly expressed.

4. Accuracy and valuation: Financial and other information are disclosed fairly and at appropriate amounts.

13. BASIC PRINCIPLES GOVERNING AN AUDIT [BASED ON SA 200]

Ethical He shall comply with ethical requirements including independence. He is required to
Requirements comply with code of ethics issued by ICAI.

• Integrity & Objectivity: He should be straight forward and sincere in his approach to
the profession work. He should be fair without any bias or prejudice.

• Independence: He shall be independent. Thus he can form an opinion without being

affected by influences.

• Professional competence and due care: The auditor requires specialized skill and
competence which are acquire through a combination of education, technical
knowledge obtain through study and practical experience.

• Confidentiality: The auditor should not leak the information collected by him, during the
course of his professional work, to any third party without specific authority from client.

• Professional behavior: Auditor supposed to maintain professional behavior.

Professional He should recognize the conditions indicating possible misstatements. It includes being
Skepticism alert to, for example:-

• Contradictory evidences

• Conditions indicating possible frauds

• Conditions questioning reliability

Moreover, it requires critical assessment of audit evidences gathered by maintaining

professional skepticism, overall risk can be reduced.

Crux: “Auditor should be a questioning mind not of suspicious mind”. Therefore he should
always alert and do not hesitate to ask any question/clarification from the management.

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Professional It is necessary to make proper decisions during audit. For example decisions about-
Judgment • Materiality
• Audit risk
• Nature, Time and Extent of Audit Procedure
• Sufficiency & appropriateness of evidence etc.

While making professional judgement he considers level of consultation if required. It also

needs to be appropriately documented.

Sufficient & Sufficiency refers to quantum of evidence whereas appropriateness refers to its quality.
appropriate • He should consider SA 500.
audit evidence • It is required to reduce audit risk to an acceptable low level.
and audit risk • Audit risk is a technical risk. It does not include Business risk.
• It consists of risk of material misstatements and detection risk.

However, due to inherent limitations of audit, audit risk cannot be reduced to Zero.

Conduct of (a) Complying with • He shall comply with relevant SAs.

audit in SAs relevant to • An SA is relevant if it is effective and circumstances stated in
accordance the audit that SA exist.
with SAs. • The auditor shall compliance entire SA to apply it properly.
• He shall represent compliance with SAs in auditor’s report
only if he has complied with requirements of all relevant SAs.

(b) Objectives stated • He shall determine whether any additional procedure is

in individual SAs. required to fulfil the objectives stated in SA.
• He shall evaluate whether sufficient appropriate evidence has
been obtained keeping in view the objectives stated in SA.
(c) Complying with He shall comply with each requirement of a SA unless:
relevant • Entire SA is not relevant or,
requirement • Requirement is not relevant because it is conditional & the
condition is not present.
However, in exceptional circumstances, he may depart from
relevant requirement in SA. He shall perform alternative
procedures in that case.
(d) Failure to achieve In that case, he shall consider the need to
an objective in • Modify the audit report, or
relevant SAs. • Withdraw from the engagement

It is a significant matter requiring documentation as well.

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